Question

. Probably Excel or other spreadsheet

You have been assigned to manage a project to upgrade all your company's data centre servers with new models. Each new server will cost you $25,000 to purchase, and you need 10 of them in total. Each new server comes with three years' free maintenance worth $2,500/year (you'll have to pay this in the fourth and fifth years). Each new server saves you $2,000/year in electrical costs. Each new server saves you $1,000/year in air conditioning expenses.

The required Internal Rate of Return (IRR) on this project, over a five year period, is 15% above breakeven. It will take you $15,000/month for three months to install the new machines. (The old ones are scrap and have no value.) After that you have no further project expenses.

Using a discount rate of 2.5% to do the discounted cash flows, is there a case for this project (it meets or exceeds the IRR) or not?

Answer 1

Initial cost = $25,000 * 10 = $250,000

Present value of installation charges = ($15,000 / 1.025^(1/12)) + ($15,000 / 1.025^(2/12)) + ($15,000 / 1.025^(3/12)) = $44,815.25

Net initial cost = $250,000 + $44,815.25 = $294,815.25

Yearly maintenance cost for 4th and 5th year = $2,500 * 10 = $25,000

Annual savings in electrical costs = $2,000 * 10 = $20,000

Annual savings in air conditioning expenses = $1,000 * 10 = $10,000

Internal rate of return of the project:

Using any percentage as discount rate will not make the project acceptable because the project's IRR is negative. Therefore, it can be said that the project does not meet the requirement of required IRR.