Question

CHAO HYE Ltd wants to buy an automated packaging system to fill orders. There are two models to choose from: Model A and Model B. Both models do the same job and have identical capacities (identical revenue). Annual operating and maintenance (O&M) costs are $5,000 for Model A and $4,000 for Model B. Model A costs $12,500 to buy, is semi-automatic, and will last for three years after which the seller will buy it back for $2,000. Model B costs $15,000 to buy, is fully automatic, and will last for four years after which the seller will buy it back for $1,500. CHAO HYE Ltd plans on using the automated packaging system indefinitely. Assume none of the prices or costs change for any replacement machines. CHAO HYE Ltd has a MARR = 15%.

Using net present value analysis, determine which is the better choice to buy: Model A or Model B. Show all workings clearly to get full marks.

Answer 1

MARR = 15%

analysis will be carried for 12 yrs (LCM of 3 & 4)

Model A will be bought four times at EOY 0, EOY 3, EOY 6 & EOY 9

Model B will be bought three times at EOY 0, EOY 4 & EOY 8

PW of model A = -12500 - 5000*(P/A,15%,12) - (12500 - 2000)*(P/F,15%,3) - (12500 - 2000)*(P/F,15%,6) - (12500 - 2000)*(P/F,15%,9) + 2000*(P/F,15%,12)

= -12500 - 5000*(P/A,15%,12) - 10500*(P/F,15%,3) - 10500*(P/F,15%,6) - 10500*(P/F,15%,9) + 2000*(P/F,15%,12)

= -12500 - 5000*5.420619 - 10500*0.657516 - 10500*0.432328 - 10500*0.284262 + 2000*0.186907

= -53657.40

PW of model B = -15000 - 4000*(P/A,15%,12) - (15000 - 1500)*(P/F,15%,4) - (15000 - 1500)*(P/F,15%,8) + 1500*(P/F,15%,12)

= -15000 - 4000*(P/A,15%,12) - 13500*(P/F,15%,4) - 13500*(P/F,15%,8) + 1500*(P/F,15%,12)

= -15000 - 4000*5.420619 - 13500*0.571753 - 13500*0.326902 + 1500*0.186907

= -48533.96

As the present cost of model B is less, it should be selected