You have an option of either buying a new machine for R2 million or employing 4 people to do the same job at the annual wage of R100,000 per person per year. Assume the following: • Equipment maintenance is 2% of the capital cost per year, the discount rate, equivalent to your working average cost of capital (WACC), is 16% and the project duration is 10 years • Salaries are paid at the end of the year, as from the end of year one. Calculate the following: a. The Annual Worth (AW) of both options b. Which option will be better for you? Why? c. Do a sensitivity analysis showing the variation in the AW of both options (separately) with ±25% changes in WACC, capital cost (option 1 only) and number of employees (option 2 only). Draw two separate graphs showing the relationships between the variables. d. Assume that wages are rising; at what salary per employee is the two options equivalent? e. Now assume that WACC is falling; at what value of WACC are the two scenarios equivalent (use base case conditions apart from WACC)? f. What does this suggest about labor vs capital opportunities in countries with a low cost of capital and high wage costs (such as developed countries)?
You have an option of either buying a new machine for R2 million or employing 4 people to do the same job at the annual wage of R100,000 per person per year. Assume the following:
• Equipment maintenance is 2% of the capital cost per year, the discount rate, equivalent to
your working average cost of capital (WACC), is 16% and the project duration is 10 years
• Salaries are paid at the end of the year, as from the end of year one.
Calculate the following:
a. The Annual Worth (AW) of both options
b. Which option will be better for you? Why?
c. Do a sensitivity analysis showing the variation in the AW of both options (separately) with
±25% changes in WACC, capital cost (option 1 only) and number of employees (option 2
only). Draw two separate graphs showing the relationships between the variables.
d. Assume that wages are rising; at what salary per employee is the two options equivalent?
e. Now assume that WACC is falling; at what value of WACC are the two scenarios equivalent
(use base case conditions apart from WACC)?
f. What does this suggest about labor vs capital opportunities in countries with a low cost of capital and high wage costs (such as developed countries)?
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