Wheatstone Manufacturing normally spends $500,000 per year on regularly schedule

Question

Wheatstone Manufacturing normally spends $500,000 per year on regularly scheduled preventive maintenance for the equipment on its production line.  However, the recent downturn in the economy has forced Wheatstone to consider forgoing preventive maintenance during each of the next 3 years.  If Wheatstone forgoes preventive maintenance over the next 3 years, the firm will need to spend $2 million at date 4 to replace equipment that has prematurely reached the end of its economic life.  Estimate the IRR for the decision to postpone preventive maintenance and concisely discuss the conditions under postponing maintenance is a desirable short-run financial strategy for Wheatstone.

Explanation / Answer

let IRR = r

2000000/(1+r)^4 = 50000*(1-(1+r)^-3)/r

r=15.1%

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