6. A company is considering replacing its air conditioner. Management has narrow

Question

6. A company is considering replacing its air conditioner. Management has narrowed the choices to two alternatives that offer comparable performance and considerable savings over their present system. The effective annual interest rate is 8%. What is the net annual benefit of each system? Which one would you recommend? Initial Cost Estimated Life Salvage Value Annual Savings System $7000 15 years $500 $1500 System II $9000 15 years *- $1250 $1900 At the end of life, you have to pay someone $1250 to haul it away.

Explanation / Answer

System I System II Annual Savings 1500 1900 Annuity Present Value factor for 15 yrs at 8% 8.5595 8.5595 Present Value of Cash inflowws 12839.25 16,263 Add/ (Less): Salvage /(Haulage cost) 157.6 -394 (* PVf of 15th year i.e. 0.3152) Net Present Inflows 12996.85 15,869 Less: Initial Investment 7000 9,000 Net present value 5996.85 6,869 Divide: Annuity Factor 8.5595 8.5595 Net Annual Equivalent benefit 700.61 802.5 System II is recommended

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