economics problem. thank you! Advanced Modular Technology (AMT) typically exhibi

Question

economics problem. thank you!

Advanced Modular Technology (AMT) typically exhibits net annual revenues that increase over a fairly long period. In the long run, an AMT project may be profitable as measured by IRR, but its simple payback period may be unacceptable. Evaluate this AMT project using the IRR method when the company MARR is 16% per year and its maximum allowable payback period is three years. What is your recommendation? Capital investment at time 0 Net revenues in year k $103,000 $18,000 Market (salvage) value Life 9,000. (k-1) $9,000 5 years

Explanation / Answer

Cahs flows in year 0: -103000

Cash flows in year 1: 18000+9000*0=18000

Cash flows in year 2: 18000+9000*1=27000

Cash flows in year 3: 18000+9000*2=36000

Cash flows in year 4: 18000+9000*3=45000

Cash flows in year 5: 18000+9000*4+9000=63000

Payback is 3+(103000-18000-27000-36000)/45000=3.49 years

As per payback this project should not be accepted because it is having payback higher than the maximum allowed

IRR is the rate at which NPV=0

NPV=-103000+18000/(1+r)+27000/(1+r)^2+36000/(1+r)^3+45000/(1+r)^4+63000/(1+r)^5

=>0=-103000+18000/(1+r)+27000/(1+r)^2+36000/(1+r)^3+45000/(1+r)^4+63000/(1+r)^5

=>r=19.49%

or, IRR=19.49%

As IRR is more than MARR of 16%, the project should be accepted as per IRR rule and not accepted as per payback rule

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