Question

Salvage value: You are involved with a project that is expected to last 50 years and have a salvage value of $10 million. A consultant has advised your company that an expenditure of only $100,000 at the end of every 5 years will double the salvage value. Your company generally uses a (minimally acceptable rate of return) MARR of 15%—do you buy the consultant’s recommendation?

Answer 1

Solution:

Expenditure of $100,000 after 5 years will double the salvage value from $10 million to $20 million

Increase in salvage value after 50 years = $20,000,000 - $10,000,000 = $10,000,000

Expenditure required after 5 years = $100,000

Required rate of return = 15%

Present value of increase in salvage value after 5 years = $10,000,000 * PV factor at 15% for 45th period

= $10,000,000 * 0.001856 = $18,560

As present value of increase in salvage value is less than $100,000, therefore i will not buy consultant's recommendation.