A construction company is considering procuring one of two types of heavy constr

ID: 1180545 • Letter: A

Question

A construction company is considering procuring one of two types of heavy construction

equipment (A and B). Each type of equipment is expected to have a 5-year useful life

with zero salvage value. Equipment A can be purchased at a cost of $30,000, while

Equipment B would cost $55,000. The net cash flows for each type of equipment are

given below.

(a) Using the conventional payback period approach, determine which type of

equipment (A or B) the company should purchase.

(b) Consider the time value of money to be 12%. Use the benefit cost ratio approach

and determine which type of equipment (A or B) the company should procure.

YEAR A B

0 -30,000$ -55,000$

1 6,000$ 24,000$

2 6,000$ 10,000$

3 12,000$ 21,000$

4 6,000$ -7,000$

5 25,564$ 26,610$

a) payback period for A = 4 years

payback period for B = 5 years

so project A should be selected on payback criteria

b) NPV for project A = -30000 + 6000/1.12 +6000/1.12^2 + 12000/1.12^3 +6000/1.12^4 + 25564/1.12^5 = 7000.48

benefit to cost ratio for A = 7000.48/30000 = 0.23

NPV for project B = -55000 + 24000/1.12 +10000/1.12^2 + 21000/1.12^3 -7000/1.12^4 + 26610/1.12^5 = -1.5

benefit to cost ratio for B = -1.5/55000 = -0.002

so project A should be selected

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