Question

A currently-owned shredder for use in a refuse-powered electrical generating plant has a present net realizable value of $200,000 and is expected to have a market value of $10,000 after 4 years. The shredder was purchased for $500,000 10 years ago. Operating and maintenance disbursements are $100,000 per year. An equivalent shredder can be leased for $200 per day plus $80 per hour of actual use as determined by an hour meter, with both components assumed to be paid at the end of the year. Actual use is expected to be 1,500 hours and 250 days per year. Using a 4 year planning horizon, a before tax analysis, and a MARR of 15%, determine the preferred alternative using the annual cost criterion:

Please show cash flow diagram and do not use excel functions.

a. Consider only the above information and use the cash flow approach (insider´s viewpoint approach).

b. Consider the additional information that the annual cost of operating without a shredder is $150,000 and use the cash flow approach (insider´s viewpoint approach). Hint: this is an extra challenger.

c. Consider only the original information and use the opportunity cost approach (outsider´s viewpoint approach).

d. Consider the additional information that the annual cost of operating without a shredder is $150,000 and use the opportunity cost approach (outsider´s viewpoint approach). Hint: this is an extra challenger.

Answer 1

Part a:

In this part, cash flows under both the alternatives are identitied and discounted at MART = 15%.

Since the cost of owning and operating the shredder is lesser as compared to that of leasing the shredder, hence owning the shredder should be preferred.

Note: Depriciaition of shredder is considered in the analysis since depriciation is an implicit cost of owning the asset

Part B:

While looking at the cash flows, it is still desirable to have shredder owned since the cost are minimum.

Part C:

Assumption:

• The scrapper was sold and the $200,000 was invested at MARR @ 15%

The opportunity cost of holding the scrapper is the interest income forgone by investing on some other oppotunity.

After considering the impact of opportunity cost, below is the analysis:

As per the analysis, after considering the impact of opportunity cost leasing the shredder is more economical.

Part 4:

Taking the impact of opportunity cost in case of not using the shredder:

Not using the shredder in the operation is the most economical.