Question

A firm is considering the purchase of a new machine to increase the productivity of existing production process. All the alternatives have a life of 10 years and they have negligible market value after 10 years. Use the IRR method (incrementally) to make your recommendation. The firm’s MARR is 10% per year.

(10 marks) A firm is considering the purchase of a new machine to increase the productivity of existing production process. All the alternatives have a life of 10 years and they have negligible market value after 10 years. Use the IRR method (incrementally) to make your recommendation. The firm's MARR is 10% per year. Alternative Capital Investment Annual Operating Cost $100,000 $20,000 $110,000 $18,500 $125,000 $17,000 $130.000 $15,500 $150,000 $10,000

Answer 1

As we seen in TABLE - 1 based on ranking the best option to recommend is Alternative - 5.

Given MARR = 10% Alternative 1. Initial capital investment = $ 3,00, ooo Present value of operating Total Annual cost (w.N.) = $1, 22,891 cost $2,22,89 1 W.N. - Annual per annum = $20,000 operating cost = 10 years. LiFe MARR : 10% calculation of Annuity factors present value for 10 years. PN. AF = 2 0, - Chaise et.... 11.10 6.1446 Preseat value on Annual Operating cost = $20,000 (6.146) = $ 1,22,891

Alternative 2 = $110,000 Initial present (+) capital investment value of Annual Operating cost (w.n-1) = $1, 13, 675 Total cost $ 2, 13, 675 W.N-2:- Annual operating cost per annum = $ 18,500 present value Annuity DOMADA factor to years = 6.1446 at MARR 10% @ cu . p. v. OF Annual operating cost $ 18,500 (6.1446) $1,13, 675 Alternative - 3 Initial capital investment = $1,25,000 A present value operating Annual cost x of Annual cost present value Annw'ty factos $ 1,04,458 $17,000 (61446) TOTal cost $ 8, 29,458

Alternative - 4 . Initial Capital Investment 130,ooo (+ present value operating of Annual cost present value Annugly factoa. Annual cost x $ 15,500 X 6.1446 $.95,241 $ 2,25,241 107 al COH Altona tive - 5 Initial capital investment = $ 150,00 0 to present value Operating Annual cost Annual cost x - present value Annuity factor $10,000 * 6.1446 $ 61,446 TOTal cost = $2, 11, 446 TEALITEEDICTITI

Table 1 Alteenative TOTal cost Ranking $ 2, 22,897 $ 2, 13, 675 $ 2,89,458 $ 2,25,241 $ 2, 11, 446 . As we seen in the above table Alternative 5 is to be recommended.