Question

(Requesting fully solution please)

A bottling company needs a new capping machine for their product line. They have two choices for filling this need. Revenues from the line are $20 000 per year. The company uses a MARR of 10% and the “do nothing” option is not viable. The choices are:  Buy a used machine for $36 000 which will have a $0 salvage value at the end of 6 years. Maintenance costs are $3000 in the first year, increasing by 25% per year thereafter.  Contract with a packaging supplier for a “free” junked machine that requires $6000 to fix it before it is ready for use. Additional packaging costs $15 000 per year over the next 6 years.

Using rate of return analysis, which machine should they buy?

Answer 1

For both mahines, Net annual benefit = Annual revenue - Annual cost

Rate of return is computed as following, using Excel IRR function.

MACHINE - A
Year	Revenue ($)	Cost ($)	Net annual benefit ($)
	(A)	(B)	(A) - (B)
0		36,000	-36,000
1	20,000	3,000	17,000
2	20,000	3,750	16,250
3	20,000	4,688	15,313
4	20,000	5,859	14,141
5	20,000	7,324	12,676
6	20,000	9,155	10,845
		IRR =	35.92%
MACHINE - B
Year	Revenue ($)	Cost ($)	Net annual benefit ($)
	(A)	(B)	(A) - (B)
0		6,000	-6,000
1	20,000	15,000	5,000
2	20,000	15,000	5,000
3	20,000	15,000	5,000
4	20,000	15,000	5,000
5	20,000	15,000	5,000
6	20,000	15,000	5,000
		IRR =	80.96%

Since Machine B has higher IRR (which is > MARR), this machine should be purchased.