Question

Audrey Raines, P.Eng. is a project engineer at an electronics company. She is evaluating replacing one of the plant’s manual assembly lines with automated equipment. The project is expected to cost $500,000 but will have savings of $100,000 per year in labour and $20,000 per year due to quality improvements. If the company’s MARR is 8% and the project’s life is 6 years, what is the external rate of return? Should Audrey go ahead with this project?

Answer 1

Initial cost = $ 500,000

Annual saving = $ 100,000 + $ 20,000 = $ 120,000 per year

MARR = 8%

Useful life = 6 years

We are required to determine the External rate of return. Convert the cost into present value and saving into terminal value.

PV of cost = $ 500,000

Future value of saving is

Now the external rate of return can be determined as follows

External rate of return = 8.68 %

The external rate of return is greater than the MARR are therefore the company should go ahead with the project.

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