3. Evaluating Alternatives You are the owner of a small earthwork construction f

Question

3. Evaluating Alternatives

You are the owner of a small earthwork construction firm and you own two scrapers. You are considering the purchase of a new scraper. Your current scraper earns you $23,000 per year and has a yearly maintenance cost of $4,100 that is increasing by $1,095 per year. The salvage value is $45,000 but that value is decreasing by $4,000 per year. You have paid off your current scraper.

Choice#1: The first new model has a cost of $195,000, is capable of earning you $55,000 per year, and has a yearly maintenance cost of $5,100, which increases by $740 every year thereafter. The salvage value for this machine is $180,000, which decreases by $18,000 every year thereafter.

Choice#2: The second model has a cost of $170,000, is capable of earning $45,000 per year, and has a yearly maintenance cost of $4,000 that increases by $950 per year thereafter. The salvage value for this machine is $158,000, which decreases in value by $14,000 each year thereafter.

If you plan to have whatever scraper you purchase for a 6-year period, which choice (current, choice#1, choice#2) is optimal? Assume a 4% APR compounded yearly

Explanation / Answer

Net profit from each current scraper is $96239 which is higher than the choice#2, but lower than choice#1. Net profit from choice#1 is $128456 and choice#2 $69745.

So, choice#2 is not acceptable.

Now I can sell any present scrapper to buy choice#1 or I can add above my present two scrapers.

a.I can add choice#1 with present scrapers which has net profit of $224695.

b. Or can sell any scrapper and use that salvage value to purchase choice#1. Then net profit$173456

So optimal choice is purchase of choice#1 in addition to present two scrappers.(option a)

Calculation to find optimal:

Current Paid 1 2 3 4 5 6 Earning 23000 23000 23000 23000 23000 23000 23000 Maintenance -4100 -5195 -6290 -7385 -8480 -9575 -10670 Salvage value 45000 41000 37000 33000 29000 25000 21000 Present value of Earning @4% 120569 22115 21265 20447 19660 18904 18177 Present vaue of Maintenance@4% -40927 -4995 -5815 -6565 -7249 -7870 -8433 Single payment presnt worth of salvage value 21000@4% 16597 total 96239 Net profit Choice#1 cost -195000 Earning 55000 55000 55000 55000 55000 55000 Maintenance -5100 -5840 -6580 -7320 -8060 -8800 Salvage value 180000 162000 144000 126000 108000 90000 Present value of Earning @4% 288318 52885 50851 48895 47014 45206 43467 Present vaue of Maintenance@4% -35990 -4904 -5399 -5850 -6257 -6625 -6955 Single payment presnt worth of salvage value 90000@4% 71128 total 323456 Net profit 128456 Choice#2 cost -170000 Earning 45000 45000 45000 45000 45000 45000 Maintenance -4000 -4950 -5900 -6850 -7800 -8750 Salvage value 158000 144000 130000 116000 102000 88000 Present value of Earning @4% 203047 43269 41605 40005 38466 36987 35564 Present vaue of Maintenance@4% -32849 -3846 -4577 -5245 -5855 -6411 -6915 Single payment presnt worth of salvage value 88000@4% 69548 total 239745 Net profit 69745

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