The company wishes to purchase a piece of equipment for various metals recycling
ID: 2493095 • Letter: T
Question
The company wishes to purchase a piece of equipment for various metals recycling. Machine 1 costs $50,000 with annual revenue of $42,500. Machine 2 costs $113,000, with $84,500 annual revenue. The MARR is 15%. Assume a life of 4 years.
a) List the table of Incremental Cash Flow based on the two alternatives.
b) Calculate the Incremental IRR for the company's investment.
c) Which alternative should be chosen? Why?
Machine 1 Machine 2 Initial Cost 50,000 113,000 Annual O&M Saving 42,500 84,500 Project Life 4 Years 4 YearsExplanation / Answer
Answer: a)
Incremental cash flow = Cash flow from larger project - Cash flow from smaller project
Here, the larger project is Machine 2 and smaller project is Machine 1.
Therefore, Incremental cash flow = Cash flow from Machine 2 - Cash flow from Machine 1
Note: Year 0 represents initial cost of the machines. Since it is a cash outflow , therefore, it is a negative item.
Answer:b)
Calculation of Incremental IRR:
Therefore, the incremental IRR of the company's investment is 55%.
Answer: c)
Since IRR of 55% is more than MARR of 15%, therefore, alternative of Machine 2 should be chosen because it is the larger project which resulted in greater IRR of 40% (55% - 15%).
Year Machine 1 Machine 2 Incremental cash flow = Machine 2 - Machine 1 0 -50000 -113000 -63000 1 42500 84500 42000 2 42500 84500 42000 3 42500 84500 42000 4 42500 84500 42000