A firm is considering an investment.The most likely data values were found durin

Question

A firm is considering an investment.The most likely data values were found during the feasibility study.Analyzing past data of similar projects shows that optimistic values for the first cost and the annual benefitare 5% better than most likely values.Pessimistic values are 15% worse.The firm’s most experiencedproject analyst has estimated the values for the useful life and salvage value.

Cost Net Annual Benefit Salvage Value Useful Life in Years
Optimistic $950 210 $100 12
Most Likely $1000 200 0 10
Pessimistic $1150 170 0 8

1. Compute the rate of return for each estimate.

2. If a 10% before-tax MARR is required, is the investment justified under all three scenarios?

Explanation / Answer

1.

2.

If required return is 10%,then Investment under Most likely and pessimistic case is justified because of Actual return is more than required, But in OPtimistic it is not justified as return(7%) is less than required (10%).

Case Life in Years Cost Net Annual Benefit Salvage Value Return-15% Optimistic                        12             950                210            100.00                 7.00 Most Likely                        10         1,000                200                      -                 20.00 Pessimistic                          8         1,150                170 -               15.00                      -   Return = Average Income /Average Investment Optimistic = (210+(100-950)/12)/(100+950)/2 = 7% Most Likely = 200/1000' = 20% Pessimistic = 170/1150' = 15%

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