Solved problem on present worth method - 1
Solved problem on present worth method - 1
Alpha
Industry is planning to expand its production operation. It has identified three
different technologies for meeting the goal. The initial outlay and annual
revenues with respect to each of the technologies are summarized in Table.
Suggest the best technology which is to be implemented based on the present
worth method of comparison assuming 15% interest rate, compounded annually.
Initial outlay (Rs.)
|
Annual Revenue (Rs.)
|
Life (years)
|
|
Technology1
|
15,00,000
|
4,00,000
|
10
|
Technology2
|
25,00,000
|
5,00,000
|
10
|
Technology3
|
20,00,000
|
6,00,000
|
10
|
Given data
Method
= Present worth method - revenue dominated cash flow
i
= 15%
Technology 1
P
= Rs. 15,00,000
R1
= R2 = … = R10 = A = Rs. 4,00,000
n
= 10
S
= 0
Technology 2
P
= Rs. 25,00,000
R1
= R2 = … = R10 = A = Rs. 5,00,000
n
= 10
S
= 0
Technology 3
P
= Rs. 20,00,000
R1
= R2 = … = R10 = A = Rs. 6,00,000
n
= 10
S
= 0
Formula used
Here
the revenue is equal for all the years.
Therefore
PW(i) = -P + A (P/A,
i, n) + S (P/F, i, n)
Solution
Technology 1
PW(15%)1 = -15,00,000 + 4,00,000 (P/A, 15%, 10) +
0 (P/F, 15%, 10)
= -15,00,000 + 4,00,000 (5.0188)
+ 0
= -15,00,000 + 20,07,520
PW(15%)1 = Rs. 5,07,520
Technology 2
PW(15%)2 = -25,00,000 + 5,00,000 (P/A, 15%, 10) +
0 (P/F, 15%, 10)
= -25,00,000 + 5,00,000 (5.0188)
+ 0
= -25,00,000 + 25,09,400
PW(15%)2 = Rs. 9,400
Technology 3
PW(15%)3 = -20,00,000 + 6,00,000 (P/A, 15%, 10) +
0 (P/F, 15%, 10)
= -20,00,000 + 6,00,000 (5.0188)
+ 0
= -20,00,000 + 30,11,280
PW(15%)3 = Rs. 10,11,280
Result
In present worth
method revenue dominated cash flow, the alternative which has maximum present
worth amount is the best alternative. Therefore alternative 3 i.e Technology 3
is selected.