Question

Use an appropriate analysis technique of your choosing to evaluate the following three mutually exclusive projects each lasting 6 years. Which project should be selected if MARR = 6%.

Project 1 involves an initial cost of $300,000 and annual costs of $50,000. The project will generate annual revenues of $110,000. At the end of year 6, the project will have a salvage value of $25,000.

Project 2 will require an initial investment of $150,000 and annual costs of $25,000. There will be no revenues in years 1-3, but years 4-6 will have annual revenues of $150,000. There is no salvage value.

Project 3 also has an initial cost of $150,000. Annual costs are 75,000, and annual revenue in year 1 is $90,000, increasing by $10,000 each year through year 6. There is no salvage value.

Use an appropriate analysis technique of your choosing to evaluate the following three mutually exclusive projects each lasting 6 years. Which project should be selected if MARR = 6%. Project 1 involves an initial cost of $300,000 and annual costs of $50,000. The project will generate annual revenues of $110,000. At the end of year 6, the project will have a salvage value of $25,000. Project 2 will require an initial investment of $150,000 and annual costs of $25,000. There will be no revenues in years 1-3, but years 4-6 will have annual revenues of $150,000. There is no salvage value. Project 3 also has an initial cost of $150,000. Annual costs are 75,000, and annual revenue in year 1 is $90,000, increasing by $10,000 each year through year 6. There is no salvage value.

Answer 1

Since all projects have equal lives, we use PW method.

(a) Project 1

Annual net benefit (NAB) = Annual revenue - Annual cost

In year 6, Annual revenue = 110,000 + 25,000 = 135,000

PW is computed as follows.

PROJECT - 1
Year	Revenue	Cost	NAB	PV Factor@6%	Discounted NAB
0		3,00,000	-3,00,000	1.0000	-3,00,000
1	1,10,000	50,000	60,000	0.9434	56,604
2	1,10,000	50,000	60,000	0.8900	53,400
3	1,10,000	50,000	60,000	0.8396	50,377
4	1,10,000	50,000	60,000	0.7921	47,526
5	1,10,000	50,000	60,000	0.7473	44,835
6	1,35,000	50,000	85,000	0.7050	59,922
				PW of NAB ($) =	12,663

(b) Project 2

Annual net benefit (NAB) = Annual revenue - Annual cost

PW is computed as follows.

PROJECT - 2
Year	Revenue	Cost	NAB	PV Factor@6%	Discounted NAB
0		1,50,000	-1,50,000	1.0000	-1,50,000
1	0	25,000	-25,000	0.9434	-23,585
2	0	25,000	-25,000	0.8900	-22,250
3	0	25,000	-25,000	0.8396	-20,990
4	1,50,000	25,000	1,25,000	0.7921	99,012
5	1,50,000	25,000	1,25,000	0.7473	93,407
6	1,50,000	25,000	1,25,000	0.7050	88,120
				PW of NAB ($) =	63,714

(c) Project 3

Annual net benefit (NAB) = Annual revenue - Annual cost

PW is computed as follows.

PROJECT - 3
Year	Revenue	Cost	NAB	PV Factor@6%	Discounted NAB
0		1,50,000	-1,50,000	1.0000	-1,50,000
1	90,000	75,000	15,000	0.9434	14,151
2	1,00,000	75,000	25,000	0.8900	22,250
3	1,10,000	75,000	35,000	0.8396	29,387
4	1,20,000	75,000	45,000	0.7921	35,644
5	1,30,000	75,000	55,000	0.7473	41,099
6	1,40,000	75,000	65,000	0.7050	45,822
				PW of NAB ($) =	38,353

(d) Decision:

Since Project 2 has highest PW, Project 2 is to be selected.