Question

A marine engineering firm purchased and installed a new production facility for fabrication of its line of fluid machinery at a cost of $750,000, funded by a bank loan at an interest rate of 8.5% for a period of five (5) years. The firm’s cost accountants determined that, because of the efficiency of the new facilities, the company’s production costs would be reduced by $300,000 per year over the five year term of the bank loan. A Present Value Analysis shows that the Return On Investment (ROI) for this project has a rate of return could be?

Answer 1

ANSWER:

I will calculate both the net present worth as well as the rate of return on this investment for your better understanding.

npw = initial purchase + savings(p/a,i,n)

initial purchase = $750,000

savings = $300,000

n = 5 years

i = 8.5%

npw = -750,000 + 300,000(p/a,8.5%,5)

npw = -750,000 + 300,000 * 3.94

npw = -750,000 + 1,182,192.62

npw = $432,192.62

now we will find the rate of return.

in order to find the rate of return we will have to equate npw to zero.

npw = initial purchase + savings(p/a,i,n)

0 = -750,000 + 300,000(p/a,i,5)

750,000 = 300,000(p/a,i,5)

solving by trial and error we get i = 28.65%

so the rate of return is 28.65%