A firm is considering which of two machines to install to reduce costs. Both mac

Question

A firm is considering which of two machines to install to reduce costs. Both machines have useful life of 5 years and no salvage value. Machine A costs 826 QAR and can be expected to result in 200 QAR savings annually. Machine B costs 1,450 QAR and will provide cost savings of 300 QAR the first year but will increase 50 QAR annually, making the second-year savings 350 QAR, the third-year savings 400 QAR and so forth. 1. Develop the cash flow series (Incremental Cash Flow Table) 2. Set up the present worth relation for the incremental ROR. 3. If the company's MARR is 10% per year, determine which machine should be selected based on incremental present worth ROR analysis? 4. Find the exact ROR.

Explanation / Answer

a) The incremental cash flow is shown below

b) For fiding the ROR, we need to show that PW = 0

-624 + 100(P/A, i%, 5) + 50(P/G, i%, 5) = 0

c) The rate of return that satisfies condition b is found to be 15%. This implies that machine B should be chosen because incremental ROR is > MARR which is 10%

d) Interpolation gives ROR = 14.998%

Cash flows End of year A B B-A 0 -826 -1450 -624 1 200 300 100 2 200 350 150 3 200 400 200 4 200 450 250 5 200 500 300

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