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A process control manager is considering two robots to improve materials handling capacity in the production...
A process control manager is considering two robots to improve materials handling capacity in the production of rigid shafts. Robot X has a first cost of $84,000, an annual M&O cost of $31,000, a $40,000 salvage value, and will improve revenues by $96,000 per year. Robot Y has a first cost of $146,000, an annual M&O cost of $28,000, a $47,000 salvage value, and will increase revenues by $119,000 per year. The company's MARR is 15% per year and it uses a 3-year study period for economic evaluations. Which one should the manager select a) on the basis of ROR values b) on the basis of incremental ROR values c) Which is the correct selection basis?
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Expert Solution
| Answer: | ||||||
| a) | Net present value of Robot X | |||||
| Year 0 | Year 1 | Year 2 | Year 3 | |||
| Revenue | $ 96,000.00 | $ 96,000.00 | $ 96,000.00 | |||
| Add: | Salvage | $ 40,000.00 | ||||
| A | Total | $ - | $ 96,000.00 | $ 96,000.00 | $ 136,000.00 | |
| Less: | ||||||
| Initial cost | $ 84,000.00 | |||||
| M&O cost | $ 31,000.00 | $ 31,000.00 | $ 31,000.00 | |||
| B | Total | $ 84,000.00 | $ 31,000.00 | $ 31,000.00 | $ 31,000.00 | |
| C=A-B | Cash flow | $ (84,000.00) | $ 65,000.00 | $ 65,000.00 | $ 105,000.00 | |
| D | Discount @ 15% | 1 | 0.8696 | 0.7561 | 0.6575 | |
| C*D | Present value of cash flow | $ (84,000.00) | $ 56,521.74 | $ 49,149.34 | $ 69,039.20 | |
| Net present value | $ 90,710.28 | |||||
| Net present value of Robot Y | ||||||
| Year 0 | Year 1 | Year 2 | Year 3 | |||
| Revenue | $ 119,000.00 | $ 119,000.00 | $ 119,000.00 | |||
| Add: | Salvage | $ 47,000.00 | ||||
| A | Total | $ - | $ 119,000.00 | $ 119,000.00 | $ 166,000.00 | |
| Less: | ||||||
| Initial cost | $ 146,000.00 | |||||
| M&O cost | $ 28,000.00 | $ 28,000.00 | $ 28,000.00 | |||
| B | Total | $ 146,000.00 | $ 28,000.00 | $ 28,000.00 | $ 28,000.00 | |
| C=A-B | Cash flow | $ (146,000.00) | $ 91,000.00 | $ 91,000.00 | $ 138,000.00 | |
| D | Discount @ 15% | 1 | 0.8696 | 0.7561 | 0.6575 | |
| C*D | Present value of cash flow | $ (146,000.00) | $ 79,130.43 | $ 68,809.07 | $ 90,737.24 | |
| Net present value | $ 92,676.75 | |||||
| On the basis of ROR the manager should select Robot Y as it has greater NPV of $92,676.75. | ||||||
| b) | On the basis of intremental ROR | |||||
| Year 0 | Year 1 | Year 2 | Year 3 | |||
| Incremental revenue (Robot Y- Robot X) | $ 23,000.00 | $ 23,000.00 | $ 23,000.00 | (119000-96000) | ||
| Add: | Incremental Salvage | $ 7,000.00 | (47000-40000) | |||
| A | Total | $ - | $ 23,000.00 | $ 23,000.00 | $ 30,000.00 | |
| Less: | ||||||
| Incremental Initial cost | $ 62,000.00 | (146000-84000) | ||||
| Inremental M&O cost | $ (3,000.00) | $ (3,000.00) | $ (3,000.00) | (28000-31000) | ||
| B | Total | $ 62,000.00 | $ (3,000.00) | $ (3,000.00) | $ (3,000.00) | |
| C=A-B | Cash flow | $ (62,000.00) | $ 26,000.00 | $ 26,000.00 | $ 33,000.00 | |
| D | Discount @ 15% | 1 | 0.8696 | 0.7561 | 0.6575 | |
| C*D | Present value of cash flow | $ (62,000.00) | $ 22,608.70 | $ 19,659.74 | $ 21,698.04 | |
| Net present value | $ 1,966.47 | |||||
| On the basis of incremental ROR Robot Y should be selected as it has an incremental NPV of $1,966.47 | ||||||
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