A manufacturer receives components, that go into its products, in cardboard boxe

Question

A manufacturer receives components, that go into its products, in cardboard boxes. The company is currently paying a fee of $16,000 per year to have the discarded boxes picked up and hauled away to a landfill for disposal. A local paperboard recycler is willing to pay the company $4,000 per year for the cardboard, but they will not pick up the cardboard at the plant. The manufacturer estimates that it would cost them $12,000 per year to haul the cardboard to the recycler, which means they would only break even, but if they installed a compactor for the boxes, the hauling cost would drop to $5,000 per year. The compactor will cost $14,000 to install and $1,000 per year to operate. Which option is the best investment, based on the internal rate of return? Assume a five-year life for the compactor and a 10 percent discount rate.

Explanation / Answer

In the first case there is no internal rate of return.

In the second case, IRR = 12000/4000 = 3

In the third case, IRR = (14000*0.90+5000)/5000 = 3.52

therefore third option is best for investment.

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