A small manufacturing company is considering the addition of one product line (M

Question

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 determine using trial and error method. NB: The rate of return must determine using trial and error method

Explanation / Answer

For this we have to calculate IRR with highest IRR Lets calculate NPV first so that we can think what can be approximate IRR T3 S2 U4 R1 Revenue per year 630 485 699 320 M& O Cost -400 -300 -400 -200 Cash Inflow C 230 185 299 120 Cash inflow for 5 Years   1150 925 1495 600 PVIFA(20%,5)    P 2.9906 2.9906 2.9906 2.9906 Present Value of cash inflow C*P 688 553 894 359 Less: Intial cash outflow -500 -400 -700 -200 NPV 188 153 194 159 Now IRR is where NPV=0 Lets take following % 35% 35% 35% 35% 36 36 32 52.8 PVIFA(35%,5)    P 2.2199 2.2199 2.2199 2.2199 Present Value of cash inflow C*P 511 411 664 266 Less: Intial cash outflow -500 -400 -700 -200 NPV 11 11 -36 66 So it will be slight more for T3 and S2 36% 36% U4 will be less as NPV is negative 32% R1 rate will be much more 52% PVIFA(36%,5)    P 2.1807 2.1807 PVIFA(32%,5)    P 2.3452 PVIFA(53%,5)    P 1.6617 Present Value of cash inflow C*P 502 403 701 199 Less: Intial cash outflow -500 -400 -700 -200 NPV 2 3 1 -1 IRR is approximately (rounded off) 36% 36% 32% 53% Rank 3 2 3 1 So the company should go with R1

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