Question

economics problem

"Motors R Us requires a specific painting process for one its automobiles that will be manufactured for exactly eight years. Three options are available. Neither option 2 nor option 3 can be repeated after its process life. However, option 1 will always be available at the same cost during the period of eight years. Here are the options:
-Option 1 is to subcontract out the process at a cost of $100,000 per year.
-Option 2 costs $176,000 immediately and has annual operating and labor costs of $93,000 and a useful service life of eight years with a salvage value of $55,000.
-Option 3 costs $114,000 immediately and has annual operating and labor costs of $79,000 and a useful service life of five years with a salvage value of $17,000. For years six through eight, the firm will follow option 1.
Enter the ""net present cost"" for the option that you would recommend if i = 14.6%. Enter your answer as positive number."

Answer 1

Ans1 . The net present cost will be calculated taking the same format as the net present value is calculated, which is inflow-outflow.

Each option will be considered and based on the cost flow the best option will be considered.

		Option 1
Year	1	2	3	4	5	6	7	8
Cost	$          (100,000)	$             (100,000)	$             (100,000)	$             (100,000)	$             (100,000)	$             (100,000)	$             (100,000)	$             (100,000)
Interest	14.60%
Present Value year wise	$87,260.03	$76,143.14	$66,442.53	$57,977.77	$50,591.42	$44,146.10	$38,521.90	$33,614.22
Total	$454,697.11

With option 1 the total cost ciming upto $454,697.11

Option 2

The salvage value is the inflow (in this case it is cosnidered negative). The vost of 176,000 is considered at 0 year.

			Option 2
Year	0	1	2	3	4	5	6	7	8
Cost	$                             (176,000)	$             (93,000)	$               (93,000)	$               (93,000)	$               (93,000)	$               (93,000)	$               (93,000)	$               (93,000)	$               (93,000)
Inflow									$                 55,000
Interest	14.60%
Present Value of cost year wise	$176,000.00	$81,151.83	$70,813.12	$61,791.55	$53,919.33	$47,050.03	$41,055.87	$35,825.37	$31,261.23
Present value of salvage value	($18,487.82)
Total prsent value of cost	$598,868.31
Total present value of cost net salvage value	$580,380.49

The total value of cost net salvage vlaue is $580,380.49

Option 3

			Option 3
Year	0	1	2	3	4	5	6	7	8
Cost	$                             (114,000)	$             (79,000)	$               (79,000)	$               (79,000)	$               (79,000)	$               (79,000)	$             (100,000)	$             (100,000)	$             (100,000)
Inflow						$                 17,000
Interest	14.60%
Present Value of cost year wise	$114,000.00	$68,935.43	$60,153.08	$52,489.60	$45,802.44	$39,967.23	$44,146.10	$38,521.90	$33,614.22
Present value of salvage value	($8,600.54)
Total prsent value of cost	$497,629.98
Total present value of cost net salvage value	$489,029.44

The cost net of salvage value coming is $489,029. Becuase the salvage value is at 5th year, and the higher cost of 100,000 is at last two years, the present value is also less.

Out of all the three options the first has the least net present value of the cost, because of the subcontract option and it does not include any heavy immideate cost like the other two options has. The options 3 is second best becuase of the less amount of immediate cost, and salvage vlaue comig at the fifth year.