Question

QUESTION 2: i) Use (a) no-return payback, (b) discounted payback at 12%, and (c) PW analysis at 12% to select a system. Comment on the results. (10) System 2 System 1 12,000 3,000 8,000 1,000 (year 1-4) 3,000 (year 5-14) 14 First cost, $ NCF, S per year Maximum life, years Solution: i) What is guideline/Criterion for economic justification of single project using B/C analysis? Is following roject justified? (10) P=$5 AOC $300 K per year $1,2000 K per year B D $200 K per year 1-7% n 10 years

Answer 1

		ANALYSIS OF SYSTEM 1
		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=12%=0.12
		N=Year of Cash Flow
	N	Year	0	1	2	3	4	5	6	7
	CF	Cash flow	($12,000)	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	SUM
	PV=CF/(1.12^N)	Present value of Cash Flow	($12,000)	$2,679	$2,392	$2,135	$1,907	$1,702	$1,520	$1,357	$1,691
		Cumulative Cash Flow(No Return)	($12,000)	($9,000)	($6,000)	($3,000)	$0	$3,000	$6,000	$9,000
		Cumulative Present Value (12% discounted)	($12,000)	($9,321)	($6,930)	($4,795)	($2,888)	($1,186)	$334	$1,691
		Payback Period =Period in which Cumulative cash flow=Zero(Period when initial cost is recovered)
	(a)	No return payback=	4	years
	(b)	Discounted Payback at 12%=5+(1186/1520)	5.78	years
		Net Present worth	$1,691
		Net Present worth of repeat investment	$765	(1691/(1.12^7)
	.(c)	Total Net present Worth of 14 years operation	$2,456	(1691+765)
		ANALYSIS OF SYSTEM 2
	N	Year	0	1	2	3	4	5	6	7	8	9	10	11	12	13	14
	CF	Cash flow	($8,000)	$1,000	$1,000	$1,000	$1,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	$3,000	SUM
	PV=CF/(1.12^N)	Present value of Cash Flow	($8,000)	$893	$797	$712	$636	$1,702	$1,520	$1,357	$1,212	$1,082	$966	$862	$770	$688	$614	$5,810
		Cumulative Cash Flow(No Return)	($8,000)	($7,000)	($6,000)	($5,000)	($4,000)	($1,000)	$2,000	$5,000	$8,000	$11,000	$14,000	$17,000	$20,000	$23,000	$26,000
		Cumulative Present Value (12% discounted)	($8,000)	($7,107)	($6,310)	($5,598)	($4,963)	($3,260)	($1,740)	($383)	$828	$1,910	$2,876	$3,738	$4,508	$5,196	$5,810
		Payback Period =Period in which Cumulative cash flow=Zero(Period when initial cost is recovered)
	(a)	No return payback=(5+(1000/30000	5.33	years
	(b)	Discounted Payback at 12%=7+(383/1212)	7.32	years
		Net Present worth	$5,810
		PW of System 2 is higher . Hence System 2 is recommended
		Payback (No return) and discounted payback of System 2 is higher