Question

3.1 Henry, owner of the Monster Gym located in Black River, wants to replace all its equipments. The investment will cost $150,000 and will generate $60,000 revenue per year for 5 years. The salvage value will be $35,000 after the 5 years. Assume the equipment has a 25% MARR. a) Determine the IRR for the machine using interpolation. (8 points) b) Since the operator requires at least a 25% return on thier investments, should the machine be purchased? Why? (1 point + 1 point]

Answer 1

Initial investment = 150,000

Annual revenues = 60,000

Salvage Value = 35,000

Life = 5 years

MARR = 25%

a. Calculate the IRR

Calculating IRR using trial and error and interpolation

Let the rate of interest is 30%. Calculate the PW at 30%

PW = -150,000 + 60,000 (P/A, 30%, 5) + 35,000 (P/F, 30%, 5)

PW = -150,000 + 60,000 (2.43557) + 35,000 (0.26933) = 5,560.75

The PW is positive. So, increase the rate of interest to get a negative PW. Increase the rate of interest to 32%.

PW = -150,000 + 60,000 (P/A, 32%, 5) + 35,000 (P/F, 32%, 5)

PW = -150,000 + 60,000 (2.34521) + 35,000 (0.24953) = -553.85

Using interpolation

IRR = 30% + [5,560.75 – 0 ÷ 5,560.75 – (553.85)] * 2%

IRR = 31.8%

b. Should the machine be purchased?

YES. Machine should be purchased.

Why?

As the IRR is greater than MARR, the machine should be purchased.