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

Year	0	1	2	3	4	5
Initial purchase cost(25000*10)	-250000
Installation costs(15000*3)	-45000
Maintenance expenses(2500*10)					-25000	-25000
Savings in electrical costs(2000*10)		20000	20000	20000	20000	20000
Savings in A/c costs(1000*10)		10000	10000	10000	10000	10000
Total cash flows	-295000	30000	30000	30000	5000	5000
IRR	-35%

NPV of the CFs at 2.5%p.a.=

Discounting the 1st 3 months installation costs at 2.5%/12= 0.208% p.m. & the balance yr.1 to yr. 5 CFs at 2.5% p.a.

NPV= -250000-(15000/1.00208^1)-(15000/1.00208^2)-(15000/1.00208^3)+(30000/1.025^1)+(30000/1.025^2)+(30000/1.025^3)+(5000/1.025^4)+(5000/1.025^5)=

-200183.72

No. There is NO case for this project as it's NPV is NEGATIVE

& it's break-even rate , ie. The IRR, -35% ---- does not meet the required IRR of 15%