Question

Tulsa Company is considering investing in new bottling equipment and has two options: Option A has a lower initial cost but would require a significant expenditure to rebuild the machine after four years; Option B has higher maintenance costs, but also has a higher salvage value at the end of its useful life. Tulsa’s cost of capital is 11 percent. The following estimates of the cash flows were developed by Tulsa’s controller:  

	Option A			Option B
Initial investment	$	320,000		$	454,000
Annual cash inflows		150,000			160,000
Annual cash outflows		70,000			75,000
Costs to rebuild		120,000			0
Salvage value		0			24,000
Estimated useful life		8	years		8	years

Required:

Calculate NPV. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Negative amounts should be indicated by a minus sign. Round your "Present Values" to the nearest whole dollar amount.)

	Option A: Year Cash Flows PV factor Present Value 11% Initial Investment 0 Annual Cash Flows 1-8 Cost to Rebuild 4 Salvage 8 Net Present Value Option B: Year Cash Flows PV factor Present Value 11% Initial Investment 0 Annual Cash Flows 1-8 Cost to Rebuild 4 Salvage 8 Net Present Value

Answer 1

		Option A
			Year	Cash Flows	PV Factor @ 11%	Present Value
	Initial Investment	0	$       (320,000)	1	$        (320,000)
	Annual Cash Flows	1-8	$            80,000	5.146	$          411,680
	Cost to Rebuild	4	$       (120,000)	0.6587	$          (79,044)
	Salvage		8	$                     -	0.4339	$                      -
	Net Present Value				$            12,636
		Option B
			Year	Cash Flows	PV Factor @ 11%	Present Value
	Initial Investment	0	$       (454,000)	1	$        (454,000)
	Annual Cash Flows	1-8	$            85,000	5.146	$          437,410
	Cost to Rebuild	4	$                     -	0.6587	$                      -
	Salvage		8	$            24,000	0.4339	$            10,414
	Net Present Value				$            (6,176)
	As we see NPV of option A is higher so we can go with option A