Question

Lego Group in Bellund, Denmark, manufactures Lego toy construction blocks. The company is considering two methods for producing special-purpose Lego parts. Method 1 will have an initial cost of $320,000, an annual operating cost of $90,000, and a life of 3 years. Method 2 will have an initial cost of $520,000, an operating cost of $100,000 per year, and a 6-year life. Assume 13% salvage values for both methods. Lego uses an MARR of 10% per year.

Which method should it select on the basis of a present worth analysis?

The present worth of method 1 is $______ and that of method 2 is $ _______

Answer 1

Method 1

Investment = 320000

Annual cost = 90000

Salvage value = 0.13*320000 = 41600

t=3yrs

Present value = -320000 - 90000 * (P/A, 10%,3) + 41600*(P/F,10%,3)

= -320000 - 90000 * 2.4868519 + 41600*0.7513148

=-512561.97

Method 2

Investment = 520000

Annual cost = 100000

Salvage value = 0.13*520000 = 67600

t=6 yrs

Present value = -520000 - 100000 * (P/A, 10%,6) + 67600*(P/F,10%,6)

= -520000 - 100000*4.3552606 + 67600*0.5644739

= -917367.62

We should choose method 1 as its NPV is having less present cost