Merco, Inc., a machinery builder in Louisville, Kentucky, is considering making an investment of $1,250,000 in a complete structural-beam-fabrication system. The increased productivity resulting from the installation of the drilling system is central to the project’s justification. Merco estimates the following figures as a basis for calculating productivity:

• Increased fabricated-steel production: 2,000 tons/year
• Average sales price per ton of fabricated steel: $2,566.50
• Labor rate: $10.50/hour
• Tons of steel produced in a year: 15,000
• Cost of steel per ton (2,205 lb): $1,950
• Number of workers on layout, hole making, sawing, and material handling: 17
• Additional maintenance cost: $128,500/year

With the cost of steel at $1,950 per ton and the direct-labor cost of fabricating 1 lb at 10 cents, the cost of producing a ton of fabricated steel is about $2,170.50. With a selling price of $2,566.50 per ton, the resulting contribution to overhead and profit becomes $396 per ton. Assuming that Merco will be able to sustain an increased production of 2,000 tons per year by purchasing the system, the projected additional contribution has been estimated to be 2,000 tons × $396 = $792,000. 

Since the drilling system has the capacity to fabricate the full range of structural steel, two workers can run the system, one operating the saw and the other operating the drill. A third worker is required to operate a crane for loading and unloading materials. Merco estimates that to perform equivalent work with a conventional manufacturing system would require, on average, an additional 14 people for center punching, hole making with a radial or magnetic drill, and material handling. This factor translates into a labor savings in the amount of $294,000 per year 114 × $10.50 × 40 hours/week × 50 weeks/year 2. The system can last for 15 years with an estimated after-tax salvage value of $80,000. However, after an annual deduction of $226,000 in corporate income taxes, the net investment costs, as well as savings, are as follows:

• Project investment cost: $1,250,000
• Projected annual net savings:

($792,000 + $294,000) - $128,500 - $226,000 = $731,500

• Projected after-tax salvage value at the end of year 15: $80,000

(a) What is the projected IRR on this investment?
(b) If Merco’s MARR is known to be 18%, is this investment justifiable?