Two alternative investment proposals are under consideration

Two alternative investment proposals are under consideration for a vacant owner by Urban Development Corporation. Plan A would require an immediate investment of $120,000 and first-year expenditure for property taxes, maintenance, and insurance of $4,000, with this amount expected to increase at a rate of $1,000 per year. Plan B would have a first cost of $170,000 and total first-year expenses of $9,000, with an increase of $1,000 per year. The economic life of each project is forecast to be 10 years; and at the end of this time, only the facilities from Plan B with a value of $50,000 are expected to salvage. During the life of the project, the facility in plan A is expected to produce $34,000 annually, whereas Plan B is expected to produce $42,000 . a) Determine the rate of return of each plan. b) Determine the rate of return of the Additional investment required in Plan B compared with Plan A. c) Which plan should Urban Development select if the company uses a MARR of 12 percent?

Solution

Plan A Assume have ra = rate of return Plan A would require an immediate investment of $120,000 and first-year expenditure for property taxes, maintenance, and insurance of $4,000, with this amount expected to increase at a rate of $1,000 per year The economic life of each project is forecast to be 10 years the facility in plan A is expected to produce $34,000 annually Writing Present value of Plan A PVa = -120000- 4000(1+ra)^-1 - 1000(P/G, ra, 10) + 34000(P/A, ra, 10) Finding Rate of returns for Plan A PVa at ra should be 0 Solving we get ra = 21.6 % Similarly, Plan B would have a first cost of $170,000 and total first-year expenses of $9,000, with an increase of $1,000 per year. The economic life of each project is forecast to be 10 years; and at the end of this time, only the facilities from Plan B with a value of $50,000 are expected to salvage. During the life of the project, the facility in Plan B is expected to produce $42,000. Writing Present value of Plan B PVb = -170000 - 9000(1+rb)^-1 - 1000(P/G, rb, 10) + 42000(P/A, rb, 10) + 50000(P/F,rb, 10) Finding Rate of returns for Plan B PVb at rb should be 0 rb is approximately equal to 18.98% say 19% b) Determine the rate of return of the Additional investment required in Plan B compared with Plan A. rate of return = 21.6 - 19 = 2.6% c) Which plan should Urban Development select if the company uses a MARR of 12 percent? They should go for plan having highest rate of return which is Plan A