Question

Alternative R has a first cost of $70,000, annual M&O costs of $50,000, and a $20,000 salvage value after 5 years.

Alternative S has a first cost of $175,000 and a $67,000 salvage value after 5 years, but its annual M&O costs are not known.

Determine the M&O costs for alternative S that would yield a required incremental rate of return of 23%

The M&O cost for alternative S is $__________ .

Answer 1

Year	Total Costs		Incremental Cash flows
	R	S
0	-70,000	-175,000	-105,000
1	-50,000	x	x+50000
2	-50,000	x	x+50000
3	-50,000	x	x+50000
4	-50,000	x	x+50000
5	-30,000	x+67,000	x+97000

let x be the annual M&O cost
year 5 incremental cash flow can be re-written as x+50,000+47,000
PV of 47000 = 47,000/1.23^5 = 16694.46

Including this in the incremental first cost = -88,306

considering x+50,000 be y
88,306 = y/1.23 + y/1.23^2 + y/1.23^3 + y/1.23^4 + y/1.23^5
y = 31499

x+50,000 = 31499
x = -18,501