Engineering Economy
Engineering Economy
8th Edition
ISBN: 9780073523439
Author: Leland T Blank Professor Emeritus, Anthony Tarquin
Publisher: McGraw-Hill Education
Question
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Chapter 8, Problem 22P
To determine

Calculate the incremental rate of return.

Expert Solution & Answer
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Explanation of Solution

Table-1 shows the cash flow.

Table -1

AlternateVD
First cost (C)-250,000-225,000
Annual cost (O)per year-231,000-235,000
Overhaul cost (O3) year 30-26,000
Overhaul cost (O4) year 4-39,0000
Salvage value (SV)50,00010,000
Life (n)66

MARR is 15%.

Incremental rate of return can be calculated as follows:

(CVCD)=((OVOD)((1+i)n1i(1+i)n)+(O3VO3D)(1+i)3+(O4VO4D)(1+i)4+(SVVSVD)(1+i)n)(250,000(225,000))=((231,000(235,000))((1+i)61i(1+i)6)+(0(26,000))(1+i)3+(39,0000)(1+i)4+(50,00010,000)(1+i)6)25,000=(4,000((1+i)61i(1+i)6)+26,000(1+i)339,000(1+i)4+40,000(1+i)6)

Substitute the incremental rate of return as 17% by trial-and-error method in the above equation.

25,000=(4,000((1+0.17)610.17(1+0.17)6)+26,000(1+0.17)339,000(1+0.17)4+40,000(1+0.17)6)25,000=(4,000(2.565210.17(2.5652))+26,0001.601639,0001.8739+40,0002.5652)25,000=(4,000(1.56520.4361)+26,0001.601639,0001.8739+40,0002.5652)25,000=(4,000(3.5891)+16,233.7720,812.21+15,593.33)25,000=(14,356.4+16,233.7720,812.21+15,593.33)25,000=25,371.29

The calculated value is greater than the present value factor. Thus, increase the incremental rate of return to 17.43%.

25,000=(4,000((1+0.1743)610.1743(1+0.1743)6)+26,000(1+0.1743)339,000(1+0.1743)4+40,000(1+0.1743)6)25,000=(4,000(2.622310.1743(2.6223))+26,0001.619339,0001.9016+40,0002.6223)25,000=(4,000(1.62230.4571)+16,056.3220,509.05+15,253.78)25,000=(4,000(3.5491)+16,056.3220,509.05+15,253.78)25,000=(14,196.4+16,056.3220,509.05+15,253.78)25,000=24,997.45

The calculated value is nearly equal to the incremental present value factor. Thus, it is confirmed that the incremental rate of return is 17.43%.

The incremental rate of return from alternative V and alternative D is greater than MARR. Thus, the firm should select the new alternative V.

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