Question

A long-term project you are currently working on, as a project manager, will be completed in 9 years. One of the site supervisors approaches you with idea of buying a bigger compacting machine. After some analysis, you identify that you can save five (5) workers' wages to a value of R145 000 per annum for the next five years if you replace the workers with the mentioned machine. The machine costs R450 000 and you can sell it for R25 000 at the end of 5 year period. The company required rate of return is 15%. Determine and interpret the net present value (NPV) of the project (6) b. Determine and interpret the internal rate of return (IRR) for the project (7) If the NPV of this proposed idea is RO based on a required rate of return of 15%, would you recommend the company to go-ahead with the decision? (2) a. C.

Answer 1

	Year 0	Year1	Year2	Year3	Year4	Year4
Wages savings		145000	145000	145000	145000	145000
Machine cost	-450000
Salvage value						25000
Net cashflow	-450000	145000	145000	145000	145000	170000

a. NPV = initial investment + present value of savings from year 1 to year 5
	=-450000 + NPV (15%, Year 1 to Year 5 cashflow)
	=E6+NPV(15%,F6:J6)	48,492
NPV is positive means the machine cost is justified in terms of savings attained in wages which
is higher over a period of 5 years

b.

b. IRR of the project is the internal return we are getting on our investment in machine
For IRR, we equare the investment to present value of future savings to determine the rate
In excel we use the IRR formula as below:
	=IRR(E6:J6)	19.4%
This is a good IRR and since this is higher than company's reqd rate of return of 15%, the investment is good

c. If the NPV of this ideas is R0 based on 15% return, would you recommend the company to go ahead with this?

If the NPV is zero, this project is not justified since we are not gaining any benefits in monetary terms and letting

go of 5 workers wages may also be not right from the labour management standpoint in that case

Excel snapshot given below:

A B С D E F G Н. J к 1 2 Year 0 Year1 145000 Year2 145000 Year3 145000 Year4 145000 Year4 145000 3 4 -450000 Wages savings Machine cost Salvage value Net cashflow 5 25000 170000 6 -450000 145000 145000 145000 145000 7 8 9 10 a. NPV = initial investment + present value of savings from year 1 to year 5 =-450000 + NPV (15%, Year 1 to Year 5 cashflow) =E6+NPV(15%,F6:J6) 48,492 NPV is positive means the machine cost is justified in terms of savings attained in wages which is higher over a period of 5 years 11 12 13 14 15 16 17 18 19 20 21 22 b. IRR of the project is the internal return we are getting on our investment in machine For IRR, we equare the investment to present value of future savings to determine the rate In excel we use the IRR formula as below: =IRR(E6:J6) 19.4% This is a good IRR and since this is higher than company's reqd rate of return of 15%, the investment is good c. If the NPV of this ideas is RO based on 15% return, would you recommend the company to go ahead with this? If the NPV is zero, this project is not justified since we are not gaining any benefits in monetary terms and letting go of 5 workers wages may also be not right from the labour management standpoint in that case 23