ECON A3
1.
Water supply for an irrigation system can be obtained from a stream in nearby mountains. Two
alternatives are being considered, both of which have essentially infinite lives, provided proper
maintenance is performed. The first is a concrete reservoir with a steel pipe system, and the second is an
earthen dam with a wooden aqueduct. Below are the costs associated with each. Compare the present
worth of the two alternatives using an interest rate of 8%. Which one should be selected?
Concrete Reservoir: First cost $500,000, annual maintenance cost: $2000.
Earthen Dam: First cost $200,000, annual maintenance cost: $12,000, replacing the wood portion of the
aqueduct every 15 years: $100,000.
2.
Margaret has a project with a first cost of $28,000 that returns $5000 per year over its 10-year life. It has
a salvage value of $3000 at the end of 10 years. If the MARR is 15%, what is the annual worth of the
project?
3.
A new packaging machine will save Green Cheese Ltd. $3000 per year in reduced spoilage, $2500 per
year in labour, and $1000 per year in packaging material. The new machine will have additional expenses
of $700 per year in maintenance and $200 per year in energy. If it costs $20,000 to purchase, what is its
payback period?
4.
Marin is considering purchasing a $24,000 car. After five years, he can sell the vehicle for $8,000. Petrol
costs will be $2000 per year, insurance $600 per year, and parking $600 per year. Maintenance costs for
the first year will be $1000, rising by $400 per year thereafter. The alternative is for Marin to take taxis
everywhere. This will cost an estimated $6000 per year. Marin will also rent a vehicle each year at a total
cost of $600 for the family vacation if he has no car. Should he buy the car if Marin values money at 11%
annual interest? Use the annual worth comparison method.
5.
The city of Cambridge is installing a new swimming pool in the municipal recreation center. Two designs
are under consideration, both of which are to be permanent (i.e., last forever). The first design is for
reinforced concrete which has a first cost of $1,500,000. Every 10 years the inner surface of the pool would
have to be refinished and painted for $200,000.
The second design consists of a metal frame and a plastic liner, which would have an initial cost of
$500,000. For this alternative, the plastic liner must be replaced every 5 years at a cost of $100,000, and
every 15 years, the metal frame would need replacement at a cost of $150,000. Extra insurance of $5000
per year is required for the plastic liner (if the liner leaks to cover repairs). The city’s cost of long-term
funds is 5%. Determine which design has a lower present cost.
6. CB Electronix must buy a piece of equipment to place electronic components on the printed
circuit boards it assembles. The proposed equipment has a 10-year life with no scrap value.
The supplier has given CB several purchase alternatives. The first is to purchase the
equipment for $850 000. The second is to pay for the equipment in 10 equal installments
of $135 000 each, starting one year from now. The third is to pay $200 000 now
and $95 000 at the end of each year for the next 10 years.
(a) Which alternative should CB choose if its MARR is 11 percent per year? Use an
IRR comparison approach.
(b) Below what MARR does it make sense for CB to buy the equipment now for
$850 000?
7. The following table summarizes information for four projects:
The data can be interpreted in the following way: The IRR on the incremental investment between project
4 and project 3 is 13 percent.
(a) If the projects are independent, which projects should be undertaken if the MARR is 16 percent?
(b) If the projects are mutually exclusive, which project should be undertaken if the MARR is 15
percent? Indicate what logic you have used.
(c) If the projects are mutually exclusive, which project should be undertaken if the MARR is 17
percent? Indicate what logic you have used.
8. The following cash flows result from a potential construction contract for Erstwhile Engineering.
Receipts of $500 000 at the start of the contract and $1 200 000 at the end of the fourth year
Expenditures at the end of the first year of $400 000 and at the end of the second year of $900
000.
A net cash flow of zero at the end of the third year. Using an appropriate rate of return method,
for a MARR of 25 percent, should Erstwhile Engineering accept this project?