W7_Said Alamri_ Upgrade plant production decision making based on IRR & NPV


  1. Problem Recognition

Nitrogen plant management wants to increase plant production. They decided to upgrade the plant by purchasing new high speed machine. They got two quotations from vendor. Management decided to use Internal Rate Return (IRR) and Net Present Value (NPV) to decide which option is worth to invest in? Management want to know the profitability of which investment is most attractive.

2       Development the Feasible Alternative

Vendor offers two quotations for two different machines:

  • Machine A cost $15000 US dollars
  • Machine B cost $20000 US dollars

3       Development of the Outcome for Alternative

Microsoft Excel will be used to calculate cash flow, present value & net present value (NPV) after that Internal Rate of Return for each option.

 

4       Selection of Criteria

The option with highest positive NPV & IRR will be considered.

5       Analysis and Comparison of the Alternative

Table-1 represent option for purchase machine A, Table-2 represent option for purchase machine B.

Table-1 NPV for Machine A

Table-1 NPV for Machine A

 

Table-2 NPV for machine B

Table-2 NPV for machine B

 

 

Table-3 Comparison of IRR for machine A&B

Table-3 Comparison of IRR for machine A&B

 

6       Selection of the Preferred Alternative

From the tables above, Machine B has the highest positive NPV also has the highest IRR. Option of purchase Machine B is the most attractive investment.

7       Performance Monitoring and the Post Evaluation of Result

In the next blog same example will be used to calculate MARR for the investment and compare it with MARR in Oman.

8      References:

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2 thoughts on “W7_Said Alamri_ Upgrade plant production decision making based on IRR & NPV

  1. HI Said, OK you did a great job on your analysis but I have no idea how you did these calculations BEFORE you calculated your MARR? And what MARR did you use for this calculation?

    My suggestion would be to calculate your MARR which is normally the FIRST set of calculations you make and THEN you do your NPV and IRR. IF you have picked an unrealistic MARR, then your entire analysis is FLAWED. (Garbage In/Garbage Out)

    Also there is a WEAKNESS in using IRR that not everyone is aware of. Go HERE http://www-ieem.ust.hk/department/ugcourse/WEB97-fall/cjchapt4-all/sld040.htm, and HERE http://www.planwithintegrity.com/blog/ .

    Then in your W9 blog posting AFTER you’ve calculated your MARR, share with us your thoughts on using ERR instead of IRR and if that would make any difference in your decisions.

    BR,
    Dr. PDG, Jakarta

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