Please use the Challenger-Defender rate of return analysis (pair-wise incrementa
ID: 2781612 • Letter: P
Question
Please use the Challenger-Defender rate of return analysis (pair-wise incremental analysis)
2. Problem 8-38. (70 points) The New England Soap Company is considering adding some processing equipment to the plant to aid in the removal of impurities from some raw materials. By adding the processing equipment, the firm can purchase lower-grade raw material at reduced cost and upgrade it for use in its products. Four different pieces of equipment, all with 20year lives, are being considered. S18,000 TS25000 S6,000 S7,500 S30000 $9,000 Initial cost TS10,000 Annual Benefit S4,000 (savings in materials cost) Annual S2,000 Operating Cost S3,000 S3,000 S4,000 The company can obtain a 15% annual return on its investment in other projects and is willing to invest money on the processing equipment only as long as it can obtain 15% annual return on each increment of money invested, which one, if any, of the alternatives should be selected ? Use a challengerdefender rate of analysis pain -wise incremental return - analysisExplanation / Answer
Answer :
The New England Soap Company has five alternative i.eprocessing equipmentA, B, C and D , do not invest in processing equipment .
We will calculate rate of return in each case and the case rate of return is maximum will be the best alternative .
Processing equipment A
Initial investment = $10,000
Annual saving in materials costs = $4,000
Annual operating cost = $2,000
Hence total return = 4,000 - 2,000
= $2,000
Rate of return = (2000/10,000)*100
= 20%
Processing equipment B
Initial investment = $18,000
Annual saving in materials costs= $6,000
Annual operating cost = $3,000
Hence total return = 6,000 - 3,000
= $3,000
Rate of return = (3000/18,000)*100
= 16.67%
Processing equipment C
Initial investment = $25,000
Annual saving in materials costs = $7,500
Annual operating cost = $3,000
Hence total return = 7,500 - 3,000
= $4,500
Rate of return = (4500/25,000)*100
= 18%
Processing equipment D
Initial investment = $30,000
Annual saving in materials costs = $9,000
Annual operating cost = $4,000
Hence total return = 9,000 - 4,000
= $5000
Rate of return = (5000/30,000)*100
= 16.67%
Do not invest in Processing equipment
Rate of return = 15% (By investing in other project)
Hence , Investing in Processing equipment A is the best alternative as the rate of return is maximum in this case .