Question

3) In order to meet some new environmental standards, engineers and technicians at a chemical firm have designed a new waste control system for one of the processes. The cost of the installed design is expected to be $3500, 000. It will have little or no salvage value at the end of the 12 years. The savings over the current disposal costs are expected to be $65,000 per year. The firm typically desires a return of 12% in projects such as this. A) Evaluate the pocket using the present worth, future worth, and annual amount methods and determine whether the projects should be accepted or not? (6 points) B) Determine the IRR of the project (3 points) C) Compare the answer in part (b) to the target value of 12%.(2 points) D) What nonfinancial benefits are associated with this type of project? (2 points)

Answer 1

A)

The present worth of the project is calculated as follows:-

PW = - $ 350,000 + $ 65,000 ( P/A, 12% , 12 years)

where ( P/A, 12% , 12 years) = Uniform series present worth factor

Present worth = - $ 350,000 + $ 65,000 6.194374

Present worth  = $ 52,634.3 $ 52,634

Future worth = - $ 350,000 (F/P, 12%, 12 years) + $ 65,000 (F/A, 12% , 12 years)

(F/P, 12%, 12 years) = Single payment compound amount

(F/A, 12% , 12 years) = Uniform series compound amount

Future worth = - $ 350,000 3.895976 + $ 65,000 24.133133

Future worth = $ 205,062.1 $ 205,062

Annual worth = Present worth Capital recovery factor

Annual worth = $ 52,634 ( A/P, 12%,12 years) =  $ 52,634 0.161437

Annual worth = $ 8497.1 $ 8497

Based on the present worth, future worth and annual worth the project should be accepted because the values are positive and greater than the initial investment.

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B)

IRR is the discount rate that makes the present value of the cash inflows equal to the initial investment.

In the above equation the value of r is the internal rate of return. The value of r is found using trial and error method.

let r = 14%

Net present value = 17919

Let r = 15%

Net present value = $ 2340

Let r = 16%

Net present value = - $ 12188

IRR lies between 15 % and 16%

IRR = 15.8%

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C)

Comparing the IRR with the target value of 12%, we can say that the IRR is greater than the MARR , therefore the project can be accepted.

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D)

The non financial benefits associated with this type of project are:

• Helps to reduce pollution.
• Controls waste
• Helps to improve corporate image as the firm will be considered as environmental friendly.