Question

Q3. To manufacture part of the Internet of Tea Maker we are using a hydraulic press. The operating costs of the press are $900,000 each year. There is an add-on that is available for the press. The add- on costs $190,000, has an estimated life of 30 years, and no salvage value. The use of the add-on will reduce the operating costs to $750,000 each year. The add-on itself will require $10,000 additional maintenance. Find the rate of return if the add-on is installed. i) If interest is fixed at 3%, find the payout period for the add-on. ii)

Answer 1

The rate of return is calculated from given data:

Previously the machine operating cost is $900,000 per year.

The add-on machine cost is $190,000.

The maintenance cost of add-on machine is $10,000.

The new machine operating cost is $750,000 per year.

The life of add-on machine is 30 year only.

The rate of return is calculated using NPV(Net present value) of machine from formula:

NPV = (1+i)"

where, i is the discounted rate taken as 10%,

A is net cash flow and

n is time of cash flow.

the value of rate of return or internal rate of return is calculated using spreed sheet:

Cash Flows Cumulative cash flows Year 50,000) S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S 50,000 90.000 230,000 370,000 510,000 650,000 790,000 930,000 1,070.000 1.210.000 1,350,000 1,490.000 1,630.000 1,770.000 1,910,000 2,050.000 2.190.000 2.330.000 2,470,000 2.610.000 10 12 13 15 16 17 18 19 20

S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 140,000 S S 4,150,000S 2,750.000 2,890.000 3,030.000 3.170.000 3.310.000 3.450.000 3.590.000 3,730.000 3,870.000 4,010,000 4,150,000 23 24 25 26 27 28 29 30 Total 10% Let Discounted rate of return $1,147,040.75 NPV 28000 IRR

c. 1YearCash Flows Cmulative cash flows 3 A2+1 140000 4A3+1 140000 5 =A4-1-140000 6 =A5+1 140000 7 A6+1 140000 8 =A741-140000 9A8+1 140000 10 =A9-1 |=140000 11 =A10-11-140000 12 All+1-140000 13 =A12-1-140000 4 A13+1 140000 15 =A14-11-140000 16 =A15-1-140000 17 =A16-11-140000 18 =A17-1-140000 19 A18+1 140000 20 =A19-1-140000 21 A20+1-140000 22 EA21+11 140000 23 A22+1 -140000 24 A23+1-140000 25 A24+1-140000 26 A25+11 140000 27 A26+1-140000 28 =A2741-140000 29 A28+11 140000 30 =A29-1-140000 31 A30+1-140000 32 B6+C5 B7+C6 В 10-C9 B11+C10 В 12-С11 В 13-С12 В 14-С13 B15-C14 B17+C16 B18-C17 B19 C18 B20-C19 B21-C20 B22 C21 B23 C22 B24 C23 B25+C24 B26+C25 B27+C26 B28-C27 B29-C28 B30-C29 B31+C30 Total SUM(B2:B32) SUM(C2:C32 )

35 Let Discounted rate of return 0.1 30 37 38 39 NPV NPV(B35.B2:B31) IRR IRR B2:B31)

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