Question

You are a water filter manufacturer trying to decide if you should invest in an automatic or manually operated machinery. Both alternatives’ present costs are pegged at $5000, however, they lead to different revenue patterns thereafter. The automatic machine allows for higher production levels and thus more revenues immediately, however more energy costs over time than the manual machine means that net revenues diminish over time. The manual machine does not produce as many filters initially but has no energy cost, so its net revenues increase over time. The expected net revenues of the automatic machine are $3200, $1500, $690, and $310 by the ends of years one to four, respectively. The expected net revenues for the manual machine are $280, $710, $1900, and $3000 by the ends of years one to four, respectively.

1. Calculate the Internal Rate of Return of each alternative and compare them. Which is more feasible?

2. Knowing the MARR is 8%, use NPW analysis to compare these alternatives and find out which one is better.

3. Calculate the benefit cost ratio of the both alternatives.

Answer 1

Year	Cashflow Automatic Machine	Cashflow Manual Machine	PVF @ 8%	PV Cashflow Automatic Machine	PV Cashflow Manual Machine
N	A	B	C=1/1.08^N	D=A*C	E=B*C
-	-5,000	-5,000	1.000	-5,000	-5,000
1	3,200	280	0.926	2,963	259
2	1,500	710	0.857	1,286	609
3	690	1,900	0.794	548	1,508
4	310	3,000	0.735	228	2,205
IRR	8.3%	5.1%	NPW(Sum of D/E)	25	-419
Benefit Cost ratio	1.14	1.18

1. IRR is calculated in EXCEL by using formula = IRR(Cashflows)

As IRR of Project A is higher we will select Automatic Machine.

2. Based on MARR of 8%, Automatic Machine is resulting in higher NPW hence it should be selected.

3. Benefit Cost (BC) Ratio of Automatic Machine = (3200+1500+690+310)/5000

Benefit Cost (BC) Ratio of Manual Machine = (280+710+1900+3000)/5000

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