Question

Manufacturing costs from a scraped poor-quality product are $6000 per year. AN investment in an employee training program can reduce this cost. Program A reduces the cost by 75% and requires an investment of $12,000. Program B reduces the cost by 95% and will cost $20,000. Based on low turnover at the plant, either program should be effective for the next 5 years. If interest is 20%, the present worth of the two programs is nearest what values? (Consider cost reduction a positive cash flow)

Answer 1

We see that Prog A will give an annual CF of 75%*$6000 = $4500

Prog B will give annual CF of 95%*$6000 = $5700

Disc Rate Kd = 20%

So PV of Annuity of $1 for 5 yrs with Kd = 20% is 2.9906

So NPV of Prog A = CF0+CF1+ ....+Cf5 = -12000+2.9906*4500 = $1,458

So NPV of Prog B= CF0+CF1+ ....+Cf5 = -20000+2.9906*5700 = $(2,954)

So Prog A is more effective as it gives a Positive NPV