Background and Information

Berkshire Controllers usually finances its engineering projects with a combination of debt and equity capital. The resulting MARR ranges from a low of 4% per year, if business is slow, to a high of 10% per year. Normally, a 7% per year return is expected. Also the life estimates for assets tend to go down about 20% from normal in a vigorous business environment and up about 10% in a receding economy. The following estimates are the most likely values for two expansion plans currently being evaluated. Plan A will be executed at one location; Plan B will require two locations. All monetary estimates are in $1000 units.

Plan A Plan B

Location 1 Location B

First Cost, $: -$10,000 -$30,000 -$5,000

AOC, $ per year: -$500 -$200 -$100

Salvage value: $1,000 $1,000 -$200

Estimated life, years: 40 40 20

Questions:

At the weekly meeting, you were asked to examine the following questions from Berkshire's president:

1. Are the PW values for plans A and B sensitive to changes in the MARR?
2. Are the PW values sensitive to varying life estimates?
3. Is the breakeven point for the first cost of plan A sensitive to the changes in MARR as business goes from vigorous to receding?