Question

QUESTION 2 (25 MARKS) A chemical company is considering two processes for isolating DNA material. The incremental cash flows between the two alternatives, J and S, have an incremental internal rate of return that is less than 40%, which is the MARR of the company. However, the company CEO prefers the more expensive process S. She believes the company can implement cost controls to reduce the annual cost of the more expensive process. By how much would she have to reduce the annual operating cost of alternative S (in RM per year) for it to have an incremental internal rate of return of exactly 40%? (25 marks) Table Q2. Incremental cash flow S-J Year Incremental cash flow (S-J), in RM -2,700,000 1,200,000 1,200,000 1,200,000 2 3

Answer 1

A chemical company is considering two processes for isolating DNA material. The incremental cash flows between the two alternatives. Annual payment A = p[i(1 + i)^n/(1 + i)^n - 1] where, p = present value n = number of years i = annual rate of interest. the standard notation equation A = p(A/p, Gn) 0 = -2,700,000 + AOC(p/A, 40%, 3) 0 = -2,700,000 + AOC(1.5889) therefore AOC = 2,700,000/1.5889 = 1699288.816 almostequalto 1699289 therefore Required reduction = 1,699,289 - 1,200,000 = 4,99,289 therefore Required reduction = $4,99,289