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Two methods can be used to produce expansion anchors. Method A costs $70,000 initially and will have a $19,000 salvage value after 3 years. The operating cost with this method will be $29,000 in year 1, increasing by $3800 each year. Method B will have a first cost of $109,000, an operating cost of $9000 in year 1, increasing by $9000 each year, and a $39,000 salvage value after its 3-year life. At an interest rate of 9% per year, which method should be used on the basis of a present worth analysis?

Sagot :

Answer:

Method B should be used on the basis of a present worth analysis.

Explanation:

Given - Two methods can be used to produce expansion anchors.

              Method A costs $70,000 initially and will have a $19,000

              salvage value after 3 years. The operating cost with this method

              will be $29,000 in year 1, increasing by $3800 each year.

              Method B will have a first cost of $109,000, an operating cost of  

              $9000 in year 1, increasing by $9000 each year, and a $39,000

              salvage value after its 3-year life.

To find - At an interest rate of 9% per year, which method should be used

              on the basis of a present worth analysis?

Proof -

Method A :

Year          Initial                Cash         Net cash     Discount         Present value

                 Investment       Outflow         flow            rate

0                70,000              -                   70,000         1                  70,000

1                                           29,000        29,000         0.917          26,593

2                                          32,800         32,800         0.842         27,617.6         3               -19,000               36,600         17,600          0.772         13,587.2      

                                              Present Worth                                  $137,797.8

Method B :

Year          Initial                Cash         Net cash     Discount         Present value

                 Investment       Outflow         flow            rate

0                109,000              -                109,000         1                  109,000

1                                            9,000          9,000         0.917             8253

2                                           18,000         18,000        0.842            15,156          

3               -39,000               27,000        -12,000       0.772            -9,264                                                              Present Worth                               $123,145

∴ we get

Present Worth of A = $137,797.8

Present Worth of B = $123,145

Now,

As the present worth is low in Method B, so Method B should be used.

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