3. A company must purchase one reactor to be used in an overall operation. Four

Question

3. A company must purchase one reactor to be used in an overall operation. Four reactors have been designed, all of which are equally capable of giving the required service. The following data apply to the four design Designl Design 2 $12,000 Design 3 $14,000 Design 4 $16,000 Fixed-Capital$10,000 Investment Sum of after-tax $3,000 operating and fixed costs per year (all other costs are constant $2,800 $2,350 $2,100 If the company demands a 15% return after taxes on any unnecessary investment, which of the four designs should be accepted?

Explanation / Answer

Answer
the life of the reactors is not given so we are going to work on infinity term or the perpetuities formula going to be used

The company should accept a project which has the lowest PW of costs
PW=inital cost+A/i
A=annual cost
i=interest rate

PW of cost of design 1
=10000+3000/0.15
=30000
PW of cost of design 2
=12000+2800/0.15
=30666.6667
PW of cost of design 3
=14000+2350/0.15
=29666.6667

PW of cost of design 4
=16000+2100/0.15
=30000

design 3 has the lowest cost so it should be accepted

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