Question

ROR ANALYSIS WITH ESTIMATED LIVES THAT VARY Background Make-to-Specs is a software system under development by ABC Corporation. It will be able to translate digital versions of three-dimensional computer models, containing a wide variety of part shapes with machined and highly finished (ultra smooth) surfaces. The product of the system is the numerically controlled (NC) machine code for the part’s manufacturing. Additionally, Make-to-Specs will build the code for superfine finishing of surfaces with continuous control of the finishing machines. Information There are two alternative computers that can provide the server function for the software interfaces and shared database updates on the manufacturing floor while Make-to- Specs is operating in parallel mode. The server first cost and estimated contribution to annual net cash flow are summarized below. Server 1 Server 2 First cost, $ 100,000 200,000 Net cash flow, $/year 35,000 50,000 year 1, plus 5000 per years 2, 3, and 4 (gradient) 70,000 maximum for years 5 on, even if the server is replaced Life, years 3 or 4 5 or 8 The life estimates were developed by two different individuals: a design engineer and a manufacturing manager. They have asked that, at this stage of the project, all analyses be performed using both life estimates for each system. Case Study Exercises Use spreadsheet analysis to determine the following:

CASE STUDY ROR ANALYSIS WITH ESTIMATED LIVES THAT VARY Background The life estimates were developed by two different individuals: a design engineer and a manufacturing manager. They have Make-to-Specs is a software system under development by asked that, at this stage of the project, all analyses be performed ABC Corporation. It will be able to translate digital versions of using both life estimates for each system. three-dimensional computer models, containing a wide variety of part shapes with machined and highly finished (ultra- Case Study Exercises smooth) surfaces. The product of the system is the numerically controlled (NC) machine code for the part's manufacturing Use spreadsheet analysis to determine the following: Additionally, Make-to-Specs will build the code for superfine 1. If the MARR = 12%, which server should be selected? finishing of surfaces with continuous control of the finishing Use the PW or AW method to make the selection. machines 2. Use Incremental ROR analysis to decide between the servers at MARR = 12% Information 3. Use any method of economic analysis to display on the spreadsheet the value of the incremental ROR between There are two alternative computers that can provide the server 2 with a life estimate of 5 years and a life estimate server function for the software Interfaces and shared da- of 8 years. tabase updates on the manufacturing floor while Make-to- Specs is operating in parallel mode. The server first cost and estimated contribution to annual net cash flow are summarized below. Server 1 Server 2 First cost $ Net cash flow. $/year 100,000 35,000 200,000 50,000 year 1. plus 5000 per year for years 2.3, and 4 (gradient) 70,000 maximum for years 5 on, even if the server is replaced 5 or 8 Life, years 3 or 4

1. If the MARR = 12%, which server should be selected? Use the PW or AW method to make the selection.

2. Use incremental ROR analysis to decide between the servers at MARR = 12%.

3. Use any method of economic analysis to display on the spreadsheet the value of the incremental ROR between server 2 with a life estimate of 5 years and a life estimate of 8 years.

Answer 1

Answer-1 PW At 12% Particulars Server 1 for 3 years -15,936 Server 1 for 4 years 6,307 Server 2 for 5 years 12,224 This Option will be selected because this is having the 1,07,624 maximum PW Server 2 for 8 years Server- 1 for 4 years Server 2 for 5 years Years Server- 2 for 8 years Years Server 1 for 3 years Amount Years PW At 12% PW At 12% Amount Years PW At 12% Amount Amount PW At 12% -2,00,000 0 -100000 -100000 -100000 -1,00,000 0 -200000 -200000 -2,00,000 35000 31,250 50000 44,643 50000 1 31250 1 35000 1 1 44,643 35000 27901.79 35000 24912.31 27,902 2 2 35000 2 55000 43,846 2 55000 43,846 3 35000 24,912 3 60000 42,707 3 60000 42,707 65000 65000 -15935.9 22,243 41,309 41,309 4 35000 4 4 6,307 39,720 5 70000 39,720 5 70000 35,464 12,224 6 70000 7 70000 31,664 70000 8 28,272 1,07,624

Answer 2 IRR Means when Present Value of all future cash inflowes is equal to Todays cash Outflow associated with the project IRR for all the 4 Particlars diiferent Project Server 1 for 3 years 2.48% Server 1 for 4 years 14.96% Server 2 for 5 years 14% Server 2 for 8 years 25.04% This Server is having Maximum IRR, Hence this will be selected

Answer 3 Annual net present Value Net Present Value/Annuity Discount Factor for the Project Life PW At 12% Life of Project Annuity Factor Annual Net Present Value Particulars Server 2 for 5 years 12,223.89 3,391 5 3.60 This Option will be selected because this is having the 21,665 maximum annual Net present value Server 2 for 8 years 1,07,624.34 8 4.97 Factor @ 12% Years Annual Factor 0.89285714 1 2 0.80 0.71 4 0.64 3.60 Annuity Factor for 5 years 5 0.57 6 0.51 7 0.45 4.97 Annuity Factor for 8 years 0.40 To compare the return on Invetment on servers 2 for different life estimates, we have used Equivalent Annual Annuity Approach. Equivalent annual annuity (EAA) approach (also called the annual net present value method) ranks projects based on their net present value per year which is calculated by dividing the net present value by the present value of annuity factor corresponding to the hurdle rate and life of the project. The project with higher annual net present value is accepted. Annual net present value method is also called the equivalent annual annuity approach.