Question

y Sdn. Bhd. is evaluating new FastBits Electronic Compan precision inspection devices to help verify package quality. The manager has obtained the following bids from four All devices have a life of five years and a minimum attractive rate of return of 5%. The alternatives are mutually exclusive. companies Descriptio Company A Company B Company C Company D Initial Cost (RM 350000 Anmual Costs (RM) 900 Net Cash Flows (RM) 87500 IRR 112000 550000 23000 200000 12000 1360 137500 12.4% 9000 46200 7.9% 7.9% 5% Determine the annual benefits of the devices from all four companies Company A: Company B Company C: Company D:Forma:46400 Device from which company has the highest annual benefit? Format 58800 Format: 32690 Format: 890700 Format: A FastBits should reject the bid from which company based on the given individual IRR? Using incremental internal rate of return analysis, from which company, if any, should the manager purchase the new precision inspection device? Use trial and error method with 5% and 1 190 Format: A interest rates. Understood? (YN) Format : A Step 1-Eliminate Company Step 2 - Rank Company from no 1-2-3 Format: A Format X-X-X Step 4 Incremental IRR first comparison Step 5 - Remove Company from selection Repeat Step 4 Incremental IRR 2nd comparison Step 5 Choose Company Format : 2.4 : A Format : 5.6 Demonstrate that the same c Format Format: A ompany selection would be made with proper application of the Present Worth (PW) method. PW Company A Format: 59967 Format: 28729 Format: 78806 Format:35 PW Company B PW Company C PW Company D Thus, choose Company Format: A

Answer 1

Answer:

Please recall that Net Cash flow = Annual benefits - Annual Cost

Hence, Annual benefit = Net cash flow + Annual cost

The Net cash flow and Annual cost have been provided in the question. Hence we can calculate the left hand side of the equation by adding net cash flow to the annual cost. Please see the table below:

Description	Linkage	Company A	Company B	Company C	Company D
Initial Cost	P	370,000	112,000	510,000	200,000
Annual Cost	Q	900	12,000	23,000	9,000
Net cash flow	R	92,500	31,360	127,500	46,200
Annual benefit	S = R + Q	93,400	43,360	150,500	55,200

So, please fill your answers as below

Annual benefit of

Company A: 93400

Company B: 43360

Company C: 150500

Company D: 55200

Device from which company has the highest annual benefit?: C

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If a bid has to be rejected on the basis of IRR, reject the bid with IRR less than equal to MARR of 5%. Company's D bid has least IRR of 5% which is just equal to MARR. Hence reject Company's D bid.

FastBits should reject bid from which company based on the given individual IRR?: D

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Understood (Y/N): Y

Step -1: Eliminate Company: D

We eliminate D upfront because its bid has the least IRR and IRR just equal to MARR.

Step -2:Rank Company 1-2-3: C-A-B

I have ranked on the basis of NPV at discount rate of 5%. Please see table below:

Year	Linkage	-	1	2	3	4	5	NPV@5%
Cash flows of
Company A	A	(370,000)	92,500	92,500	92,500	92,500	92,500	30,477
Company B	B	(112,000)	31,360	31,360	31,360	31,360	31,360	23,772
Company C	C	(510,000)	127,500	127,500	127,500	127,500	127,500	42,008

Step-3 NPV has been calculated using NPV function in excel. For example, NPV of company A has been calculated as = -370,000 + NPV(5%, 92500, 92500, 92500, 92500, 92500) = 30,477

There is no step 3 in the question

Step-4

Let's have A - B as the first comparison. Please see the table below:

Year	Linkage	-	1	2	3	4	5	NPV@5%	NPV@10%
Cash flows of
Company A	A	(370,000)	92,500	92,500	92,500	92,500	92,500
Company B	B	(112,000)	31,360	31,360	31,360	31,360	31,360
Company C	C	(510,000)	127,500	127,500	127,500	127,500	127,500
Company A - Company B	A - B	(258,000)	61,140	61,140	61,140	61,140	61,140	6,704	(26,231)
Company C - Company A	C - A	(140,000)	35,000	35,000	35,000	35,000	35,000	11,532	(7,322)

IRR_A-B = Point interpolated between 5% and 10% = 5% + (10% - 5%) x [6,704 / (26,231 + 6,704)] = 6.02% which is greater than MARR of 5%. Hence select A over B.Please see the highlighted row above. Incremental cash flows for A - B have been calculated and then NPV of this series has been calculated at discount rate of 5% and 10%.

Step -4 Incremental IRR first comparison: 6.0

Step-5 Remove company from selection: B

Repeat step 4 for second comparison

Consider C - A. Please see the table above once more, the last row. Incremental cash flows for C - A are given. NPV at 5% and 10% have been calculated, please see the last two columns.

IRR_C-A = Point interpolated between 5% and 10% = 5% + (10% - 5%) x [11,532 / (11,532 + 7,322)] = 8.06% which is greater than MARR of 5%. Hence select C over A.

Repeat Step -4 Incremental IRR second comparison: 8.1

Repeat Step-5 Choose Company: C

Present worth method:

Present worth is NPV at MARR

Hence, PW of Company A's offer @ 5% = -370,000 + NPV(5%,92500, 92500,92500, 92500,92500) = 30,477

Apply the similar equation for Company B & C as well. the result is summarised below.

PW Company A: 30477

PW of Company B: 23772

PW of Company C: 42008

Since Company C has the highest PW, thus

Choose Company: C