Question

Two methods can be used to produce solar panels for electric power generation. Method 1 will have an initial cost of $800,000, an AOC of $150,000 per year, and $125,000 salvage value after its 3-year life. Method 2 will cost $910,000 with an AOC of $125,000 and a $230,000 salvage value after its 5-year life. Assume your boss asked you to determine which method is better, but she wants the analysis done over a three-year planning period. You estimate the salvage value of Method 2 will be 40% higher after three years than it is after five years. If the MARR is 14% per year, which method should the company select?

Which method should the company select?

Answer 1

MARR = 14%

Study period = 3 yrs

Method 1

Investment = 800000

Annual operating cost = 150000

Salvage value = 125000

life = 3 yrs

Present worth = -800000 - 150000 * (P/A, 14%, 3) + 125000*(P/F, 14%,3)

= -800000 - 150000 * 2.3216320 + 125000*0.6749715

= -1,063,873.36

Method 2

Investment = 910000

Annual operating cost = 125000

Salvage value = 230000

life = 5 yrs

As study period is 3 years, salvage value after 3 years is 40% higher than the salvage value at the end of five year

salvage value after 3 years = 1.4*230000 = 322000

Present worth = -910000 - 125000 * (P/A, 14%, 3) + 322000*(P/F, 14%,3)

= -910000 - 125000 * 2.3216320 + 322000*0.6749715

= -982,863.18

As the net present cost of Method 2 is low, we should choose method 2