Question

Lego Group in Bellund, Denmark, manufactures Lego toy construction blocks. The company is considering two methods for producing special-purpose Lego parts. Method 1 will have an initial cost of $360,000, an annual operating cost of $130,000, and a life of 3 years. Method 2 will have an initial cost of $760,000, an operating cost of $130,000 per year, and a 6-year life. Assume 13% salvage values for both methods. Lego uses an MARR of 13% per year.

Required:
a. Which method should it select on the basis of a present worth analysis?
b. If the evaluation is incorrectly performed using the respective life estimates of 3 and 6 years, will Lego make a correct or incorrect economic decision? Explain your answer.

Answer 1

a) method 1 has a lower present worth, so it should be selected.

b) in order to properly compare both projects, we must assume that method 1 will be repeated at he end of year 3. That way both projects will have the same life span.

Step-by-step explanation:

we must first determine the equivalent cash flows:

method 1 method 2

initial outlay -360,000 -760,000

cash flow year 1 -130,000 -130,000

cash flow year 2 -130,000 -130,000

cash flow year 3 -443,200 -130,000

cash flow year 4 -130,000 -130,000

cash flow year 5 -130,000 -130,000

cash flow year 5 -83,200 -31,200

the present worth of method 1 = -$1,074,266

the present worth of method 2 = -$1,232,226