EPC, Inc. uses a minimum attractive rate of return of 12% per year compounded se
ID: 2779901 • Letter: E
Question
EPC, Inc. uses a minimum attractive rate of return of 12% per year compounded semiannually The company is evaluating two new processes for expanding its manufacturing operations. The cash flows associated with each process are shown below. In evaluating the processes on the basis of a rate of return analysis, the incremental investment rate of return equation to use is Alt I Alt J First cost,S Annual Cost, S/yr Salvage Value, S Life, years -420,000520,000 5,000 12,000 6,000 5,000 (a) 0-100,000+ 3,000(P/A,i,3) + 1000(P/F,i%,3) (b) 0-420,000-1 5,000( P/A, i,3) + 5,000( P/F,i%,3) (c) 0--520,000-12.000(P/A,1,3) + 6,000( P/F,i%,3) (d) 0-100,000-3,000(P/A,i,3) + 1000(P/F,i%,3) (e) 0 -100,000 + 3,000(P/A,1,3)-1000(P/F,i%,3)Explanation / Answer
Answer: Option [a]
Explanation:
Incremental First cost = -520000-[-420000] = -100000 No need to discount at it occurs at t0.
Incremental Annual cost = -12000-[-15000] = +3000. The present value is given by3000*[P/A,i,3]
Incremental salvage value = 6000-5000 = 1000: the PV is given by 1000*[P/F,i,3]
The IRR is that rate of discount for which NPV = 0.
So the equation for getting IRR = -100000+3000*[P/A,i,3]+1000*[P/F,i,3]
For comparing the IRR so obtained, the MARR has to be converted to effective MARR to reflect the semi-annual compounding. The effective MARR would be (1+0.12/2)^2-1 = 12.36%
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