Schneeberger, Inc. is considering investing in one of two alternatives for incre

Question

Schneeberger, Inc. is considering investing in one of two alternatives for increasing the acceleration of its linear motor actuators. The first, alternative X, requires an initial investment of $175,000 and its cash flows exhibit an annual rate of return of i*x = 23%. The second, alternative Y, requires an initial investment of $145,000 and its cash flows have an annual rate of return of i*Y = 15%. Schneeberger’s MARR is 20% per year. Answer the following questions;

(a) Will the rate of return on the incremental investment in X be larger or smaller than i*X?

(b) What is the expected i*X-Y?

Please show all work thoroughly.

Explanation / Answer

(A)

alternative X

alternative Y

initial investment of $175,000

annual rate of return of i*X = 23%

MARR= minimum acceptable rate of return is 20% per year

initial investment of $145,000

annual rate of return of i*Y = 15%

MARR is 20% per year

Alternative X is acceptable as in this case annual rate of return is greater than MARR. rate of return on the incremental investment in X will be larger than in case Y.

Also, from solution in (b) obtained because the incremental ROR = 61.6% > MARR = 20%, the incremental investment in X over Y is desirable.

Y is do-nothing alternative in this case and therefore rejected.

(b) What is the expected i*X-Y?

Alternative X (ROR = 23%)

EOY

NCF ($)

0

- 175000

1

+ 215250

Alternative Y (ROR = 15%)

EOY

NCF ($)

0

- 145000

1

+ 166750

EOY 0: -175000 - (-145000) = -30,000

EOY 1: +215250 - (+ 166750) = +48500

EOY

Incremental NCF ($)

0

-30000

1

+ 48500

i*X-Y= Incremental ROR on NCF= (48500 - 30000) / 30000 = 0.616 = 61.6%

alternative X

alternative Y

initial investment of $175,000

annual rate of return of i*X = 23%

MARR= minimum acceptable rate of return is 20% per year

initial investment of $145,000

annual rate of return of i*Y = 15%

MARR is 20% per year

Alternative X is acceptable as in this case annual rate of return is greater than MARR. rate of return on the incremental investment in X will be larger than in case Y.

Also, from solution in (b) obtained because the incremental ROR = 61.6% > MARR = 20%, the incremental investment in X over Y is desirable.

Y is do-nothing alternative in this case and therefore rejected.

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