Problem 1 (14 points) Compare the following alternatives using an interest rate
ID: 2798885 • Letter: P
Question
Problem 1 (14 points) Compare the following alternatives using an interest rate of 12% compounded monthly answering the following questions, Project C can be replaced with a similar item with the same cash flows every 10 years: Project C $80,000 1,500 Project D $70,000 2,000 Initial cost Monthly O&M; costs Salvage value Useful life (years) 1,000 10 a. What is the decision criterion? (2 pts) b. Choose the best project. (8 pts) Bonus: What is the effective annual interest rate? (3 pts) Remember to clearly show the cash flow diagram(s) and the necessary equivalent model(s). (4 pts)Explanation / Answer
1. The decesion createria is the Present value of monthly cost along with the initial cost and selecting the project which has the lowest cost
2. Project C: Present value of monthly costs =pv(rate,nper,pmt,fv) =pv(0.12/12,120,1500,0,0) = 104,550.78
Present worth of salvage value = pv(0.12/12,120,0,1000) = 302.99
Net PV of costs for first 10 years = 104,550.78 + 80,000 -302.99 = 184,247.79
This happens every ten years = 184,247.79 +184,247.79/ (1+ 1.20) = 267,996.79
PV of costs for Project C = 267,996.79
PV of costs for Project D = 2000/0.01 = 200,000 + 70,000 = 270,000
Since Project C has lower costs, Project C is better
Bonus question: Effective annual interest rate= (1+0.12/12)^12 -1 0.1268 = 12.68%
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