A small manufacturing company is considering the addition of one product line (M

Question

A small manufacturing company is considering the addition of one product line (Mutually Exclusive alternatives). If the total amount of investment capital available for any of the product line of choice is shown on the table below, which one should the company undertake on the basis of rate of return? Assume the company uses a 5-year project recovery period and a MARR of 20% per year. All cash flow estimates are in $1000 units. The rate of return must determine using trial and error method NB: The rate of return must determine using trial and error method

Explanation / Answer

The evaluation of rate of return based on product lines are as follows:-

(In $000's)

Note:-

IRR has been computed above using the =IRR formula in excel.

Decision:- Since MARR is the minimum rate that should be adhered by the product line, we should select the product lines having IRR > 20%. All the product lines give IRR above the MARR, but we should select only one product line since these 4 are mutually exclusive. ie: Product line R1 should be selected as it gives the highest IRR @53%.

For your information:- IRR can be computed using trial and error method as follows-

Step-1: Compute IRR by taking two random discount rates. Here 1st discount rate shall be considered as Lr1 and second as Lr2.

Step-2: Compute NPV at Lr1 and Lr2.

Step-3: Now IRR=Lr1+(NPV1/(NPV1-NPV2))*(Lr2-Lr1)

year T3 S2 U4 R1 0 -500 -400 -700 -200 1 230 185 299 120 2 230 185 299 120 3 230 185 299 120 4 230 185 299 120 5 230 185 299 120 IRR 36% 36% 32% 53%

Note:-

IRR has been computed above using the =IRR formula in excel.

Working notes Particulars T3 S2 U4 R1 M & O/ year -400 -300 -400 -200 Revenue/Year 630 485 699 320 Cashflows 230 185 299 120

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