Question

•Burnout Batteries

•Initial Cost = $36 each

•3-year life

•$100 per year to keep charged

•Expected salvage = $5

•Straight-line depreciation

•Long-lasting Batteries

•Initial Cost = $60 each

•5-year life

•$88 per year to keep charged

•Expected salvage = $5

•Straight-line depreciation

The machine chosen will be replaced indefinitely and neither machine will have a differential impact on revenue. No change in NWC is required.

The required return is 15%, and the tax rate is 34%.

Which battery should be chosen?

Answer 1

	Burnout batteries(Mach.A)	Long last. batt.(Mach.B)
Initial Cost Life Keep up charges Expected salvage value Dep method , SL dep.	$36 each 3 yr $100 $5 ($36-$5)/3 = $ 10.33	$60each 5 yr $88 $5 ($60-$5)/5 = $ 11

	Mach.A(burnout)	Mach.B(longlife)
Initial cost plus keep up charges Dep. Total cost Running cost of mach per year Cumulative PV factor for mach.A for 1-3 yrs @15%* Cumulative PV factor for mach.A for 1-5 yrs @15%* PV of Running cost of mach's(1) PV of Salvage value at the year end(2) Total PV of Running cost of mach's(1+2) Equivalent annual PV of Cash outflows	$136 $10.33 $146.33 (146.33/3) =$48.77 2.2825 $111.317 $3.28 $114.597 114.597/2.2825 = $50.206	$148 $11 $159 (159/5) =$31.8 3.35197 $106.59 $5*.4977=$2.48 $109.07 109.07/3.35197 =$35.53

Battery with long ife should be chosen as it has lower cash outflows as compared to the burnout one.

* For calculating PV factor = 1/(1+r)^n

where r= rate of return

n = time period

Note that *

PV of Salvage value of Mach.A will be at the end of 3yrs, and of Mach.B will be at the end of 5 years

* Also sorry for diff. spacing in table!! Hope you understand.