Question

The final tally is in: This year’s operating costs were down $100,000, a decrease directly attributable...

The final tally is in: This year’s operating costs were down $100,000, a decrease directly attributable to the $520,000 investment in the automated materials handling system put in place at the beginning of the year. If this level of annual savings continues for five more years, resulting in six total years of annual savings, what compounded annual rate of return will that represent? If these annual savings continue for nine more years, what compounded annual rate of return will that represent? (You may ignore income taxes.)

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Answer #1

We can use IRR to calculate the rate:

$ -5,20,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
IRR 4.25%

Excel formula: =IRR(A1:A7) where A1 to A7 are the cash flows with A1 being -520,000

Similarily in second case:

$ -5,20,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
$   1,00,000.00
IRR 14.08%

Excel formula: =IRR(A1:A10) where A1 to A7 are the cash flows with A1 being -520,000

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