Question

A company is considering purchasing the following 4 different pieces of equipment of the same useful life of 5 years. The company can obtain a 15% annual return on its investment in other projects and is willing to invest money on one of the four pieces, as long as it can obtain 15% annual return on each increment of money invested. Which one, if any, of the alternatives should be selected? Use rate of return analysis.

	A	B	C	D
Initial investment	$10,000	$18,000	$25,000	$$30,000
Annual savings	$4,000	$6,000	$7,500	$9,000
Annual cost	$2,000	$3,000	$3,000	$4,000

Answer 1

For each option, Annual Net Benefit (NAB) = Annual benefit - Annual cost

Rate of return (ROR) of NAB are calculated by Excel IRR function.

Option - A
Year	Benefit	Cost	NAB
0		10000	-10000
1	4000	2000	2000
2	4000	2000	2000
3	4000	2000	2000
4	4000	2000	2000
5	4000	2000	2000
		ROR =	0.00%
Option - B
Year	Benefit	Cost	NAB
0		18000	-18000
1	6000	3000	3000
2	6000	3000	3000
3	6000	3000	3000
4	6000	3000	3000
5	6000	3000	3000
		ROR =	-5.79%
Option - C
Year	Benefit	Cost	NAB
0		25000	-25000
1	7500	3000	4500
2	7500	3000	4500
3	7500	3000	4500
4	7500	3000	4500
5	7500	3000	4500
		ROR =	-3.41%
Option - D
Year	Benefit	Cost	NAB
0		30000	-30000
1	9000	4000	5000
2	9000	4000	5000
3	9000	4000	5000
4	9000	4000	5000
5	9000	4000	5000
		ROR =	-5.79%

Since all the Options has zero or negative ROR, No Option should be selected.