Question

A manufacturer, whose MARR is 8%, is considering two alternative plant layouts, A1 and A2. The first cost represent the expenses of rearranging the current layout to the alternative new layout and the annual savings represent the reduction in the production costs of the new layout compared to the current layout. Using the internal rate of return as the decision criterion, what course of action do you recommend? Year A1 A2 First Cost 0 $120,000 $130,000 Annual Savings 1 to infinity $11,000 $14,500

Answer 1

Answer:

Choose Alternative :  A2

Explanation:

MARR = 8%

Alternatives : A1 and A2

                                    Year               A1                      A2

First cost                      0                  $120,000         $130,000

Annual savings           1 to infinity    $11,000          $14,500

determine what course of action to recommend

Incremental rate of return for infinite project  ( r )  i.e. from A2 - A1

Apply this formula below to resolve the question

-first cost of more expensive alternative - (-first cost of less expensive alternative) + savings of more expensive/r - savings of less expensive/r  = 0

= - 130,000 - ( - 120,000 ) + 14500 / r -  11,000 / r = 0

= -130,000 + 120,000 = 11,000 / r - 14,500 / r

= - 10,000 = - 3500 / r

∴ r = 3500 / 10000 = 0.35 = 35%

The incremental rate of return from A2 - A1 = 35% which is > MARR ( 8%)

hence choose alternative A2