Question

A process control manager is considering two robots to improve materials-handling capacity in the production of rigid shaft couplings that make dissimilar drive components. Robot X has a first cost of $94,000, an annual M&O cost $31,000, and $35,000 salvage value, and it will improve revenues by $96,000 per year. Robot Y has a first cost of $146,000, an annual M&O cost of $28,000, and $47,000 salvage value, and it will increase revenues by $125,000 per year. The company's MARR is 13% per year, and it uses a 3-year study period for economic evaluations. Calculate the incremental ROR, and identify the robot the manager should select %. The incremental ROR is 50458.40 The manager should select robot Y

Answer 1

The answer is 42.77%. Explaination is as follows:

Incremental ROR is an analysis of the financial return when 2 competing investment involving a different amount of investment occurs.

The analysis is applied to the difference between the costs of the two investments.

Thus, you would subtract cash flows from less expensive investment from the cash flows from more expensive investments. and then perform the Internal Rate of Return analysis.

Now every year the cost of maintenance and operations of x is 31000 while the rise in revenue is 96000, for y it is 28000 and 125000 respectively. We can say the real raise in revenue (revenue - M&O cost) for x = 65000 and for y is 97000.

The following excel sheet will help you understand it better

Year	y	Income	Difference	x	income	Difference	Y diff - X diff
0	-146000	0	-146000	-94000	0	-94000	-52000
1	-28000	125000	97000	-31000	96000	65000	32000
2	-28000	125000	97000	-31000	96000	65000	32000
3	-28000	125000	97000	-31000	96000	65000	32000
Resale	47000	0	47000	35000	0	35000	12000
ROR							42.77%

So the incremental rate of return is 42.77% and it being positive means Y is a better option

Think it like this:

The incremental price we pay for machine Y is less than the Incremental benefits we are getting from it.

Year	y	Income	Difference	x	income	Difference	Y diff - X diff
0	-146000	0	-146000	-94000	0	-94000	-52000
1	-28000	125000	97000	-31000	96000	65000	32000
2	-28000	125000	97000	-31000	96000	65000	32000
3	-28000	125000	97000	-31000	96000	65000	32000
Resale	47000	0	47000	35000	0	35000	12000
ROR							43%

This ROR is really an Internal rate of return formula. Used in the spreadsheet as =IRR(Values)

here =IRR(H2:H6)