In an effort to increase productivity, a corporation decides to purchase a new piece of equipment. Two models are available; both reduce labor costs. Model A costs $50,000, saves $12,000 per year in labor costs, and has a useful life of 10 years. Model B costs $42,000, saves $10,000 annually in labor costs, and has a useful life of 8 years. If the time value of money is 10% per annum, what piece of equipment provides a better investment?
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NPV of A = 12000*(1-1.1^-10)/0.1 - 50,000 = $23,734.81
NPV of B = 10000(1- 1.1^-8)/0.1 - 42000 = $11,349.26
although A appears to be the clear winner, periods differ,
so we shall take 40 years of both to make assurance doubly sure
NPV of A = 23,734.81(1-1.1^-4)/0.1 = $75,236.15
NPV of B = 11,349.26(1-1.1^-5)/0.1 = $43,022.62
A provides a better investment
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NPV of B = 10000(1- 1.1^-8)/0.1 - 42000 = $11,349.26
although A appears to be the clear winner, periods differ,
so we shall take 40 years of both to make assurance doubly sure
NPV of A = 23,734.81(1-1.1^-4)/0.1 = $75,236.15
NPV of B = 11,349.26(1-1.1^-5)/0.1 = $43,022.62
A provides a better investment
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price and quality