Question

MLB The company may build a $20M facility now to handle anticipated market demand for the next 10 years. Alternatively, the company may build a $10M facility now and expand at the end of 4 and 7 years to take care of the anticipated increase market demands. The 4 and 7-year expansions will cost the company $8M and $6M respectively. If money is worth 10%, compute the PW of costs for both alternatives.

Answer 1

Answer:

Alternative 1 has present worth of $20,000,000.00

Alternative 2  has present worth of $18,543,040.00  

Explanation:

The present of the first alternative is the cost of the building the facility now,year zero which is $20 million.The value can be validated as follows:

Year      Cash  flows         Discount factor  present worth

                                                                      cash flow* discount factor

0            $20,00,000       1/(1+10%)^0=1            $20,000,000

The PW of the second alternative:

Year      Cash  flows         Discount factor            present worth

                                                                              cash flow* discount factor

0            $10,000,000       1/(1+10%)^0=1                      $10,000,000

4             $8,000,000        1/(1+10%)^4=0.68301           $5,464,080

7             $6,000,000         1/(1+10%)^7=0.51316            $3,078,960

Present worth of second alternative                            $ 18,543,040

Hence alternative with PW is better as it has lower present worth of $ 18,543,040.00