A company has to buy a new gadget maker and must choose between 2 options. The...

A company has to buy a new gadget maker and must choose between 2 options.

The first gadget maker costs $400,000, and will need maintenance of $225,000 at the end of the fifth year. The salvage value after 10 years will be $175,000.

The second option costs $250,000 and will require annual maintenance of $30,000 each year for 10 years. At the end of 10 years, the salvage value will be $75,000.

Which gadget maker should the firm select if interest is 8.5% compounded annually?

*Can you please show formulas used.

Expert Solution

Calculation of Present Worth of Gadgets
Year	First Gadget	Second Gadget
Cash Flows	Discount Factor @8.5%	Discounted Cash Flows	Cash Flows	Discount Factor @8.5%	Discounted Cash Flows
A	B	C = 1/(1+8.5%)^A	*D = BC**	E	F = 1/(1+8.5%)^A	*G = EF**
0	-400000	1	-400000	-250000	1	-250000
1	0	0.921658986	0	-30000	0.921658986	-27649.76959
2	0	0.849455287	0	-30000	0.849455287	-25483.6586
3	0	0.782908098	0	-30000	0.782908098	-23487.24295
4	0	0.721574284	0	-30000	0.721574284	-21647.22853
5	-225000	0.665045423	-149635.2202	-30000	0.665045423	-19951.3627
6	0	0.612945091	0	-30000	0.612945091	-18388.35272
7	0	0.564926351	0	-30000	0.564926351	-16947.79052
8	0	0.520669448	0	-30000	0.520669448	-15620.08343
9	0	0.479879675	0	-30000	0.479879675	-14396.39026
10	175000	0.442285415	77399.94763	45000	0.442285415	19902.84368
PW			-472235.2726			-413669.0356
PW of First Gadget is -$472,235.27
PW of Second Gadget is -$413,669.04
Therefore, it is better to choose second gadget since PW of second gadget is lower than PW of first gadget

jeff jeffy answered 1 year ago

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