Question

Lesco Chemical is considering two processes for making a cationic polymer. Process A has a first cost of $106,000 and an annual operating cost (AOC) of $62,000 per year. The first cost of process B is $165,000. If both processes will be adequate for 7 years and the rate of return on the increment between the alternatives is 25%, what is the amount of the AOC for process B?

Answer 1

Let Amount of annual operating cost = $ x

Incremental cash outflow in year 0 (B - A) = (-162000 - (106000) = -$56000

Incrementa cashflwo in subsequent year = (- x - (-62000)) = 62000 - x

to find the value of x,one has to solve below equation

0 = -56000 + (62000 - x)/(1.25)^1 + ........ + (62000 - x)/(1.25)^7

	0	1	2	3	4	5	6	7
A	-106000	-62000	-62000	-62000	-62000	-62000	-62000	-62000
B	-162000	-44285	-44285	-44285	-44285	-44285	-44285	-44285
Incremntal	-56000	17715	17715	17715	17715	17715	17715	17715
Present Value	-56000	14172	11337.6	9070.08	7256.064	5804.851	4643.881	3715.105
NPV	-0.42

After solving the equation we will get the value of x = $44285