Modern Medical Mechanics (M 3 ) chooses one major upgrade to implement in their

Question

Modern Medical Mechanics (M3) chooses one major upgrade to implement in their production facility each year. The choice is made based only on the internal rate of return criterion. The forecasted cash flows for five alternatives are shown below. If M3 uses a MARR of 15%, which alternative should be selected? Show excel formula/calculation. Investment in Year 0 1 2 3 A Pharmaceutical robots ($675,000) $280,000 $305,000 $360,000 B X-ray quality inspection ($950,000) $350,000 $400,000 $600,000 C Security System Upgrades ($575,000) $225,000 $250,000 $400,000 D Warehouse automation ($700,000) $275,000 $300,000 $350,000 E CNC lathe ($350,000) $100,000 $150,000 $250,000 Modern Medical Mechanics (M3) chooses one major upgrade to implement in their production facility each year. The choice is made based only on the internal rate of return criterion. The forecasted cash flows for five alternatives are shown below. If M3 uses a MARR of 15%, which alternative should be selected? Show excel formula/calculation. Investment in Year 0 1 2 3 A Pharmaceutical robots ($675,000) $280,000 $305,000 $360,000 B X-ray quality inspection ($950,000) $350,000 $400,000 $600,000 C Security System Upgrades ($575,000) $225,000 $250,000 $400,000 D Warehouse automation ($700,000) $275,000 $300,000 $350,000 E CNC lathe ($350,000) $100,000 $150,000 $250,000

Explanation / Answer

Since, the choice is made on the basis of IRR, we will have to calculate the IRR for each type of alternative. The IRR can be calculated with the use of IRR Function in EXCEL/Financial Calculator. The basic formula for calculating IRR is :

NPV = 0 = Cash Flow Year 0 + Cash Flow Year 1/(1+IRR)^1 + Cash Flow Year 2/(1+IRR)^2 + Cash Flow Year/(1+IRR)^3

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Calculation of IRR with the use of EXCEL has been given below:

A) Pharmaceutical Robots:

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B) X-Ray Quality Inspection

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C) Security System Upgrades

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D) Warehouse Automation

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E) CNC Lathe

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IRR Comparision Table:

Alternative C should be selected as it has the highest IRR.

Year Cash Flow 0 -675,000 1 280,000 2 305,000 3 360,000 IRR =IRR(-675000,280000,305000,360000) = 18.04%

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