Question

Quantum Logistics, Inc., a wholesale distributor, is considering constructing a new warehouse to serve the southeastern geographic region near the South Carolina-Georgia border. There are three cities being considered. After site visits and a budget analysis, the expected income and costs associated with locating in each of the cities have been determined. The life of the warehouse is expected to be 12 years, and MARR is 15 percent / year. Based on an internal rate of return analysis, which city should be recommended?

City	Initial Cost	Net Annual Income
Clemson	$1,260,000	$480,000
Augusta	$1,000,000	$410,000
Beaufort	$1,620,000	$520,000

Answer 1

Refer the attached picture below I have solved it using excel

The internal rate of return can be determined using trial and error method.

Assume i = 35%

Now assume rate 38%

Apply linear interpolation

IRR = 37.28%

Similarly we can determine the IRR of Augusta and Beaufort.

Calculating the IRR of Augusta

Assume a rate of 40%

Now assume rate 41%

Apply linear interpolation

Now calculate the IRR of Beaufort. Assume rate = 30%

Now assume rate = 31%

Apply linear interpolation

The internal rate of return of Augusta is highest thus select Augusta using IRR technique.

Not asked but you can use incremental IRR too to evaluate the alternative. First consider the alternative will lowest initial investment as base selection then determine the incremental cash flow. Here Augusta has the lowest initial investment thus it is the base selection then subtract the cash flow of Clemson from it. Refer the excel screenshot

The Incremental IRR of (Clemson - Augusta) = 25.09% (greater than MARR 15%)

Hence reject Augusta and select Clemson.

Now calculate the incremental cash flow between Clemson and Beaufort. Refer the attached picture below

Incremental IRR is less than MARR, 15% therefore reject the costly alternative and select the cheaper one. You must select Clemson.

Select Clemson using the incremental IRR.

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