Caterpillar Inc. would like to upgrade current fabrication techniques on its Exc

Question

Caterpillar Inc. would like to upgrade current fabrication techniques on its Excavator assembly line. Upgrades include state of the art equipment designed to automate specific portions of fabrication which have been very labor intensive in the past. To meet current floor plan space, four equipment design alternatives have been considered, which will have capital investment and annual operating expenses as shown in the table below. Assuming a useful life of 8 years for each design, no end-of-life market (salvage) value, and a desired before-tax MARR of 12% per year, determine which design should be selected based on: a) the PW method, and b) the IRR method.

Design -525,000 Design 2 -850,000 Design 3 -1,135,000 Design 4 1,420,000 1 Capital investment Annual expenses: Power Labor Maintenance Taxes and insurance -168,000 -20,000 -345,000 -12,000 -180,000 -25,000 -200,000 -15,000 -220,000 65,000 -320,000 -25,000 -235,000 -50,000 370,000 -30,000

Explanation / Answer

a) Design 1 Design 2 Design 3 Design 4                   1 Annual Outflow         (5,45,000)         (4,20,000)            (6,30,000)            (6,85,000) 2 Disc. Factor 4.96764 4.96764 4.96764 4.96764 3 PV         (5,44,995)         (4,19,995)            (6,29,995)            (6,84,995) 4 Add: Initial Outflow         (5,25,000)         (8,50,000)         (11,35,000)         (14,20,000) 5 NPW       (10,69,995)       (12,69,995)         (17,64,995)         (21,04,995) 6 7 Design 1 has lowest cost so it is acceptable 8 IRR Analysis Design 2-1 Design 2-3 Design 3-4 Design 1-4 Design 1-3 Design 2-4 Annual Outflow           1,25,000           2,10,000                  55,000              1,40,000         85,000     2,65,000 Disc. Factor at 34%             2.65824 Disc. Factor at 36%             2.54043 PV at 34%           3,32,281 PV at 36%           3,17,554 Add: Initial Outflow         (3,25,000)           2,85,000              2,85,000              8,95,000     6,10,000     5,70,000 NPW at 34%                 7,281 Since in all these incremental inflow & outflow is positive So NO IRR NPW at 36%               (7,446) Only we can find out the IRR Design 1-2 IRR=34+7281/(7281+7446)*(36-34) 34.99% So if we see through IRR, Design 2 have 34.99% incremental IRR, so it is acceptable

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