Question

You are evaluating two different manufacturing work cells to produce a specific product for your company. You will make this product for 6 years. Work Cell 1: This work cell costs $275,200 and has a $21,000 salvage value at the end of six years. Annual operating costs are $28,000 and annual profits generated are $123,000. Work Cell 2: This work cell costs $226,300 and has no salvage value at the end of six years. Annual operating costs are $34,000 and annual profits generated are $117,000. Your company minimum attractive rate of return is 13%.

a) If your company requires net present worth analysis, calculate the net present worth of each alternative and state which alternative you recommend and why.

b) If you company requires annual equivalent worth analysis, calculate the annual equivalent worth of each alternative and state which alternative you recommend and why.

c) Are your recommendations for (a) and (b) the same or different, and explain why.

Answer 1

	Cell 1	Cell 2
Initial Cost	275,200	226,300
Salvage Value	21,000	Nil
Annual Operating Cost	28,000	34,000
Annual Profit	123,000	117,000
Life	6 years	6 years
MARR	13%	13%

a. Calculate Present Worth of each cell.

Present Worth of Cell 1

PW = -275,200 + (123,000 – 28,000) (P/A, 13%, 6) + 21,000 (P/F, 13%, 6)

PW = -275,200 + 95,000 (P/A, 13%, 6) + 21,000 (P/F, 13%, 6)

PW = -275,200 + 95,000 (3.99755) + 21,000 (0.48032) = 114,653.97 or 114,654

Present Worth of Cell 2

PW = -226,300 + (117,000 – 34,000) (P/A, 13%, 6)

PW = -226,300 + (83,000) (P/A, 13%, 6)

PW = -226,300 + (83,000) (3.99755) = 105,496.65 or 105,497

Recommend the Cell 1 as it has highest PW.

b. Calculate the Annual Worth

AW = PW (A/P, 13%, 6)

AW of Cell A = 114,654 (A/P, 13%, 6)

AW of Cell A = 114,654 (0.25015) = 28,681

AW of Cell B = 105,497 (A/P, 13%, 6)

AW of Cell B = 105,497 (0.25015) = 26,390

Recommend the Cell 1 as it has highest Annual Worth.

c) Are your recommendations for (a) and (b) the same.

Yes. The recommendations will be same. A particular project or alternative that is accepted in the Present Worth method cannot be rejected in the annual worth method. Since the annual worth method just spreading the present worth into number of years or life of the project, the answer will not vary. In this question in the present worth method we selected the Cell 1. This otherwise means that in the annual worth method also we have to select the Cell 1.