Alternative R has a first cost of $100,000, annual M&O costs of $50,000, and a $20,000 salvage value after 5 years. Alternative S has a first cost of $175,000 and a $40,000 salvage value after 5 years, but its annual M&O costs are not known. Determine the M&O costs for alternative S that would yield a required incremental rate of return of 20%. Solve (a) by hand, and (b) using the Goal Seek tool or RATE function on a spreadsheet.
What will be an ideal response?
By hand: Let x = M & O costs. Perform an incremental cash flow analysis.
0 = -75,000 + (-x + 50,000)(P/A,20%,5) + 20,000(P/F,20%,5)
0 = -75,000 + (-x + 50,000)(2.9906) + 20,000(0.4019)
x = $27,609
M & O cost for S = $27,609
By spreadsheet: Enter any number for M&O in cell C3 and use Goal Seek to display
20.00% in cell D8. If RATE is used, different cash flow values must be
entered repeatedly into cell C3.
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