Question

RealTurf is considering purchasing an automatic sprinkler system for its sod farm by borrowing the entire $75,000 purchase price. The loan would be repaid with four equal annual payments at an interest rate of 12%/year. It is anticipated that the sprinkler system would be used for 9 years and then sold for a salvage value of $9,000. Annual operating and maintenance expenses for the system over the 9-year life are estimated to be $15,000 per year. If the new system is purchased, cost savings of $25,000 per year will be realized over the present manual watering system. RealTurf uses a MARR of 15%/year for economic decision making. Show the internal rate of return used to reach your decision: % Based on an internal rate of return analysis, is the purchase of the new sprinkler system economically attractive? Carry all interim calculations to 5 decimal places and then round your final answer to 1 decimal place. The tolerance is +0.2.

Answer 1

First, we calculate the four annual payments for $75,000 loan @ 12%.

PMT(12%,4,-75000,0,1) = $22,046.95

Now, we plot the cash flows:

Evey year we need to add back the net benefit of $25000 -$15000 = $10000 after accounting for operating and maintainence costs.

Time	0	1	2	3	4	5	6	7	8	9
Cash Flow		-12046.95	-12046.95	-12046.95	-12046.95	10000	10000	10000	10000	19000

Solving for IRR, we get r = 4.32% which is lower than MARR of 15% and purchase is not economically attractive based on internal rate of return method.