A Project manager would like to select the more economical of two alternatives f
ID: 2644885 • Letter: A
Question
A Project manager would like to select the more economical of two alternatives for an excavation dust control. Help the project manager evaluate and select the proper alternative knowing that the estimated MARR = 12% per year.
Equipment
Option 1
Option 2
Initial Cost $
40,000
75,000
Annual Operating Cost (AOC), $ per year
25,000
15,000
Life, years
4
6
Salvage value, $
10,000
7,000
Equipment
Option 1
Option 2
Initial Cost $
40,000
75,000
Annual Operating Cost (AOC), $ per year
25,000
15,000
Life, years
4
6
Salvage value, $
10,000
7,000
Explanation / Answer
Option 1
Initial cost = 40,000
AOC = 25,000
Annual depreciation = (Cost - Salvage Value) / Life = (40,000 - 10,000) / 4 = 7,500 per year (assuming straight-line depreciation)
So annual total cost = 32,500 per year for 4 years
PV of 32,500 per year for 4 years (at MARR 12%) = 32,500 (1 + 0.8929 + 0.7972 + 0.7118) = 110,562
So Net Present Value = 40,000 - 110,562 = -70,562
Option 2
Initial cost = 75,000
AOC = 15,000
Annual depreciation = (Cost - Salvage Value) / Life = (75,000 - 7,000) / 6 = 11,333 per year (assuming straight-line depreciation)
So annual total cost = 26,333 per year for 6 years
PV of 26,333 per year for 6 years (at MARR 12%) = 26,333 (1 + 0.8929 + 0.7972 + 0.7118 + 0.6355 + 0.5674) = 121,259
So Net Present Value = 75,000 - 121,259 = -46,259
Thus, the discounted net cost is lower for Option 2 (46,259) compared to Option 1 (70,562).
Therefore Option 1 should be preferred.