QUESTION 3 Not complete Points out of 3.00 Flag question Payback Period and IRR

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QUESTION 3 Not complete Points out of 3.00 Flag question Payback Period and IRR of a Cost Reduction Proposal-Differential Analysis A light-emitting diode (LED) is a semiconductor diode that emits narrow-spectrum light. Although relatively expensive when compared to incandescent bulbs, they use significantly less energy and last six to ten times longer, with a slow decline in performance rather than an abrupt failure. Metropolitan City currently has 80,000 incandescent bulbs in traffic lights at approximately 12,000 intersections. It is estimated that replacing all the incandescent bulbs with LED will cost $54.03 million. However, the investment is also estimated to save the City $11.1 million per year in energy costs. a. Determine the payback period of converting Metropolitan City traffic lights to LEDs Round answer to one decimal place. years b. If the average life of an incandescent streetlight is one year and the average life of an LED streetlight is seven years, should the City finance the investment in LED's at an interest rate of five percent per year? Justify your answer. 1. Compute the internal rate of return on the project. Round to the nearest whole percent. 2. Select the most appropariate answer based on computation. :No, the City should not make the investment because the IRR of the investment in LEDs is 50% of the interest rate Yes, the City should make the investment because the IRR of the investment in LEDs is 50% of the interest rate. ·No, the City should not make the investment because the IRR of the investment in LEDs is 200% of the interest rate. Yes, the City should make the investment because the IRR of the investment in LEDs is 200% of the interest rate. Check

Explanation / Answer

Answer:

Payback Period

= Total Project Cost/Annual Cash Flows

=54.03/11.1

= 4.867

=4.87 years

It means 4 Years 10 months 12 days (12X0.867= 10.40, 30X0.40= 13)

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2)

Yes, City should finance the investment in LED even at 5% interest rate. Justification is as follows:

Interest expense:
$54.03 million X 5%= $2.70 million

Saving in Cost: $11.1 million

Net Saving per year

=11.1-2.70

= $8.40 million

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3

Iternal rate of return on the project is

0=-54.03 + 11.1(1+r)1+11.1(1+r)2+11.1(1+r)3+11.1(1+r)4+11.1(1+r)5+11.1(1+r)6+11.1(1+r)7

solving this equation we will get IRR
IRR =10 %

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4

Yes, City should make the investment becuase IRR of the investment in LED is 200% of the interest rate

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