Question

Mowasalat is considering between two alternatives for purchasing sensors to improve the monitoring of transport services in Qatar.

Alternative 1: Purchase sensors at a cost of 30 QAR per unit that can be used directly in the vehicles.

Alternative 2: It can manufacture the sensors locally at 20 QAR per unit. However, it needs to buy an electronic device today at 150,000 QAR. Labor and other operating costs are estimated to be 30,000 QAR per year over the study period of 10 years. Salvage value is estimated at 10% of first cost and interest rate is 10% per year. Using the breakeven analysis, determine which alternative Mowasalat will choose if the number of needed sensors is 5,500 each year.

Answer 1

First of all we need to calculate per year cost by both alternative

Per year cost as per alternation 1:

= 30 QAR * 5500 unit to be produced

= 165000 QAR

Per year cost as per alternation 2:

= 20 QAR * 5500 units

=110000 QAR

Now we can calculate saving due to electrical device

= Total cost if purchased - Total cost if manufactured

= 165000 - 110000

= 55000

Now, we have

Per year saving 55000 QAR.

Per year operating cost 30000 QAR, we can find net cash flow as = 55000 - 30000 = 25000, thus firm will have 25000 QAR saved every year

One time purchase of electric device 150000,

Salvage value 10% i.e. 15000 which can be realized in last year

Interest rate 10 % & year 10, we will find Pw values

Please find cash flow statement as below for 10 years

Year	Cash flow	PVIF @ 10%	PV values
0	-150000	1	-150000
1	25000	0.909	22725
2	25000	0.826	20650
3	25000	0.751	18775
4	25000	0.683	17075
5	25000	0.621	15525
6	25000	0.564	14100
7	25000	0.513	12825
8	25000	0.467	11675
9	25000	0.424	10600
10	40000*	0.386	15440
		NPV	9390

* In last year salvage value will be realized, thus added in cash flow of 10th year

NPV is positive, thus second option should be selected