Question

Solid Rock Construction must replace a piece of heavy earthmoving equipment. Cat and Volvo are the two best alternatives, and each are expected to last 5 years. Use present worth, annual cash flow, or incremental analysis to select the best alternative when the firm's minimum acceptable rate of return is 12 percent annually and explain your result.

                                                Cat                  Volvo

First Cost                                $17,000           $21,000

Annual operating cost             2,000               1,800

Salvage Value                         1,500               3,000

Answer 1

As, the choice in method is given, we follow Present worth method to amke decision making.

The present worth of both projects is as follows:

OPTION-CAT
Year	Cash flows	PVF @ 12%		Present values
0	-17000	1		-17000
1	-2000	0.892857		-1785.71
2	-2000	0.797194		-1594.39
3	-2000	0.71178		-1423.56
4	-2000	0.635518		-1271.04
5	-500	0.567427		-283.713
Present Worth of CAT-Option				-23358
OPTION_VOLVO
Year	Cash flows	PVF @ 12%		Present values
0	-21000	1		-21000
1	-1800	0.892857		-1607.14
2	-1800	0.797194		-1434.95
3	-1800	0.71178		-1281.2
4	-1800	0.635518		-1143.93
5	1200	0.567427		680.9122
Present worth of Volvo-Option				-25786
As present worth of cash outflows of Option-Cat is low
Hence, Option-Cat must be acceptable.