Cost Reduction Proposal: IRR, NPV, and Payback Period JB Chemical currently disc
ID: 2584888 • Letter: C
Question
Cost Reduction Proposal:
IRR, NPV, and Payback Period
JB Chemical currently discharges liquid waste into Calgary's municipal sewer system. However, the Calgary municipal government has informed JB that a surcharge of $4 per thousand cubic liters will soon be imposed for the discharge of this waste. This has prompted management to evaluate the desirability of treating its own liquid waste.
A proposed system consists of three elements. The first is a retention basin, which would permit unusual discharges to be held and treated before entering the downstream system. The second is a continuous self-cleaning rotary filter required where solids are removed. The third is an automated neutralization process required where materials are added to control the alkalinity-acidity range.
The system is designed to process 500,000 liters a day. However, management anticipates that only about 200,000 liters of liquid waste would be processed in a normal workday. The company operates 300 days per year. The initial investment in the system would be $360,000, and annual operating costs are predicted to be $150,000. The system has a predicted useful life of twelve years and a salvage value of $40,000.
(a) Determine the project's net present value at a discount rate of 26 percent. (Round to the nearest whole number. Use a negative sign with your answer if appropriate.)
$ Answer
(b) Determine the project's approximate internal rate of return. (Round to the nearest whole percentage.)
Answer %
(c) Determine the project's payback period.
Answer years
Explanation / Answer
Saving of surcharge of discharge if proposed system is installed:
(200000/1000 * $ 4)
=
$800 per day
No. of days
=
300 days
Annual saving
(800 * 300)
=
$240,000
Annual operating cost
=
($150,000)
Net Savings Annually
=
$90,000
NPV for Proposed System
YEAR
VALUE
DISCOUNT VALUE @ 26%
PRESENT VALUE
Initial cost
0
-360000
1.0000
-360000
Net Savings Annually
1-12
90000
3.6059
324531
Salvage value
12th
40000
0.0625
2500
-32969
(a) Project's NPV is $-32969
(b) IRR is the discounting rate which will result in NPV zero. Here NPV is -32969 when discounting rate is 26%.
and NPV is 44016 when Discount rate is 20%. Using trial and error, we get IRR
IRR
23.15%
(c) Payback period
Since NPV is negative for 12 years @ 26% payback is for more than 12 years.
Hence, with the given life of proposed system and 26% discount rate, company
is not going to realize its initial investment in a period of 12 years.
Saving of surcharge of discharge if proposed system is installed:
(200000/1000 * $ 4)
=
$800 per day
No. of days
=
300 days
Annual saving
(800 * 300)
=
$240,000
Annual operating cost
=
($150,000)
Net Savings Annually
=
$90,000
NPV for Proposed System
YEAR
VALUE
DISCOUNT VALUE @ 26%
PRESENT VALUE
Initial cost
0
-360000
1.0000
-360000
Net Savings Annually
1-12
90000
3.6059
324531
Salvage value
12th
40000
0.0625
2500
-32969
(a) Project's NPV is $-32969
(b) IRR is the discounting rate which will result in NPV zero. Here NPV is -32969 when discounting rate is 26%.
and NPV is 44016 when Discount rate is 20%. Using trial and error, we get IRR
IRR
23.15%
(c) Payback period
Since NPV is negative for 12 years @ 26% payback is for more than 12 years.
Hence, with the given life of proposed system and 26% discount rate, company
is not going to realize its initial investment in a period of 12 years.