Question

You are considering investing RM70000 in new equipment. You estimate that the net cash flows will be RM14000 during the first year, but will increase by RM2500 per year the next year and each year thereafter. The equipment is estimated to have a 11-year service life and a net salvage value of RM4600 at that time. Assume MARR of 8%.

a.Calculate the annual capital cost CR (ownership cost) for the equipment.

b.Determine the equivalent annual savings.

c.Is this a wise investment? Y/N.

Answer 1

Initial investment = 70,000

Net Cash flow in the 1^st year = 14,000, increasing by 2,500 each year thereafter

Salvage Value = 4,600

Life = 11 years, MARR = 8%

a. Calculate the annual capital recovery cost

Capital recovery cost = Initial Cost (A/P, 8%, 11) – Salvage Value (A/F, 8%, 11)

Capital recovery cost = 70,000 (A/P, 8%, 11) – 4,600 (A/F, 8%, 11)

Capital recovery cost = 70,000 (0.1401) – 4,600 (0.0601) = 9,530.54 or 9,531

This can be also calculated by the following formula

CRC = (I – S) (A/P, 8%, 11) + S*i

CRC = (70,000 – 4,600) (0.1401) + 4,600*0.08 = 9,530.54 or 9,531

b. Determine the equivalent annual savings.        

First convert the gradient net cash flow into uniform cash flow

A = A1 + G (A/G, 8%, 11)

A = 14,000 + 2,500 (4.2395) = 24,598.75 or 24,599

Now calculate equivalent annual savings

EAS = -70,000 (A/P, 8%, 11) + 24,599 + 4,600 (A/F, 8%, 11)

EAS = -70,000 (0.1401) + 24,599 + 4,600 (0.0601)

EAS = 15,068

c. Is this a wise investment? Y/N.

Yes. This is a wise investment.