| | No single correct answer. Make a case for your choice. |
| | | New Equipment | | | | | | | Keep Existing Equipment | | Straight calc for new equipment |
| | New Equipment | -585000 | | | | | | | -15000 | | -600000 |
| | | 95000 | -490000 | | | | | | -145000 | | -50000 |
| | | 95000 | -395000 | | | | | | -145000 | | -50000 |
| | | 95000 | -300000 | | | | | | -145000 | | -50000 |
| | | 95000 | -205000 | | | | | | -145000 | | -50000 |
| | | 95000 | -110000 | | | | | | -145000 | | -50000 |
| | | 95000 | -15000 | 0.1578947368 | 1.8947368421 | 6 years 2 months | | | -145000 | | -50000 |
| | | 95000 | 80000 | | | | | | -145000 | | -50000 |
| | | 95000 | | | | | | | -145000 | | -50000 |
| | | 95000 | | | | | | | -145000 | | -50000 |
| | | 95000 | | | | | | | -145000 | | -50000 |
| | | | | Payback calculation (when even cash flows) | | | | NPV | -$905,962.23 | | -$907,228.36 |
| | NPV | -$1,266.12 | | 6.1578947368 |
| | IRR | 9.95% | | | | | | | -$1,266.12 |
| | Payback | 6 years 2 months |
| | | | | | | | | IRR |
| | IRR requires a positive cash flow as well as negative cash flows. Therefore, when all cash flows are cash outflows, IRR cannot be calculcated. |
| | Also, if there are no positive cash flows, there is no payback period. |
| | For keeping the existing equipment, you could try to argue that you're "saving" the $600,000 that it would cost for the replacement equipment, therefore, the initial |
| | cash flow would be a positive $585,000. This would result in the following calculations. |
| | 585000 | | Following the "assumption" that the $585,000 is a positive cash flow, the NPV does appear much smaller than the two above |
| | -145000 | | calculations, but the IRR is over twice the cost of capital. |
| | -145000 |
| | -145000 | | This example is not meant to confuse you, but only to make you aware that it is easy to go off in a wrong direction. |
| | -145000 |
| | -145000 |
| | -145000 |
| | -145000 |
| | -145000 |
| | -145000 |
| | -145000 |
| | ($305,962.23) | NPV |
| | 21.15% | IRR | Be careful of IRR in this situation. We have a positive cash flow followed by numerious negative cash flows. The IRR doesn't care |
| | | | whether you're investing or borrowing. In this case, the $585,000 looks like a loan with a series of payback amounts. The cost of |
| | | | the loan would be 21.15%. This is apparent when you see the NPV is a large negative number. |
morpre
m4_a2_workbook.xlsx
