Question

Alpha Electronics can purchase a needed service for $130 per unit. The same service can be provided by equipment that costs $100,000 and that will have a salvage value of 0 at the end of 10 years. Annual operating costs for the equipment will be $7,000 per year plus $25 per unit produced. MARR is 12%/year.

a) Whats the annual worth if the expected production is 90units/year? 510units/year?

b)Determine the breakeven value for annual production that will return MARR on the investment in the new equipment.

Answer 1

a) Annual worth for 90 units/year = -7,550

Annual worth for 510 units/year = 36,550

b) The breakeven value for annual production that will return MARR on the investment in the new equipment is Q=235 units/year.

Step-by-step explanation:

a) We can calculate the annual worth for any expected production substracting from the "purchased service" cost, the "equipment" costs. In the equipment cost, we considered a ten-year amortization of the equipment, that is 100,000/10=$10,000/year.

`AW=C_1-C_2=(130Q)-(10,000+7,000+25Q)=105Q-17,000`

For Q=90, the annual worth is:

`AW(90)=105*90-17,000=9,450-17,000=-7,550`

For Q=510, the annual worth is:

`AW(510)=105*510-17,000=53,550-17,000=36,550`

b) We have to compare the two options (purchased service vs. equipment) in the same time span, so the two are evaluated over a 10 year period.

The purchased service option implies paying $130 per unit, so the cash flow each year is related linearly to the volume of production Q (units/year).

As the cash flow is constant for a certain level of production, we can use the annuity factor to calculate the present value PV.

The present value of this option is:

`PV_1=\sum_(k=1)^(10)(130Q)/((1+0.12)^k)=130Q*((1-(1+0.12)^(-10))/(0.12))\\\\PV_1=130Q*5.65=734.5Q`

The equipment option is more complex. We will consider the purchased in year 0 and the fixed and variable cost from year 1 to 10.

The present value is then:

`PV_2=100,000+\sum_(k=1)^(10)(7,000+25Q)/((1+0.12)^k)\\\\\\PV_2=100,000+(7,000+25Q)*((1-(1+0.12)^(-10))/(0.12))\\\\\\PV_2=100,000+(7,000+25Q)*5.65\\\\\\PV_2=100,000+7,000*5.65+5.65*25Q\\\\\\PV_2=100,000+39,550+141.25Q\\\\\\PV_2=139,550+141.25Q`

The breakeven value for annual production is the quantity for which both present values are equivalent:

`PV_1=PV_2\\\\\\734.5Q=139,550+141.25Q\\\\(734.5-141.25)Q=139,550\\\\593.25Q=139,550\\\\Q=139,550/593.25=235.23\approx235`