Question

A purchasing agent plans to buy some new equipment for the mailroom. Two manufacturers have provided bids. An analysis shows the following: For STAR company, the initial cost is $1500 and the salvage value is $200. For Mature Supplies, the initial cost is $1600 and the salvage value is $325. The useful life is 5 years for both companies' equipment. For a 5-year analysis period, which manufacturer's equipment should be selected? Assume 7% interest and equal maintenance costs.

Answer 1

The maintenance cost for the equipment is same for both the manufacturers.

So, maintenance cost is not relevant in analysis of which manufacturer's equipment should be selected.

The net present worth method (taking into account initial cost and salvage value) would be used for choice of selection of alternative.

Alternative 1 - Star Company

Initial cost = $1500

Salvage value = $200

Analysis period = 5 years

Interest rate = 7%

Calculate the net present worth -

NPW = -Initial cost + Present worth of salvage value

NPW = -1500 + [200/(1 + 0.07)⁵]

NPW = -1500 + [200/1.40255]

NPW = -1500 + 142.60

NPW = -1357.40

Thus,

The net present worth of the equipment provided by Star Company is $ -1,357.40

Alternative 2 - Mature Supplies

Initial cost = $1600

Salvage value = $325

Analysis period = 5 years

Interest rate = 7%

Calculate the net present worth -

NPW = -Initial cost + Present worth of salvage value

NPW = -1600 + [325/(1 + 0.07)⁵]

NPW = -1600 + [325/1.40255]

NPW = -1600 + 231.72

NPW = -1,368.28

Thus,

The net present worth of the equipment provided by Mature Supplies is $ -1,368.28

It can be seen that net present worth of the equipment provided by Star Company is numerically higher.

Thus,

Star Company's equipment should be selected.