a. (10) Based on a present worth analysis with an interest rate (MARR) of 6% wha

Question

a. (10) Based on a present worth analysis with an interest rate (MARR) of 6% what is the most economically attractive option? What is the present worth of each option over the analysis period?

b. (10) Calculate the incremental rate of return ?IRR for these two options. At a MARR of 6%, which of these two options is the most economically attractive option? Briefly explain why.

Initial cost Annual operating & maintenance cost Annual revenue Salvage value Useful life Option A $13000 $2000 $2500 $4000 12 years Option B $5000 $2000 $2500 $1000 4 years

Explanation / Answer

NPV= present value of net cash flow of the investment cycle

I am assumign there is no tax

Option A:

Net cash flow= -initial cost+cash flow from operating activites( 1 to 12 years)+present value of Salvage value
Cash flow from operating activites= net income+depreciation
=2500-2000-(13000/12)+(13000/12)
=500
=13000+(500/1.06^1)+(500/1.06^2)+(500/1.06^3)+(500/1.06^4)+(500/1.06^5)+(500/1.06^6)+(500/1.06^7)+(500/1.06^8)+(500/1.06^9)+(500/1.06^10)+(500/1.06^11)+(500/1.06^2)+(4000/1.06^12)
=$-6263.39

Option B:
=-5000+(500/1.06^1)+(500/1.06^2)+(500/1.06^3)+(500/1.06^4)+(1000/1.06^4)
=-2457.354

We can see that option B has low cost and so it should be prefereed.

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