Question

CB Electronics must buy a piece of equipment to place electronic components on the printed circuit boards it assembles. The proposed equipment has a 10-year life with no scrap value.

The supplier has given CB several purchase alternatives. The first is to pay $175,000 now and $100,000 at the end of each year for the next 10 years. The second is to pay for the equipment in 10 equal installments of $140,000 each, starting one year from now. The third is to pay $725,000 now.

i) Which alternative should CB choose if their MARR is 15% per year? Use an IRR comparison approach.

ii) Below what MARR does it make sense for CB to buy the equipment now for $725,000?

Answer 1

i) Which alternative should CB choose if their MARR is 15% per year? Use an IRR comparison approach.

ANSWER

CB should accept the first alternative.

 

WORKING

PV of first alternative = $175,000 + $100,000(P/F, 15%, 10) = $175,000 + $100,000(6.145) = $175,000 + $614,500 = $789,500

 

PV of second alternative = $140,000(P/A, 15%, 10) = $140,000(6.145) = $855,430

 

PV of third alternative = $725,000(P/F, 15%, 1) = $725,000(0.8696) = $632,380

 

IRR of first alternative = 20.74%

IRR of second alternative = 20.47%

IRR of third alternative = 15.00%

The first alternative has the highest IRR and should be accepted.

 

ii) Below what MARR does it make sense for CB to buy the equipment now for 

$725,000?

ANSWER

The equipment should be bought now for $725,000 when the MARR is 13.64% per year.

 

WORKING

PV of first alternative = $175,000 + $100,000(P/F, MARR, 10) = $175,000 + $100,000(6.145) = $175,000 + 

$614,500 = $789,500

 

PV of second alternative = $140,000(P/A, MARR, 10) = $140,000(6.145) = $855,430

 

PV of third alternative = $725,000(P/F, MARR, 1) = $725,000(0.8696) = $632,380

 

IRR of first alternative = 20.74%

IRR of second alternative = 20.47%

IRR of third alternative = 15.00%

 

The third alternative should be accepted when the MARR is 13.64% per year.