A new line is to be installed at the First company. Two tools are being consider
ID: 1107299 • Letter: A
Question
A new line is to be installed at the First company. Two tools are being considered for the task of attaching the glass to the rest of the bulb. Given the economic information associated with each machine (shown below), which tool should be chosen purely on an economic basis. Both machines have an expected life of 10 years, and the interests rate can be assumed to be 8%.
Also, it should be noted that the tool 1 needs maintenance after 4 years and 8 years, which costs $ 2,000 for each maintenance visit. Show all analysis, answers that merely say one machine or the other will be given zero points.
tool 1 tool 2 Initial Cost Annual Benefit Scrap Value $ 40,000 8,000 $ 10,000 Initial Cost Annual Benefit Scrap Value $30,000 $7,000 $5,000Explanation / Answer
In this question, we will use NPV method to choose between the projects, the project with higher NPV will be choosen
NPV is sum of present value of all cash flows
Present value = cash flow/(1+r)n, where r is interest rate and n is number of years
r = 8%
Life of tools = 10 years
For tool 1,
Initial Cost = $40,000
Annual Benefit = $8,000
Scrap value = $10,000
Maintenance cost in year 4 and 8 = $2,000
CF0 = -$40,000 (negative sign indicates cash outflow)
Cash flow for year 1,2,3,5,6,7,9 = Annual Benefit = $8,000
Cash flow for year 4 and 8 = Annual benefit - Maintenance cost = 8000-2000 = 6000
Cash flow for year 10 = Annual benefit + Scrap value = 8000+10000 = 18000
NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ...................... + CF9/(1+r)9 + CF10/(1+r)10
NPV = -40000 + 8000/(1.08)1 + ............. + 6000/(1.08)4 + ........... + 6000/(1.08)8 + 18000/(1.08)10 = $15,761.99
For tool 2,
Initial Cost = $30,000
Annual Benefit = $7,000
Scrap value = $5,000
CF0 = -$30,000 (negative sign indicates cash outflow)
Cash flow for year 1 to 9 = Annual Benefit = $7,000
Cash flow for year 10 = Annual benefit + Scrap value = 7000+5000 = 12000
NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ...................... + CF9/(1+r)9 + CF10/(1+r)10
NPV = -30000 + 7000/(1.08)1 + ....................... + 12000/(1.08)10 = $19,286.54
NPV is higher for tool 2 so we will choose tool 2
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