You have been asked by the president of the company you work for to evaluate the proposed acquisition of a new injection molding machine for the firm’s manufacturing plant. Two types of injection molding machines have been identified, with the following estimated cash flows:Net Cash FlownProject 1Project 20-$30,000-$40,000120,00043,000218,2005,000IRR18.1%18.1%
You return to your office, quickly retrieve your old engineering economics text, and then begin to smile: Aha—this is a classic rate-of-return problem! Now, using a calculator, you find out that both projects have about the same rate of return: 18.1%. This figure seems to be high enough to justify accepting the project, but you recall that the ultimate justification should be done with reference to the firm’s MARR. You call the accounting department to find out the current MARR the firm should use in justifying a project. “Oh boy, I wish I could tell you, but my boss will be back next week, and he can tell you what to use,” says the accounting clerk.
A fellow engineer approaches you and says, “I couldn’t help overhearing you talking to the clerk. I think I can help you. You see, both projects have the same
IRR, and on top of that, project 1 requires less investment, but returns more cash flows(-$30,000 + $20,000 + $18,200 = $8,200,and -$40,000 + $43,000 +5,000 = $8,000 ); thus, project 1 dominates project 2. For this type of decision problem, you don’t need to know a MARR!”
(a) Comment on your fellow engineer’s statement.
(b) At what range of MARRs would you recommend the selection of project 2?