Problem 1 A small manufacturing company is considering the addition of one produ

Question

Problem 1 A small manufacturing company is considering the addition of one product line (Mutually Exclusive alternatives). If the total amount of investment capital available for any of the product line of choice is shown on the table below, which one should the company undertake on the basis of rate of return? Assume the company uses a 5-year project recovery period and a MARR of 20% per year. All cash flow estimates are in $1000 units. The rate of return must be determine using trial and error method Product Lines T3 S2 U4 RI First cost, S500-400-700-200 M&O; cost, S/year-400-300-400-200 Revenue, S/year 630 485 699 320 NB: The incremental rate of return 1* must be determine using trial and error method. First comparison: two guess values are 50% and 60% Second comparison: two guess values are 18% and 19% Third comparison: two guess values are 24% and 25% Fourth comparison: two guess values are 21% and 22%

Explanation / Answer

ansss
Alternative T3:
Net revenue per year (A) = 630 - 400 = $230
Let, i = 35%
PW = -500 + 230(P/A, 35%, 5)
= -500 + 230(2.2200)
= 10.6
Let, i = 40%
PW = -500 + 230(P/A, 40%, 5)
= -500 + 230(2.0352)
= -31.9
By interpolation
i = 35% + [(10.6 - 0) / (10.6 - (-31.9))] * (40% - 35%)
= 0.35 + (10.6 / 42.5) * 0.05
= 0.3625 or 36.25%
So, Rate of return of alternative T3 is 36.25%
Alternative S2:
Net revenue per year (A) = 485 - 300 = $185
Let, i = 35%
PW = -400 + 185(P/A, 35%, 5)
= -400 + 185(2.2200)
= 10.7
Let, i = 40%
PW = -400 + 185(P/A, 40%, 5)
= -400 + 185(2.0352)
= -23.49
By interpolation
i = 35% + [(10.7 - 0) / (10.7 - (-23.49))] * (40% - 35%)
= 0.35 + (10.7 / 34.19) * 0.05
= 0.3656 or 36.56%
So, Rate of return of alternative S2 is 36.56%
Since the Rate of return of alternative S2 is greater than T3, so, alternative S3 would be selected.

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