Problem 1

Consider 3 mutually exclusive alternatives (X is variable):

Alternative
A B C
Year
0 -X -3X $0
1 $0 $200 $0
2 $100 $200 $0
3 $200 $200 $0
If X=$145, which alternative should be selected (Hint: compare present values of
alternatives):
a. if MARR=2%
b. if MARR=10%
c. if MARR=40%
If X is unknown and MARR=10%:
d. over which range of X is A a preferred alternative?

Solution
Compute incremental cash flow B-A:
Alternative
A B B-A
Year
0 -X -3X -2X
1 0 200 200
2 100 200 100
3 200 200 0
If interest rate is i%, the present values of the alternatives are:
PA  i    X  100  P / G, i %, 3
,
PB  i   3 X  200  P / A, i %, 3
,
PB  A  i   PB  i   PA  i   2 X  200  P / A, i %, 3   100  P / G , i %, 3 
;

MARR A B B-A Decision

a. 2% 139.58 141.78 2.20 Accept B
b. 10% 87.91 62.37 -25.54 Accept A
c. 40% -21.09 -117.22 -96.12 Accept C
d. The alterative A is preferred if the following conditions are satisfied
simultaneously:
 PA  i   0

 PB  A  i   PB  i   PA  i   0
So,
  X  100  P / G, i %, 3  0

2 X  200  P / A, i %, 3  100  P / G, i %, 3   0

  X  100* 2.329  0

 2 X  200* 2.487  100* 2.329  0
 X  232.9

2 X  264.5 ,

So X should satisfy: $132.25  X  $232.90

Problem 2
Consider three mutually exclusive alternatives :
A B C
First Cost 560 340 200

Uniform Annual 140 90 50

Benefits

Each alternative has a 6 year useful life and assume that MARR is 10%
Which alternative should be selected?
a) Use Benefit-Cost Ratio Analysis (compare benefit-cost ratios of individual projects,
do not consider incremental analysis);

b) Use Pay-Back period analysis;

c) Is Pay-Back period analysis consistent with Present Worth Analysis? Explain;

d) Based on part a), if you used Future Worth Analysis which alternative would be
selected (You do not have to apply future worth analysis, just state your answer and
explain)

a.

Benefit-Cost ratio computations

140( P/ A ,10 %,6 )
=1. 088
A B/C= 560
90( P/ A , 10 %,6 )
=1 .152
B B/C= 340
50( P/ A ,10 %,6)
=1. 088
C B/C= 200

b. Pay -Back period

560
=4 years
A PAYBACK= 140

340
B PAYBACK= 90 =3.77 years

120
C PAYBACK= 50 =4 years
Conclusion: select B
c. No, Pay-Back period analysis does not always select the alternative with the
largest present worth. It is an approximate economic analysis.
d. Select B: FWA and B/C are consistent.
Problem 3
Consider a $100,000 truck, with a three-year depreciable life and an estimated $10,000
salvage value. The utilization of the truck is shown below.
Year Miles
1 30,000
2 40,000
3 20,000

(15%) i. Compute the truck depreciation schedule by each of the following methods
(3%) a. Straight Line;
(3%) b. Sum-of-years digits;
(3%) c. Double Declining Balance;
(3%) d. Unit of production;
(3%) e. Modified accelerated cost recovery system;

(5%) ii. If interest rate is 10%, arrange the schedules in order of decreasing preference
(Hint: compare present values of depreciation schedules).

i. Depreciation Schedules are:

SL SOYD DDB
Year Depreciation Depreciation Depreciation BV
1 30000 45000 66666.66667 33333.33333
2 30000 30000 22222.22222 11111.11111
3 30000 15000 1111.111111 10000
NPV 74 605.56$ 76 972.20$ 79 806.33$  

Un. Prod. MACRS

Year Depreciation Depr(%) Depreciation Ordinary Losses BV
1 30000 20% 20000   80000
2 40000 32% 32000   48000
3 20000 9.60% 9600 28400 38400
NPV 75 356.87$   77 658.90$  

ii. The most desirable schedule is DDB, than MACRS, SOYD, Un.Prod, SL.
The least desirable schedule is by SL depreciation.
Problem 4
You are considering buying a device for $50,000 with useful life 2 years and a salvage
value of $10,000. This device will produce an additional annual benefit at the end of each
year during its useful life. Combined federal and state tax rate is 55%; your MARR is
20%. The device is depreciated by straight-line depreciation.
a). What is break even for annual benefit, that make the investment acceptable?
b). What is break even for annual benefit in presence of inflation 10%?( inflation affects
annual benefit and salvage value, MARR is expressed in inflated dollars)

Solution.
a). Depreciation is
 $50,000  $10, 000  / 2  $20, 000 for two years.
If X is the annual benefit generated by the device, present worth of the investment is:
P  X   50, 000
 ( X  55% *( X  20, 000))( P / F , 20%,1)
 ( X  10, 000  55% *( X  20, 000))( P / F , 20%, 2) 
 50, 000  ( X  0.55*( X  20, 000)) /  1.2 
 ( X  10, 000  0.55*( X  20, 000) /  1.2 
2
.
P X   0
To find the break even we solve the equation: .
50, 000*  1.2   (0.45* X  11, 000) *  1.2   (0.45* X  21, 000)
2

72, 000  0.99 X  34, 200

X  38,182
b). In the case when the inflation is present, the depreciation does not change, but
benefits and salvage value become greater:

P  X   50, 000
 ( X  1  0.1  55% *( X  1  0.1  20, 000))( P / F , 20%,1)
 ( X  10, 000   1  0.1  55%*( X  10, 000   1  0.1  10, 000  20, 000))( P / F , 20%, 2)
2 2


P  X   50, 000   1.1 X   0.55    1.1 X  20, 000  /  1.2  

  1.1
2
 X  10, 000    0.55   X  10, 000   1.1
2

 30, 000 /  1.2 
2

P X   0
To find the break even point we solve the equation: .
50, 000*  1.2     1.1  0.45  X  11, 000  *  1.2 
2

   1.21 X  12,100   0.55   1.21  X  10, 000   16,500 

72,000  0.594 X  13, 200  0.5445 X  21945
36,855  1.1385X ,
So, X  32,371.54 .