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    Capital Budgeting Techniques: IRR Method

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    A particular operation at a manufacturing company costs $100,000 per year in labor costs. A proposal is made to automate this operation with a robot. The cost of the robot, the controller, and ancillary systems is $200,000 installed. It has a 10-year life and no market value at the end of the ten years. The robot will save all of the $100,000 annual labor costs but will require $64,000 per year in maintenance and support. It will be depreciated over the 10-year life using Straight Line (SL) depreciation. The company has an effective income tax rate of 40% and must earn 8% after taxes on projects to consider them viable.

    (a) Use the Internal Rate of Return (IRR) method to determine if the robot acquisition is justifiable.

    (b) Use MACRS with a seven-year recovery period and determine the new IRR.

    If your IRR in part (b) is NOT greater than 8%, please give me a detailed explanation as to why this makes sense to you.
    Why is the IRR in part (b) larger than in part (a)? (If you happened to get smaller, then please re-work them.)

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    Solution Summary

    This solution depicts the steps to estimate the IRR in the given case.