ADDITIONAL SAMPLE PROBLEMS FOR COMPARISON OF ALTERNATIVES

1. A company is considering two types of equipment for its manufacturing plant. Pertinent data are as
follows:
Type A Type B
First Cost P200,000 P300,000
Annual Operating Cost P32,000 P24,000
Annual Labor Cost P50,000 P32,000
Insurance and Property Taxes 3% 3%
Payroll Taxes 4% 4%
Estimated Life 10 10

If the minimum required rate of return is 12%, which equipment should be selected?

Solution by Annual Cost Method:

Type A
First Cost = 𝑃200,000
Depreciation 𝐴
= 𝑃200,000 , 12%, 10
𝐹 = 𝑃11,396.83
0.12
= 𝑃200,000
(1.12) − 1
Annual Operating Cost = 𝑃32,000
Annual Labor Cost = 𝑃50,000
Taxes and Insurance = 0.03(𝑃200,000) = 𝑃6,000
Payroll Taxes = 0.04(𝑃50,000) = 𝑃2,000
Minimum required RR = 0.12(𝑃200,000) = 𝑃24,000
Total Annual Cost = 𝑃125,396.83

Type B
First Cost = 𝑃300,000
Depreciation 𝐴
= 𝑃300,000 , 12%, 10
𝐹 = 𝑃17,095.25
0.12
= 𝑃300,000
(1.12) − 1
Annual Operating Cost = 𝑃24,000
Annual Labor Cost = 𝑃32,000
Taxes and Insurance = 0.03(𝑃300,000) = 𝑃9,000
Payroll Taxes = 0.04(𝑃32,000) = 𝑃1,280
Minimum required RR = 0.12(𝑃300,000) = 𝑃36,000
Total Annual Cost = 𝑃119,375.25

Therefore, Type B should be selected for it has lower annual cost.

2. Choose from the two machines which is more economical.

Machine A Machine B
First Cost P8,000 P14,000
Salvage Value P 500 P2,000
Annual Operation P3,000 P2,400
Annual Maintenance P1,200 P1,000
Taxes and Insurance 4% 5%
Life, years 10 15

Money is worth at least 16%.

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Solution by Annual Cost Method:
Machine A
First Cost = 𝑃8,000
Depreciation 𝐴
= (𝑃8,000 − 𝑃500) , 16%, 10
𝐹 = 𝑃351.76
0.16
= 𝑃7,500
(1.16) − 1
Annual Operation = 𝑃3,000
Annual Maintenance = 𝑃1,200
Taxes and Insurance = 0.04(𝑃8,000) = 𝑃320
Minimum Required RR = 0.16(𝑃8,000) = 𝑃1,280
Total Annual Cost = 𝑃6,151.76

Machine B
First Cost = 𝑃14,000
Depreciation 𝐴
= (𝑃14,000 − 𝑃2,000) , 16%, 15
𝐹 = 𝑃232.29
0.16
= 𝑃12,000
(1.16) − 1
Annual Operation = 𝑃2,400
Annual Maintenance = 𝑃1,000
Taxes and Insurance = 0.05(𝑃14,000) = 𝑃700
Minimum Required RR = 0.16(𝑃14,000) = 𝑃2,240
Total Annual Cost = 𝑃6,572.29

Machine A should be selected.

Solution by Rate of Return Method:

Machine A
Total Annual Cost excluding minimum required profit
= 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 + 𝑇𝑎𝑥𝑒𝑠&𝐼𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒
= 351.76 + 1,200 + 3,000 + 320 = 𝑃4,871.76
Machine B
Total Annual Cost excluding minimum required profit
= 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 + 𝑇𝑎𝑥𝑒𝑠&𝐼𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒
= 232.29 + 2,400 + 1000 + 700 = 𝑃4,332.29
Annual savings on Machine B
= 𝑃4,871.76 − 𝑃4,332.29 = 𝑃539.47
Additional investment on Machine B
= 𝑃14,000 − 𝑃8,000 = 𝑃6,000
.
Rate of return on the additional investment = × (100) = 8.99% = 𝟗% < 𝟏𝟔%
,

Thus, Machine A is more economical since the rate of return of Machine B is not justified.

3. The Bureau of public Highways is considering two possible types of road surfacing with cost
estimates per kilometers as follows:
Type A Type B
First Cost 𝑃400,000 𝑃550,000
Resurfacing period 8 years 12 years
Resurfacing cost 𝑃200,000 𝑃250,000
Average Annual Maintenance 𝑃5,000 𝑃2,000
The periodic resurfacings do not include the base or subgrade. Compare these two types by
calculating the present worth of the cost for 24 years of service, with no salvage value at the end of
this time, and using an annual rate of interest of 8%.

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Solution:
TYPE A
This will be resurfaced twice, at the end of the 8th and 16th years.

Present worth of resurfacing = 𝑃200,000[(1.08) + (1.08) ] = 𝑃166,431.87

𝑃
= 𝑃5,000 , 8%, 24
Present worth of 𝐴
1 − (1.08) = 𝑃52,643.79
maintenance cost = 𝑃5,000
0.08
Total present worth = 𝑃400,000 + 𝑃166,431.87 + 𝑃52,643.79 = 𝑃619,075.66

TYPE B
This will be resurfaced only once in 24 years, at the end of the 12 th year.

Present worth of resurfacing = 𝑃250,000[(1.08) ] = 𝑃99,278.44

𝑃
= 𝑃2,000 , 8%, 24
Present worth of 𝐴
1 − (1.08) = 𝑃21,507.52
maintenance cost = 𝑃2,000
0.08
Total present worth = 𝑃550,000 + 𝑃99,278.44 + 𝑃21,507.52 = 𝑃670,335.96

The present worth of TYPE A is less by 𝑷𝟓𝟏, 𝟐𝟔𝟎. 𝟑𝟎

4. To augment its water requirements, a city plans to build an aqueduct which will pass through 600
meters of tunnel in a nearby mountain. Two possible alternatives are being considered. Alternative A
will require a full-capacity tunnel, 3.2 meters in diameter. Alternative B proposes to build a half-
capacity tunnel, 2.3 meters in diameter now which will be adequate for 20 years, and then build a
second parallel half-capacity.
The full-capacity tunnel can be built now for P3.5-M while the firs half-capacity tunnel can be built
for P2.5-M. Due to increasing costs, it is expected that the second half-capacity tunnel can be built 20
years hence for P3.8-M. To repair the tunnel lining every 10 years will require P9.00 per square meter for
the full-capacity tunnel and P10.00 per square meter for the half-capacity tunnel.
Due to greater friction losses in the smaller tunnels, it is estimated that pumping costs will be P20,000
each year for the first 20 years, and P40,000 each year for the second half-capacity tunnel is
operational.
If money is worth 10% compounded annually, determine the capitalized costs of the two
alternatives.

Solution:
Alternative A: Full-Capacity Tunnel
Surface Area = 3.2𝜋(600) = 6,031.86 𝑚
Repair cost = 6,031.86 (𝑃9.00) = 𝑃54,286.72/𝑚
𝑃54,286.72 𝐴
= 𝑃3.5M + ( , 10%, 10)
0.10 𝐹
Capitalized cost 0.10
= 𝑃3.5M + 𝑃542,867.21
(1.10) − 1 = 𝑷𝟑, 𝟓𝟑𝟒, 𝟎𝟔𝟐. 𝟒𝟐

Alternative B: First Half-Capacity Tunnel

Surface Area = 2.3𝜋(600) = 4,335.40 𝑚
Repair cost = 4,335.4 (𝑃10.00) = 𝑃43,354/𝑚
𝑃43,354 𝐴
= 𝑃2.5M + ( , 10%, 10)
0.10 𝐹
Capitalized cost 0.10 𝑃20,000
= 𝑃2.5M + 𝑃433,540 +
(1.10) − 1 0.10 = 𝑃2,727,202.6

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 Second Half-Capacity Tunnel
𝑃43,350 0.10 𝑃20,000 𝑃
= 𝑃3.8M + + ( , 10%, 20)
Capitalized 0.1 (1.10) − 1 0.10 𝐹
cost
= 𝑃4,0272,200.13(1.10) = 𝑃598,617.64

Total Capitalized Cost of Alternative B

= 𝑃2,727,202.6 + 𝑃598,617.64 = 𝑷𝟑, 𝟑𝟐𝟓, 𝟖𝟐𝟎. 𝟐𝟒

Alternative B has the lower capitalized cost and should be recommended.

5. Based on the estimates, the data for two types of bridges with different lives are as follows. If the
minimum attractive rate of return is 9%, determine which project is more desirable.
Timber Bridge Steel Bridge
First Cost 𝑃50,000 𝑃140,000
Salvage value 𝑃2,000 𝑃10,000
Life in years 12 36
Annual Maintenance 𝑃6,000 𝑃2,500

Solution by Annual Cost Method

Timber Bridge
Depreciation 𝐴
= (𝑃50,000 − 𝑃2,000)( , 9%, 12)
𝐹
0.09
= 𝑃48,000
(1.09) − 1 = 𝑃2,383.23
Annual Maintenance = 𝑃6,000
Minimum required profit = 0.09(𝑃50,000) = 𝑃4,500
Total Annual Cost = 𝑃12,888.23

Steel Bridge
Depreciation 𝐴
= (𝑃140,000 − 𝑃10,000)( , 9%, 36)
𝐹
0.09
= 𝑃130,000
(1.09) − 1 = 𝑃550.56
Annual Maintenance = 𝑃2,500
Minimum required profit = 0.09(𝑃140,000) = 𝑃12,600
Total Annual Cost = 𝑃15,650.56

The TIMBER BRIDGE is the better choice, since it has a lower annual cost.

Solution by Present-worth Cost Method

Assume a time horizon of 36 years
Timber Bridge
Original investment = 𝑃50,000
Present worth of first replacement 𝑃
= 𝑃50,000( , 9%, 12)
𝐹
= 𝑃50,000(1.09) = 𝑃17,776.74
Present worth of second replacement 𝑃
= 𝑃50,000( , 9%, 24)
𝐹
= 𝑃50,000(1.09) = 𝑃6,320.25
Present worth of annual disbursements 𝑃
= 𝑃6,000( , 9%, 36)
𝐴
1 − (1.09) = 𝑃63,670.58
= 𝑃6,000
0.09
= 𝑃137,767,57
Less:
Salvage Value of 1st replacement 𝑃
= 𝑃2,000 , 9%, 12 = 𝑃2000(1.09) = 𝑃711.07
𝐹

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 Salvage value of 2nd replacement 𝑃
= 𝑃2,000 , 9%, 24 = 𝑃2000(1.09) = 𝑃252.81
𝐹
Net Present Worth Cost = 𝑃136,743.70

Steel Bridge
Original investment = 𝑃140,000
Annual disbursements 𝑃
= 𝑃2,500( , 9%, 36)
𝐴
1 − (1.09)
= 𝑃2,500
0.09 = 𝑃26,529.41
Less:
Salvage value of original bridge 𝑃
= 𝑃10,000( , 9%, 36) = 𝑃449.41
𝐹
= 𝑃10,000(1.09)
Net Present Worth Cost = 𝑃166,080.00

The TIMBER BRIDGE is the better choice.

Solution by rate of Return Method:

Timber Bridge Steel Bridge
Annual expenses:
Depreciation 𝑃2,383.23 𝑃550.56
Disbursements 𝑃6,000 𝑃2,500
𝑃8,383.23 𝑃3,050.56
Annual Savings on steel bridge = 𝑃8,383.23 − 𝑃3,050.56 = 𝑃5,332.67
Additional investment on steel bridge = 𝑃140,000 − 𝑃50,000 = 𝑃90,000
Rate of return on additional investment 𝑃5,332.67
= × 100 = 5.93% < 9%
𝑃90,000

Thus, the TIMBER BRIDGE is the more desirable alternative.

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