Garrett Boone, Flint Enterprises’ vice president of operations, needs to replace

Question

Garrett Boone, Flint Enterprises’ vice president of operations, needs to replace an automatic lathe on the production line. The model he is considering has a sales price of $410,950 and will last for 12 years. It will have no salvage value at the end of its useful life. Garrett estimates the new lathe will reduce raw materials scrap by $38,300 per year. He also believes the lathe will reduce energy costs by $27,250 per year. If he purchases the new lathe, he will be able to sell the old lathe for $4,907. Click here to view the factor table.

(a) Calculate the lathe’s internal rate of return.

Explanation / Answer

IRR = WHERE Present value of cash outflows = present value of cash inflows

Present value of cash outflow = $410,950-$4,907 (Old machine sale value) = $406,043

Annual cashflows per annum= (savings) = 38,300+27250 =$65,550

Annuty factor for 12 year at present value of cashflows = present value of cash outflows = $406,043/$65,550 =6.1944

See annuity factor table for 12 years for 6.1944 at what rate = 12%

At 12% for 12 years annuity factor = 6.1944 there p.v of cash flows = p.v of cash outflows

Therefore 12% is IRR

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