Question

A factory is considering two investment alternatives to replace the equipment in one of its areas of production, given the existing equipment is vastly deteriorated.

	Proyect A	Proyect B
Cost of Equipment	$82,000	$94,000
Expected Annual Savings	$18,100	$16,500
Residual Value	$21,400	$22,850
Useful Life (years)	10	10

Annual maintenance costs are presumed identical for both alternatives. The company is going to make one of the investments, which is why not doing anything is not considered a viable alternative. The minimum rate of return (MARR) is 8%. Graph the diagram for the box plot of the increment. Determine the best alternative through an incremental internal return rate analysis.

Answer 1

Incremental Cash flow analysis:

	Project A	Project B	Difference
Cost of Equipment	($82,000)	($94,000)	$12,000
Expected Annual Savings	$18,100	$16,500	$1,600
Residual Value	$21,400	$22,850
Cash Flow last year (Expected saving for year 10 + residual value)	$39,500	$39,350	$150
Year	Cash flow of Project A	Cash flow of Project B	Incremental cash flow (A-B)
0	($82,000)	($94,000)	$12,000
1	$18,100	$16,500	$1,600
2	$18,100	$16,500	$1,600
3	$18,100	$16,500	$1,600
4	$18,100	$16,500	$1,600
5	$18,100	$16,500	$1,600
6	$18,100	$16,500	$1,600
7	$18,100	$16,500	$1,600
8	$18,100	$16,500	$1,600
9	$18,100	$16,500	$1,600
10	$39,500	$39,350	$150
IRR	19.10%	13.55%

An incremental internal return rate analysis is not possible because all the incremental cash flows values are positive. But from IRR of individual projects, we can identify that project A is superior than project B, and both are more than MARR rate of 8%.

Best alternative is Project A

Graph the diagram for the box plot of the increment.