Joe Roe is considering establishing a company to produce impellers for water pum

Question

Joe Roe is considering establishing a company to produce impellers for water pumps. An tinvestment of $ 150,000 will be required for the plant and equipment, and $ 15,000 will be required for working capital part of the investment cost can be recovered. It is expected that the property will last for 15 years, at which time only the working capital part of the investment cost can be recovered. It os estimated that sales well be $ 200,000 per year and that operating expenses will be as follows:

Materials $40,000 per year

Labor $ 70,000 per year

Overhead $10,000 + 10% of sales per year

Selling expense $ 5,000 per year

Joe has a regular job paying $ 40,000 per year, but he will keep that job even in he establishes this company. If Joe expects to earn at least 15% per year on his capital, should this investment be made? Use the IRR method.

Explanation / Answer

As we see total initial investment is $200,000 + 15,000 as initial investment and for the next 15 years gives a revenue of $55,000 every year ( 200,000-40000+70000+10000+20000+5000) and at the end of 15 the year the working capital is also recovered. By using cash flow function

-215000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 55,000; 70,000(55000+15000). Solve IRR = 32.9%

As Joe wants to earn 15% and here he is getting 32.9%. He should go for this investment.

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