Advanced Engineering (Pty) Ltd needs to replace one of the profile cutters in its factory with a computer-operated profile cutter

Answer of part 3.1 - Calculation of Internal Rate of Return of given proposed investment :-

Step 1: Select discount rates for the calculation of NPVs,we can take 13% (R1) and 18 % (R2) as our discount rates already given in question.

Step 2: Calculate NPVs of the investment using the discount rates.As NPV @ 13% discount rate is given.i.e.Rs.28,755,we have to calculate NPV @ 18 % only for calculation of IRR.

Net Present Value @ 18

Years Cash Flows Discounting Factor @ 18% Present value of Discounted Cash Flows

0 (325,000) 1.000 (325,000)

  1 140,000 0.847 118,580

  2 120,000 0.718 86,160

3 95,000 0.609 57,855

4 70,000 0.516 36,120

5 50,000 0.437 21,850

NPV of Dis.Cash flows(320,565 - 325,000) - 4435

Step 3: Calculation the IRR

=  R1%  +   [(NPV1 x (R2 – R1)%) ÷ (NPV1 – NPV2)]

=  13%  +   [(28,755 x (18 – 13)%) ÷ (28,755 – (- 4,435))]

=  13%  +   [(28,755 x 05%) ÷ (28,755 + 4,435)]

= 13% + (1437.75 / 33190)*100

=  13%  +   4.33%

=  17.33%

Therefore,IRR is 17.33%.

Answer of part 3.2: Interpretation

The investment should not be accepted by the company,because the cost of capital (i.e. 18%) is more than the IRR of 17.33%.Also,the NPV of proposed investment is negative.i.e.- 4,435 which makes the proposed investment financially nonviable.

NOTE :- Decision of the above problem is based on keeping in mind that company's Cost of capital is 18%.If we take 13% cost of capital then decision of the proposed investment is changed as that time cost of capital (i.e. 13%) is lower than the IRR of 17.33%.Also,the NPV of proposed investment is .i.e. 28,755 which makes the proposed investment financially viable.