Two methods can be used to produce solar panels for electric power generation. M
ID: 2620670 • Letter: T
Question
Two methods can be used to produce solar panels for electric power generation. Method 1 will have an initial cost of $560,000, an AOC of $170,000 per year, and $115,000 salvage value after its 3-year life. Method 2 will cost $870,000 with an AOC of $115,000 and a $170,000 salvage value after its 5-year life. Assume your boss asked you to determine which method is better, but she wants the analysis done over a three-year planning period. You estimate the salvage value of Method 2 will be 28% higher after three years than it is after five years. If the MARR is 11% per year, which method should the company select?
The company should select method 1 or method 2 ?
Explanation / Answer
Year
Method 1
Method 2
PV Factor Calculation
PV Factor @ 11 % (F)
Method 1
Method 2
Cash Flow C1
Cash Flow C2
PV = C1 x F
PV = C2 x F
0
$560,000
$870,000
1/(1+11%)^0
1
$560,000
$870,000
1
$170,000
$115,000
1/(1+11%)^1
0.900900901
$153,153
$103,604
2
$170,000
$115,000
1/(1+11%)^2
0.811622433
$137,976
$93,337
3
$55,000
($102,600)
1/(1+11%)^3
0.731191381
$40,216
($75,020)
NPC
$891,344
$991,920
Cash flow or cost for year 3 for Method 1 = Annual operating cost – salvage value
= $ 170,000 - $ 115,000 = $ 55,000
Cash flow or cost for year 3 for Method 2 = Annual operating cost – salvage value
= $ 115,000 – [$ 170,000 x (1.28)]
= $ 115,000 - $ 217,600 = - $ 102,600
As the present value of cost for Method 1 is less than Method 2 for a range of three year periods, Method 1 should be selected.
Year
Method 1
Method 2
PV Factor Calculation
PV Factor @ 11 % (F)
Method 1
Method 2
Cash Flow C1
Cash Flow C2
PV = C1 x F
PV = C2 x F
0
$560,000
$870,000
1/(1+11%)^0
1
$560,000
$870,000
1
$170,000
$115,000
1/(1+11%)^1
0.900900901
$153,153
$103,604
2
$170,000
$115,000
1/(1+11%)^2
0.811622433
$137,976
$93,337
3
$55,000
($102,600)
1/(1+11%)^3
0.731191381
$40,216
($75,020)
NPC
$891,344
$991,920
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