Code: ENGT5103 Sheet 2 of e6 Q1. a) The purchase of new office furniture for a b
ID: 1145533 • Letter: C
Question
Code: ENGT5103 Sheet 2 of e6 Q1. a) The purchase of new office furniture for a boardroom has the following two possibilities: (a) Buy modern furniture at £12000 which can be scrapped with zero salvage costs in two years. (b) Buy antique furniture at £20000 which can be sold for £13000 in two years' time. The maintenance cost for modern furniture will be £500/year whereas the cost for maintenance of the antique furniture will be £1000/year. Calculate the net present value of each possibility using the company discount rate of 12 percent. Which of the two options is better? (16 marks) b) Explain the following terms: i) Consumer Surplus in a demand curve ii) Opportunity Cost (8 marks) c) Differentiate between the following by giving examples: i) Discounted Cash Flow ii) Internal Rate of Return (9 marks)Explanation / Answer
a)
Modern Furniture
Antique Furniture
Y
Investment
Maintenance cost
Net Cash flow
Investment
Maintenance cost
Net Cash flow
0
-12000
-12000
20000
-20000
1
500
-500
1000
-1000
2
0
500
-500
13000
1000
-14000
NPV
-11,468.77
NPV
-28,619.26
b)
i) Consumer Surplus in a demand curve: It is the area above the equilibrium point of intersection between supply and demand curves. Also it is the area above the intersection of price and demand curve
ii) Opportunity cost: It is defined as the next best alternative forgone for opting a project among alternatives. Usually a bank rate or MARR is used to compare or while making decision.
c)
i) Discounted cash flow is discounting a cash flow series by a factor which would provide present value of future cash flow.
The formula used is, DCF= CF/(1+r)^n
For example an investment with NPV greater than an investment with lesser NPV is selected
ii) Internal rate of return is the return anticipated for an investment option. It is used to select projects whose IRR is more where similar investments are made. It is calculated by finding the discount rate that will make the net present value of a project to be zero
For example an investment with greater IRR is preferred over an lesser IRR for same investment
Modern Furniture
Antique Furniture
Y
Investment
Maintenance cost
Net Cash flow
Investment
Maintenance cost
Net Cash flow
0
-12000
-12000
20000
-20000
1
500
-500
1000
-1000
2
0
500
-500
13000
1000
-14000
NPV
-11,468.77
NPV
-28,619.26