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First term (2010 – 2011)

Assignment 5
Due: 5:00 p.m., 2-Dec-2010
Important notes:
1. You must submit your assignment on time. No late assignment will be accepted.
2. You must drop your assignment into the assignment collection box A09. Don’t
hand your assignment to instructor and TAs.
Problem 1 to 10 are taken from the textbook (Engineering Economy, by William G.
Sullivan, Elin M. Wicks, and C. Patrick Koelling, 14th edition, Pearson Education,
Inc. 2009.). The number in the parentheses is the problem number in the textbook.

1. (6-2) The Pure Oil Company must install antipollution equipment in a new
refinery to meet federal clean-air standards. Four design alternatives are being
considered, which will have capital investment and annual operating expenses as
shown in the following table. Assuming a useful life of 10 years for each design,
no market value, a desired MARR of 10% per year, and an analysis period of 10
years, determine which design should be selected on the basis of the PW method.
Confirm your selection by using the FW and AW methods.

Alternative Design
D1 D2 D3 D4
Capital Investment $650,000 $810,000 $1,290,000 $1,650,000
Annual Expenses at
the end of year k
(1 ≤ k ≤ useful life) :
Power 75,000 75,000 140,000 146,000
Labor 50,000 55,000 75,000 60,000
Maintenance 710,000 650,000 470,000 420,000
Taxes and insurance 14,000 17,000 27,000 30,000

2. (6-4) Three mutually exclusive design alternatives are being considered. The
estimated sales and cost data for each alterative are given in the following table.
The MARR is 20% per year.
Investment cost $40,000 $70,000 $50,000
Estimated units to be sold /year 25,000 30,000 28,000
Unit selling price, $/unit $4.20 $5.50 $4.80
Variable costs, $/unit $2.10 $2.50 $2.00
Annual expenses (fixed costs) at the $25,000 $40,000 $35,000
end of year k (1 ≤ k ≤ useful life) :
Market value (= Salvage value) $20,000 $20,000 $20,000
Useful life 10 years 10 years 10 years

Annual revenues are based on the number of units sold and the selling price.
Annual expenses are based on fixed and variable costs. Without considering “Do-
nothing” alternative, determine which selection is preferable based on AW

3. (6-25) There are three mutually exclusive alternatives that are candidate for
implementation by the Yellow Freight Company’s sorting operations center, and
doing nothing is not an option. All alternatives have a life of 10 years, and they
have negligible market (salvage) value after 10 years. Use incremental IRR
analysis to make your recommendation. The firm’s MARR is 10% per year. Using
trial and error and the linear interpolation, start your search from 8% or 25% (you
can determine which one is appropriate) and increase by 1% at each trial.

Alternative Capital Investment Annual Expenses at the

end of year k
(1 ≤ k ≤ useful life)
A $740,000 $361,940
B $1,840,000 $183,810
C $540,000 $420,000

4. (6-26) In the Rawhide Company (a leather products distributor), decisions

regarding approval of proposals for capital investment are based upon a stipulated
MARR of 18% per year. The five packaging devices listed in the following table
were compared, assuming a 10-year life and zero market value for each at that
time. Include DN alternative, using incremental ERR analysis, which one should
be selected? Make any additional calculations that you think are needed to make a
comparison, using the ERR method. Let ε = 18%.

Packaging Equipment
Capital Investment $38,000 $50,000 $55,000 $60,000 $70,000
Annual revenues less expenses 11,000 14,100 16,300 16,800 19,200
at the end of year k
(1 ≤ k ≤ useful life)
External rate of return (ERR) 21.1% 20.8% 21.4% 20.7% 20.5%

5. (6-45) A piece of production equipment has to be replaced immediately because it

no longer meets quality requirements for the end product. The two best
alternatives are a used piece of equipment (E1) and a new automated model (E2).
The economic estimates for each are shown in the accompanying table.

E1 E2
Capital Investment $15,000 $66,000
Annual Expenses at the $15,000 $10,000
end of year k
(1 ≤ k ≤ useful life)
Useful life (years) 5 20
Market value at end of $10,000 $15,000
useful life
The MARR is 20% per year.
a. Which alternative is preferred, based on the repeatability assumption? Use the
AW method.
b. If the study period is 5 years, which alternative is preferred? Use AW analysis.

6. (7-7) Justice Systems is purchasing a new bar code-scanning device for its service
center in Palm Springs. The table that follows lists the relevant cost items for this
purchase. The operating expenses for the new system are $14,000 per year, and
the useful life of the system is expected to be five years. The SV for depreciation
purposes is equal to 25% of the hardware cost.

Cost Item Cost

Hardware $170,000
Training $18,000
Installation $18,000

a. What is the BV of the device at the end of year three if the SL depreciation
method is used?
b. Suppose that after depreciating the device for two years with the SL method,
the firm decides to switch to the double declining balance depreciation method
for the remainder of the device’s life (the remaining three years). What is the
device’s BV at the end of four years?

7. (7-15) A manufacturer of aerospace products purchased three flexible assembly

cells for $600,000 each. Delivery and insurance charges were $40,000, and
installation of the cells cost another $60,000.
a. Determine the adjusted cost basis of the three cells.
b. Suppose the GDS recovery period of the cells is seven years. What is the
MACRS depreciation in year five?
c. If the cells are sold to another company for $150,000 each at the end of year
six, how much is the recaptured depreciation?

8. (7-16) A special-purpose machine is to be depreciated as a linear function of use

(units-of-production method). It costs $28,000 and is expected to produce 110,000
units. It has the salvage value of $8,200. Up to the end of the third year, it had
produced 65,000 units, and during the fourth year it produced 15,000 units. What
is the depreciation deduction for the fourth year and the BV at the end of the
fourth year?

9. (7-27) Freedom Airways is considering an investment of $900,000 in ticket

purchasing kiosks at selected airports. The kiosks (hardware and software) have
an expected life of four years. Extra ticket sales are expected to be 80,000 per year
at a discount price of $45 per ticket. Fixed costs, excluding depreciation of the
equipment, are $500,000 per year, and variable costs are $30 per ticket. The
kiosks will be depreciated over four years, using the SL method with a zero
salvage value. The onetime commitment of working capital is expected to be 1/12
of annual sales dollars and it will be fully recovered at the end of year 4. The
after-tax MARR is 15% per year, and the company pays income tax at the rate of
36%. Using the study period of 4 years, what’s the after-tax PW of this proposed
investment? Should the investment be made?

10. (7-30) The Greentree Lumber Company is attempting to evaluate the profitability
of adding another cutting line to its present sawmill operations. They would need
to purchase two more acres of land for $30,000 (total). The equipment would cost
$130,000 and could be depreciated over a five-year recovery period with
MACRS(GDS) method. Gross revenue is expected to increase by $50,000 per
year for five years, and operating expenses will be $15,000 annually for five years.
There is no depreciation for the land and the cost of the land is fully recovered at
the end of year 5. It is expected that this cutting line will be closed down after five
years. The firm’s effective income-tax rate is 50% per year. It the company’s
after-tax MARR is 5% per year, is this a profitable investment?