Question

Dodson Inc. is considering purchasing some new processing equipment. The carbon steel alternative has been quoted at $40,000 initially. It would have an eight-year life with residual salvage of $2,000. The operating costs would be $3,000 per year with a major overhaul at the end of the third and sixth years of $4,000. A more corrosion-resistant alternative to stainless steel is offered at $60,000 with a life of 12 years, an operating expense of $1,500 per year, and no major overhauls.

A) If Dodson desires an ROI of 15%, which is the better alternative? Please provide revenue information for ROI calculation.

B) Should a present worth or annual amount calculation be made?

C) Can IRR/incremental methods be used?

Answer 1

	Information given in question
	Equipment	carbon steel alternative	corrosion-resistant alternative
	cost of equipment	$40,000	$60,000
	Life of Asset in years	8	12
	Salvage value	$2,000	-
	Operating Costs	$3,000	$1,500
	overhoul expenses after 3rd and 6th year	$4,000	-
Statement showing yearly cashflows and Present value thereof
Year	carbon steel alternative		corrosion-resistant alternative
	Yearly net cashflows	Present value of cashflow	Yearly net cashflows	Present value of cashflow
0	$40,000	$40,000	$60,000	$60,000
1	$3,000	$2,609	$1,500	$1,304
2	$3,000	$2,268	$1,500	$1,134
3	$7,000	$4,603	$1,500	$986
4	$3,000	$1,715	$1,500	$858
5	$3,000	$1,492	$1,500	$746
6	$7,000	$3,026	$1,500	$648
7	$3,000	$1,128	$1,500	$564
8	$1,000	$327	$1,500	$490
9	$0	$0	$1,500	$426
10	$0	$0	$1,500	$371
11	$0	$0	$1,500	$322
12	$0	$0	$1,500	$280
Present value of cashflows		$57,168		$68,131
Equivalent Annual Cost		=($57168*0.15)/(1-1.15^-8)		=($68131*0.15)/(1-1.15^-12)
		$                        12,739.79		$                  12,568.85
A. Since the Equivalent annual cost of the Corrosion-resistant alternative is less than carbon steel alternative
hence second equipment i.e. Corrosion-resistant alternative is best.
Note: present values of yearly net cash outflows are calculated by taking discount rate of 15% (ROI)

B. Present value of cash-flows can be ascertained as explained in above above.

C. IRR can be determined when the cash inflows are also provided, in the given question IRR can not be determined.