Chapter 5, Problem 30P

To determine

Which of the three alternative refrigerators should be purchased.

Answer to Problem 30P

Equipment to be purchased is Foxhill instrument, based on net present value calculation since it results in the lowest cash outflow over a period of 20 years.

Explanation of Solution

Given information:

Installation Costs in Year 0:

Foxhill Instrument $35,000

Quicksilver $40,000

Almaden $100,000

Annual Energy costs for Years 1-20:

Foxhill Instrument $8,000

Quicksilver $7,000

Almaden $2,000

Annual Income:

Foxhill Instrument $2,000

Quicksilver $2,200

Almaden $3,500

Salvage Value in year 20:

Foxhill Instrument $20,000

Quicksilver 0

Almaden 0.

Based on the above information, the following tables outlines the net present value calculation of the equipment of Foxhill Instrument, Quicksilver, and Almaden.

Foxhill Instrument:

Year	Particulars	Cash flow	Present value Factor @10%	Present value
0	Installation Cost	$35,000.00	1	$35,000.00
1	Operating costs less Revenue	$6,000.00	0.9091	$5,454.55
2	Operating costs less Revenue	$6,000.00	0.8264	$4,958.68
3	Operating costs less Revenue	$6,000.00	0.7513	$4,507.89
4	Operating costs less Revenue	$6,000.00	0.6830	$4,098.08
5	Operating costs less Revenue	$6,000.00	0.6209	$3,725.53
6	Operating costs less Revenue	$6,000.00	0.5645	$3,386.84
7	Operating costs less Revenue	$6,000.00	0.5132	$3,078.95
8	Operating costs less Revenue	$6,000.00	0.4665	$2,799.04
9	Operating costs less Revenue	$6,000.00	0.4241	$2,544.59
10	Operating costs less Revenue	$6,000.00	0.3855	$2,313.26
11	Operating costs less Revenue	$6,000.00	0.3505	$2,102.96
12	Operating costs less Revenue	$6,000.00	0.3186	$1,911.78
13	Operating costs less Revenue	$6,000.00	0.2897	$1,737.99
14	Operating costs less Revenue	$6,000.00	0.2633	$1,579.99
15	Operating costs less Revenue	$6,000.00	0.2394	$1,436.35
16	Operating costs less Revenue	$6,000.00	0.2176	$1,305.77
17	Operating costs less Revenue	$6,000.00	0.1978	$1,187.07
18	Operating costs less Revenue	$6,000.00	0.1799	$1,079.15
19	Operating costs less Revenue	$6,000.00	0.1635	$981.05
20	Operating costs less Revenue	$6,000.00	0.1486	$891.86
20	Salvage Value	($20,000.00)	0.1486	($2,972.87)
	Net cash outflow			$83,108.51

Quicksilver:

Year	Particulars	Cash flow	Present value Factor @10%	Present value
0	Installation Cost	$40,000.00	1.0000	$40,000.00
1	Operating costs less Revenue	$4,800.00	0.9091	$4,363.64
2	Operating costs less Revenue	$4,800.00	0.8264	$3,966.94
3	Operating costs less Revenue	$4,800.00	0.7513	$3,606.31
4	Operating costs less Revenue	$4,800.00	0.6830	$3,278.46
5	Operating costs less Revenue	$4,800.00	0.6209	$2,980.42
5	Operating costs less Revenue	$4,800.00	0.6209	$2,980.42
6	Operating costs less Revenue	$4,800.00	0.5645	$2,709.47
7	Operating costs less Revenue	$4,800.00	0.5132	$2,463.16
8	Operating costs less Revenue	$4,800.00	0.4665	$2,239.24
9	Operating costs less Revenue	$4,800.00	0.4241	$2,035.67
10	Operating costs less Revenue	$4,800.00	0.3855	$1,850.61
11	Operating costs less Revenue	$4,800.00	0.3505	$1,682.37
12	Operating costs less Revenue	$4,800.00	0.3186	$1,529.43
13	Operating costs less Revenue	$4,800.00	0.2897	$1,390.39
14	Operating costs less Revenue	$4,800.00	0.2633	$1,263.99
15	Operating costs less Revenue	$4,800.00	0.2394	$1,149.08
16	Operating costs less Revenue	$4,800.00	0.2176	$1,044.62
17	Operating costs less Revenue	$4,800.00	0.1978	$949.65
18	Operating costs less Revenue	$4,800.00	0.1799	$863.32
19	Operating costs less Revenue	$4,800.00	0.1635	$784.84
20	Operating costs less Revenue	$4,800.00	0.1486	$713.49
20	Salvage Value	0	0.1486	$0.00
	Net cash outflow			$83,845.53

Almaden:

Year	Particulars	Cash flow	Present value Factor @10%	Present value
0	Installation Cost	$100,000.00	1.0000	$100,000.00
1	Operating costs less Revenue	($1,500.00)	0.9091	($1,363.64)
2	Operating costs less Revenue	($1,500.00)	0.8264	($1,239.67)
3	Operating costs less Revenue	($1,500.00)	0.7513	($1,126.97)
4	Operating costs less Revenue	($1,500.00)	0.6830	($1,024.52)
5	Operating costs less Revenue	($1,500.00)	0.6209	($931.38)
5	Operating costs less Revenue	($1,500.00)	0.6209	($931.38)
6	Operating costs less Revenue	($1,500.00)	0.5645	($846.71)
7	Operating costs less Revenue	($1,500.00)	0.5132	($769.74)
8	Operating costs less Revenue	($1,500.00)	0.4665	($699.76)
9	Operating costs less Revenue	($1,500.00)	0.4241	($636.15)
10	Operating costs less Revenue	($1,500.00)	0.3855	($578.31)
11	Operating costs less Revenue	($1,500.00)	0.3505	($525.74)
12	Operating costs less Revenue	($1,500.00)	0.3186	($477.95)
13	Operating costs less Revenue	($1,500.00)	0.2897	($434.50)
14	Operating costs less Revenue	($1,500.00)	0.2633	($395.00)
15	Operating costs less Revenue	($1,500.00)	0.2394	($359.09)
16	Operating costs less Revenue	($1,500.00)	0.2176	($326.44)
17	Operating costs less Revenue	($1,500.00)	0.1978	($296.77)
18	Operating costs less Revenue	($1,500.00)	0.1799	($269.79)
19	Operating costs less Revenue	($1,500.00)	0.1635	($245.26)
20	Operating costs less Revenue	($1,500.00)	0.1486	($222.97)
20	Salvage Value	$ -	0.1486	$0.00
	Net cash outflow			$86,298.27

Net present value is the difference of Sum of Present values of cash inflows and Sum of Present values of cash outflows. If the value is positive then the project may be accepted. While evaluation of two or more alternatives takes place, then the proposal with the higher net present value may be selected since it results in a greater cash inflow over the duration of the project.

In the given scenario, Present values are calculated by calculating the present values of cash inflows in the form of salvage value and cash outflows such as installation cost and operating cost.

In case of Foxhill, Installation Cost is $35,000, Operating costs less Revenue is $6,000 i.e. Operating costs of $8,000 less Revenues of $2,000 and Salvage value is $20,000. In case of Quicksilver, Installation Cost is $40,000, Operating costs less Revenue is $4,800 i.e. Operating costs of $7,000 less Revenues of $2,200 and Salvage value is $0. In case of Almaden, Installation Cost is $100,000, Operating costs less Revenue is ($1,500) i.e. Operating costs of $2,000 less Revenues of $3,500 and Salvage value is $0.

Present value factor is calculated as 1/1.10 ^ N where N is the year of operation of the equipment.

Conclusion:

Hence the equipment with the lowest cash outflows over a period of 20 years is selected.