The Board of Trustees has decided that we should attempt to expand our service o

Question

The Board of Trustees has decided that we should attempt to expand our service offering. They want you to evaluate the information below and determine if this is a project we should move forward with.

The MRI Trailer costs $600,000 and has an expected life of 5 years with an estimated salvage value of $200,000 at that time. After some extensive research, the numbers we have come up with look like this:

In the Excel spreadsheet template:

This is how is should be set up on the excel sheet:

MRI Trailer Purchase Year 0 1 2 3 4 5 Equipment Cost Net Revenues Less: Labor/Maintenance Costs Utilities Costs Supplies Incremental Overhead Operating Income Equipment Salvage Value Net Cash Flow Net Present Value (NPV) Internal Rate of Return (IRR)

Explanation / Answer

RI Trailer Purchase Year 0 1 2 3 4 5 Equipment Cost -600000 Net Revenues 300000 315000 330750 347287.5 364651.875 Less: Labor/Maintenance Costs -100000 -105000 -110250 -115762.5 -121550.625 Utilities Costs -10000 -10500 -11025 -11576.25 -12155.0625 Supplies -18750 -19687.5 -20671.875 -21705.46875 -22790.74219 Incremental Overhead -5000 -10250 -15762.5 -21550.625 -27628.15625 Operating Income 166250 169562.5 173040.625 176692.6563 180527.2891 Equipment Salvage Value 200000 Net Cash Flow -600000 166250 169562.5 173040.625 176692.6563 380527.2891 Net Present Value (NPV) 178239.6133 Internal Rate of Return (IRR) 19.64% yes the project can be accepted as the NPV is positive also the IRR is more than the cost of capital Assumption incremental overhead increase means over head increases every year by 5000 i.e 5000 in year 1 then 5000 + 5000 = 10000 in year 2.To this 10000 I have added inflation of 5% on 5000 = 250 making it a total of 10250 in year 2 Alternatively it can be said that incremental overhead is increase in relation to other projects in that 5000 will be constant i.e 5000 in all the years + the inflation @ 5%.this line needs to be altered as given below RI Trailer Purchase Year 0 1 2 3 4 5 Equipment Cost -600000 Net Revenues 300000 315000 330750 347287.5 364651.875 Less: Labor/Maintenance Costs -100000 -105000 -110250 -115762.5 -121550.625 Utilities Costs -10000 -10500 -11025 -11576.25 -12155.0625 Supplies -18750 -19687.5 -20671.875 -21705.46875 -22790.74219 Incremental Overhead -5000 -5250 -5512.5 -5788.125 -6077.53125 Operating Income 166250 174562.5 183290.625 192455.1563 202077.9141 Equipment Salvage Value 200000 Net Cash Flow -600000 166250 174562.5 183290.625 192455.1563 402077.9141 Net Present Value (NPV) 214220.0636 Internal Rate of Return (IRR) 21.33% yes the project can be accepted as the NPV is positive also the IRR is more than the cost of capital

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