Question

Veritas Inc. has decided to acquire a new Hydraulic Excavator. It has three options.

Caterpillar: purchase cost of $356609 and operating costs of $20439 per year (paid at the end of each year).

John Deere: purchase cost of $280828 and operating costs of $24980 per year (paid at the end of each year).

Volvo: purchase cost of $311464 and operating costs of $18932 per year (paid at the end of each year).

Assume that Geek Inc. has a budget of $337082 for this investment and all excavators have a service life of 12 years. Based on the defender-challenger approach and given that the MARR is 9%, reinvestment rate is 8%, and minimum external rate of return is 10%, compute the incremental Benefit-Cost ratio of choosing the best excavator (in economic terms) and then indicate your recommendation as follows: - answer “0” (without the commas) if your recommendation is the Caterpillar; - answer “1” (without the commas) if your recommendation is the John Deere; - write down as your answer the value of the incremental B-C ratio if your recommendation is Volvo.

PLEASE INCLUDE STEPS AND FORMULAS.

Answer 1

Since this is Best Buy Option we will have to calculate NPV of the Cash Outflow

NPV = Cash Outflow + (Cash flow in year n)/(1+Rate of discount)^No of Periods

For Caterpillar Cash flow is as below:

year	0	1	2	3	4	5	6	7	8	9	10	11	12
cost	-    $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $	20,439 $
investment	356,609 $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $
net value	(356,609) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $	(20,439) $
discount factor (@ 10%	1.00	0.92	0.84	0.77	0.71	0.65	0.60	0.55	0.50	0.46	0.42	0.39	0.36
present value	(356,609) $	(18,751) $	(17,203) $	(15,783) $	(14,480) $	(13,284) $	(12,187) $	(11,181) $	(10,258) $	(9,411) $	(8,634) $	(7,921) $	(7,267) $
NPV	(502,967) $

For John Deere

year	0	1	2	3	4	5	6	7	8	9	10	11	12
cost		24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $	24,980 $
investment	280,828 $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $
net value	(280,828) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $	(24,980) $
discount factor	1.00	0.92	0.84	0.77	0.71	0.65	0.60	0.55	0.50	0.46	0.42	0.39	0.36
present value	(280,828) $	(22,917) $	(21,025) $	(19,289) $	(17,696) $	(16,235) $	(14,895) $	(13,665) $	(12,537) $	(11,501) $	(10,552) $	(9,681) $	(8,881) $
NPV	(459,703)

For Volvo

year	0	1	2	3	4	5	6	7	8	9	10	11	12
cost		18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $	18,932 $
investment	311,464 $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $	-    $
net value	(311,464) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $	(18,932) $
discount factor	1.00	0.92	0.84	0.77	0.71	0.65	0.60	0.55	0.50	0.46	0.42	0.39	0.36
present value	(311,464) $	(17,369) $	(15,935) $	(14,619) $	(13,412) $	(12,305) $	(11,289) $	(10,356) $	(9,501) $	(8,717) $	(7,997) $	(7,337) $	(6,731) $
NPV	(447,031) $

Since the budget is $337082 Caterpillar is not qualifying for the Cost benefit analysis

In above case lowest ration should qualify as it is comarisions of costs vs costs

Incremental cost benefit analysis (ICBA) = NPV of Annual cost/Purchase price of equipment

For John Deer ICBA = 178875/280828 = 0.64

For Volvo ICBA = 135567/311464 = 0.44

and Hence Volvo with Lowest Incremental ratio of 0.44 is best option for purchase