Question

A company is looking at investing in a process upgrade. The first option would cost $12,000, with net annual benefits of $2000, and a salvage value of $1000 after 8 years. The second option would cost $20,000, with net annual benefits of $2800, and a salvage value of $4000 after 12 years. The company’s MARR is 8%.

A) Determine the Payback Period for each option.

B) Which alternative should be chosen using the payback period?

C) Determine the NPW of each option.

D) Which alternative should be chosen using the NPW method?

E) Which method would you recommend using to make your decision? Briefly discuss your reasoning…

Answer 1

REQ A:

Payback period:

Option-1: Initil investment / Annual cash inflows = 12000 /2000 = 6 years

Option -2:

20,000 /2800 = 7.14 years

Req B:

Option-1 shall be choosen, as having low payback period.

Req C:

Present value of Annual inflows($ 2000* Annuity factori.e. 5.7466)

11493.2

Present value of salvage value ($ 1000 * PVF i.e. 0.5403)

540.3

Less: Initial investment

-12000

Net present value of Option-1

33.5

Present value of Annual inflows($ 2800* Annuity factori.e. 7.536)

21100.8

Present value of salvage value ($ 4000 * PVF i.e. 0.0.3971)

1588.4

Less: Initial investment

-20000

Net present value of Option-2

2689

Req D:

Option-2 shall be recommended

Req E: In my view, Option-2 shall be recommended.

This is due to fact, though the payback period of Option-1 is low, the pst payback profitability of Option-2 is higher then Option-1