Two mutually exclusive alternatives are being considered for the environmental protection equipment at a petroleum refinery. One of these alternatives must be selected. a. Which environmental protection equipment alternative should be selected? The firm's MARR is 2020% per year. Assume the equipment will be needed indefinitely. Assume repeatability is appropriate for this comparison. b. Assume the study period is shortened to five years. The market value of Alternative B after five years is estimated to be $17 comma 00017,000. Which alternative would you recommend? Assume repeatability is appropriate for this comparison.

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Question:

Two mutually exclusive alternatives are being considered for the environmental protection equipment at a petroleum refinery. one of these alternatives must be selected. the estimated cash flows for each alternative are as follows:

ALTERNATIVE A:

capital investment= $20,000

annual expenses= $5,500

market value at end of useful life= $1,000

useful life= 5 years

ALTERNATIVE B:

capital investment= $38,000

annual expenses= $4,000

market value at end of useful life= $4,200

useful life= 10 years

a) Which environmental protection equipment alternative should be selected? the firms MARR is 20% per year. assume the equipment will be needed indefinitely

b) Assume the study period is shortened to five years. the market value of alternative B after five years is estimated to be $15,000. which alternative would you recommend

Answer / Explanation:

First, we need to identify the budget line:

The budget line shows the various combination of goods that can be brought by the consumer with the given income. The slope of the budget line is the ratio of two goods prices. It has a negative slope.

Now, to calculate for the present value, we have,

(a) Alternative A = -20,000 - 5500/( 1 + 0.20 ) ² - 5500/( 1 + 0.20 ) ³ -5500/( 1 + 0.20 ) ⁴  - 5500/( 1 + 0.20 ) ⁵ + 1000/( 1 + 0.20 ) ⁵

= − 36046.49

    Alternative B = -38,000 - 4000/ ( 1 + 0.20 )  - 4000/ ( 1 + 0.20 )² - 4000/ ( 1 + 0.20 )³ - 4000/ ( 1 + 0.20 )⁴ - 4000/ ( 1 + 0.20 )⁵ - 4000/ ( 1 + 0.20 )⁶ - 4000/ ( 1 + 0.20 )⁷ - 4000/ ( 1 + 0.20 )⁸ - 4000/ ( 1 + 0.20 )⁹

= − 54091.56

Going forward to calculate the annual worth, we have,

Alternative A = NPV / PVIFA ( 20%, 5 years)

                      − 36046.49 / 2.9906

                         =  − $ 12053.26

Alternative B =  NPV / PVIFA ( 20%, 5 years)

                    − 54091.56 / 4.1925

                       = − $ 12901.98

It should be noted that Alternative A should be chosen as it has lower annual cost.

(b) Present Value:

Alternative B = -38000  - 4000/ ( 1 + 0.20 )  - 4000/ ( 1 + 0.20 )² - 4000/ ( 1 + 0.20 )³ - 4000/ ( 1 + 0.20 )⁴ - 15000/ ( 1 + 0.20 )⁵

=  -  43934.28

Annual Worth for Alternative B therefore is

= -43934.28 / 29906

=  −  $ 14690.79

It should be noted that Alternative A should be chosen as it has lower annual cost.

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