after the annual operating costs and maintenance costs are paid) is $1000. Deter

Question

after the annual operating costs and maintenance costs are paid) is $1000. Determine the present value of the equipment. Assume an interest rate of 8%.

Problem 2: A phone company is expanding their facilities to serve a new manufacturing plant. The new plant will require 2000 phone lines this year, and another 2000 lines after expansion in 10 tears. The plan will operate for 30 years. The phone company has two options.

Option 1: Provide one cable now with the capacity to serve all 4000 lines. The cable will cost $20,000 and will have annual maintenance costs of $1500.

Option 2: Provide a cable with capacity to serve 2000 lines now and a second cable to serve the other 2000 lines in ten years. Each cable will cost $15,000 and will have annual maintenance of $1000 per cable.

Assuming a MARR of 10%, determine:

A) which alternative should be selected

B) if the demand for the additional 2000 lines occurs after five years (instead of ten) which alternative should be chosen

Explanation / Answer

2.

A.

R = 10%

Option 1:

Present value of all the cost = 20000 + 1500*(1-1/1.1^30)/.1 = $34140.37

Option 2:

Present value of all the cost = 15000 + 1000*(1-1/1.1^30)/.1 + 15000/1.1^10 + (1000*(1-1/1.1^20)/.1)*(1/1.1^10)

Present value of all the cost = $33492.41

Since the option 2 has lower present value of the cost ($33492.41) in comparison to the option 1 ($34140.37), then option 2 should be selected.

B.

If demand of additional 2000 lines, occur after 5 years,

Then,

Present value of total cost for option 2 = 15000 + 1000*(1-1/1.1^30)/.1 + 15000/1.1^5 + (1000*(1-1/1.1^25)/.1)*(1/1.1^5)

Present value of all the cost = $39376.86

Now, the option 2 has higher cost than that of option 1, then option 1 should be selected.

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