8) (25 points) A manufacturing company is considering the purchase of an existin
ID: 2617331 • Letter: 8
Question
8) (25 points) A manufacturing company is considering the purchase of an existing building for its new facility and has narrowed its choices to two buildings that are available for purchase. The company expects to operate this new facility for a 10-year period. Building A has an operating and maintenance (O&M;) cost of $100,000 for year one with the annual O&M; costs for the subsequent years increasing by $10,000 per year. Building B has an O&M; cost of $95,000 for year one with the annual O&M; costs for the subsequent years increasing by 10% per year. Calculate the present value of the O&M; costs for buildings A and B if the TVOM is 10% per year compounded annually. Based on your calculations, which building has lower O&M; costs over the 10-year period?Explanation / Answer
Building A:
Operations and Maintenance Cost in Year 1 = $ 100000
O&M cost increases by $ 10000 per annum over a 10 year period.
Interest Rate = 10 % per annum
Present Value of O&M Costs = 100000 / (1.1) + 110000 / (1.1)^(2) + 120000 / (1.1)^(3) + 130000 / (1.1)^(4) + 140000 / (1.1)^(5) +150000 / (1.1)^(6) + 160000 / (1.1)^(7) + 170000 / (1.1)^(8) + 180000 / (1.1)^(9) + 190000 / (1.1)^(10) = $ 843370.13
Building B:
O&M cost in year 1 = $ 95000
O&M Cost increases at a rate of 10 % per annum and interest rate is 10 % per annum
Therefore, Present Value of O&M Costs = 95000 / (1.1) + 95000 x (1.1) / (1.1)^(2) + 95000 x (1.1)^(2) / (1.1)^(3) +.........................+ 95000 x (1.1)^(9) / (1.1)^(10) = (10 x 95000) / (1.1) = $ 863636.36
As is observable, building A has a lower O&M Cost over the 10 year period.
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