Question

Use Present Worth Analysis to determine whether Alternative A or B should be chosen. Items are identically replaced at the end of their useful lives. Assume an interest rate of 20% per year, compounded annually. Alternative A Alternative B Initial Cost 250 575 Annual Benefit 90 158 Salvage Value 100 140 Useful Life (yrs) 2 3

Answer 1

Answer:

Alternative A should be selected since its equivalent annual cost is much lower than alternative B's

Explanation:

we first must to determine the NPV of both projects and then the equivalent annual cost:

Project A

initial outlay -250

NCF year 1 = 90

NCF year 2 = 90 + 100 = 190

NPV = -43.06

equivalent annual cost = -43.06/PV annuity factor = -43.06/1.5278 = -28.18

Project B

initial outlay -575

NCF year 1 = 158

NCF year 2 = 158

NCF year 3 = 158 +140 = 298

NPV = -161.16

equivalent annual cost = -161.16/PV annuity factor = -161.16/2.1065 = -76.51