ABC company typically exhibits increasing net annual revenues over time. In the long run, an ABC project may be profitable as measured by IRR, but its simple payback period may be unacceptable. Evaluate this ABC project using the IRR method when the company’s MARR is x1% per year. If the company’s maximum allowable payback period is three years. What is your recommendation?
Capital Investment at time 0: $100,000
Net revenue in year k :$20,000+$10,000×(k-1)
Market (Salvage) value: $X2
Useful life: 5 years
x1=25%
x2=0
Pls see table below for calculations and answer.
Time | Investment | Salvage | Revenue | Net CF | Cumulative Net CF |
0 | -100000 | -100000 | -100000 | ||
1 | 20000 | 20000 | -80000 | ||
2 | 30000 | 30000 | -50000 | ||
3 | 40000 | 40000 | -10000 | ||
4 | 50000 | 50000 | 40000 | ||
5 | 0 | 60000 | 60000 | 100000 | |
IRR | 23.3% |
This project fails both IRR (23.3% which is lower than MARR of 25%) and payback period (which is longer than 3 years, as it is between years 3 and 4 that the cumulative net CF turns from negative to positive)
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