Question

The factory manager is considering the following two quotes from two vendors for purchase and maintanance of an equipment. Vendor​ X's estimates are all in actual​ dollars, while Vendor​ Y's estimates are all in​ year-zero dollars.

		Vendor X	Vendor Y
	Initial cost	​$9,200	​$11,500
	Annual cost	​$3,900	​$3,000
	Service life​ (yrs)	10	10
	Salvage value	​$3,680	​$4,600

The manager uses an annual real interest rate of 8​% for economic analysis. If inflation rate is expected to average 5.56% per year over the next ten​ years, which vendor should the manager select that will minimize the cost of​ ownership?

​(a) Calculate PW for each alternative​ (use negative sign for​ costs)

The PW of Vendor​ X's estimates is ​$_______​(Round to the nearest whole​ number.)

The PW of Vendor​ Y's estimates is ​$_____​__(Round to the nearest whole​ number.)

​(b) The most economical alternative is

A. Vendor X

B. Vendor Y

Answer 1

For Vendor Y , one should use the Annual real interest rate of 8% as the discount rate whereas for Vendor Y , the nominal rate of Interest = 1.08*1.0556-1 = 0.14008 or 14% should be used

So, PW of Vendor X's estimate = -9200 - 3900/0.14*(1-1/1.14^10) + 3680/1.14^10 = - $28550.19

PW of Vendor Y's estimate = -11500 - 3000/0.08*(1-1/1.08^10) + 4600/1.08^10 = - $29499.55

a) The PW of Vendor​ X's estimates is ​-$28550

The PW of Vendor​ Y's estimates is ​-$29500

b) The most economical alternative is Vendor X as it has a less negative PW (A is correct option)