Question

An American multinational company is now considering two mutually exclusive alternatives for the environmental protection equipment at its manufacturing plant in the United Kingdom. One of these alternatives must be selected. The estimated cash flows for each alternative are listed in the below table.

	Alternative A	Alternative B
Capital investment	£ 20,000	£ 38,000
Annual expenses	£ 5,500	£ 4,000
Market value at end of useful life	£ 1,000	£ 4,200
Useful	5 years	10 years

Assume that the equipment will be needed indefinitely and the firm’s MARR relative to British pound (GBP) is 20% per year.

Suppose the study period is shortened to five years.

Assuming the market value of Alternative B after five years is £35,000, which alternative would you recommend? Use 4 decimal places of the compound interest factors to do the calculation. Show detailed steps of your analysis.

Answer 1

Answer:-

A) Alternative A present value will be the total of the following i.e 20,000 will be the initial capital investment and present value of the annual expense of 5,500 for 5 years and market value at the end of useful life

Present value of 5,500 annual expense for 5 years @20% the formulat will be = 5,500 /(1+.20)+5,500/(1+.20)2+5,500/(1+.20)3+5,500/(1+.20)4+5,500/(1+.20)5=16,450.50

Present value of the investement =-20,000-20,850.50+1000(1+.20)5=-20,000-16,448.3+401.9=-36,046.40

Alternative B = -38,000-4,000(1+.20)-4,000(1+.20)2+4,000(1+.20)3-4,000(1+.20)4-4,000(1+.20)5-4,000(1+.20)6-4,000(1+.20)7-4,000(1+.20)8-4,000(1+.20)9-4,000(1+.20)10+4,200(1+.20)10=-38,000-16,768+4,200*0.1615=-38,000-16,770+678.30=-54,091.70

Alternative A= Net present value/ Present value of future annuities= -36,046.4/2.9906=-12,053.23

Alternative B= -54,091.70/4.1925=-12,902.01

Since the Alternative A has lower cost hence it should be chosed

b) If the study period is reduced to 5 year and market value is 35,000 pound then the present value of Alternative B would be as follows

-38,000-4,000(1+.20)-4,000(1+.20)2+4,000(1+.20)3-4,000(1+.20)4-4,000(1+.20)5+35,000(1+.20)5=-38,000-11,962.40+14,066.50=35,895.90

Alternative B =-35,895.90/2.9906=-12,002.90

Alternative B should now be considered as it has lower cost as compared to Alternative A.