Question

Agdist Corporation distributes agricultural equipment. The board of directors is
considering a proposal to establish a facility to manufacture an electronically controlled
“intelligent” crop sprayer invented by a professor at a local university. This
crop sprayer project would require an investment of $10 million in assets and
would produce an annual after-tax net benefit of $1.8 million over a service life of
eight years. All costs and benefits are included in these figures. When the project
terminates, the net proceeds from the sale of the assets will be $1 million. Compute
the rate of return of this project. Is this a good project at MARR = 10%?

Answer 1

Initial Investment = 10,000,000

After tax net Benefits = 1,800,000

Salvage Value = 1,000,000

Life = 8 years

MARR = 10%

Calculate the Rate of Return.

Calculate the rate of return using the trial and error method.

Calculate the NPV of the above cash flow at MARR of 10%

NPV = -10,000,000 + 1,800,000 (P/A, 10%, 8) + 1,000,000 (P/F, 10%, 8)

NPV = -10,000,000 + 1,800,000 (5.3349) + 1,000,000 (0.4665)

NPV = 69,320

The NPV is positive. So increase the MARR to get negative NPV,

So let’s increase the MARR to 11%.

Calculate NPV at 11%

NPV = -10,000,000 + 1,800,000 (P/A, 11%, 8) + 1,000,000 (P/F, 11%, 8)

NPV = -10,000,000 + 1,800,000 (5.1461) + 1,000,000 (0.4339)

NPV = -303,120

Now, using the interpolation formula and calculate Rate of Return

Rate of Return = 10% + [69,320 – 0 ÷ 69,320 – (--303,120)]*1% = 10.18%

ROR > MARR – Accept the Project.

It is a good project.