The production manager on the Ofon Phase 2 offshore platform operator by Total S.A. must purchase specialized environmental equipment or an equivalent service. The first cost is $250,000 with an AOC of $75,000. The man­ager has let it be known that he does not care about the salvage value because he thinks it will make no difference in the decision-making pro­cess. His supervisor estimates the salvage might be as high as $100,000 or as low as $10,000 in 3 years at which time the equipment will be un­necessary. Alternatively, a subcontractor can provide the service for $165,000 per year. To­tal’s offshore project MARR is 15% per year. Determine if the decision to buy the equipment is sensitive to the salvage value. If the decision is sensitive, what should Total S.A. do before making

Question

the decision?

What will be an ideal response?

Answer 1

AWcontract = $-165,000

AWhigh = -250,000(A/P,15%,3) -75,000 + 100,000(A/F,15%,3)
= -250,000(0.43798) -75,000 + 100,000(0.28798)
= $-155,697 (< $-165,000)

AWlow = -250,000(A/P,15%,3) -75,000 + 10,000(A/F,15%,3)
= -250,000(0.43798) -75,000 + 10,000(0.28798)
= $-181,615 (> $-165,000)

Decision is sensitive to salvage value.

Total should estimate the salvage more closely before choosing between purchase and
subcontractor.