A firm is considering three mutually exclusive alternatives as part of an upgrad

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A firm is considering three mutually exclusive alternatives as part of an upgrade...

A firm is considering three mutually exclusive alternatives as part of an upgrade to an existing transportation network. At EOY 10, alternative III would be replaced with another alternative Ill having the same installed cost and net annual revenues. If MARR is 9% per year, which alternative (if any) should be chosen? Use the incremental IRR procedure. Installed cost Net annual revenue Salvage value Useful life Calculated IRR $35,000 $25.000 $20,000 $6,400 $5,600 $5,200 0 20 years 20 years 10 years 17.696 22.096 22.696 0 0 Which alternative would you choose as a base? Choose the correct answer below. OA, Alternative, OB. Alternative lll O C. Alternative

Explanation / Answer

Option B

The alternatives need to be arranged with the increasing order of investment, hence Alternative III need to be selected as base alternative

Year

Alternative III

Alternative II

Alternative I

Incremental IRR between III and II

Incremental IRR between II and I

0

-20000

-25000

-35000

-5000

-10000

1

5200

5600

6400

400

800

2

5200

5600

6400

400

800

3

5200

5600

6400

400

800

4

5200

5600

6400

400

800

5

5200

5600

6400

400

800

6

5200

5600

6400

400

800

7

5200

5600

6400

400

800

8

5200

5600

6400

400

800

9

5200

5600

6400

400

800

10

-14800

5600

6400

20400

800

11

5200

5600

6400

400

800

12

5200

5600

6400

400

800

13

5200

5600

6400

400

800

14

5200

5600

6400

400

800

15

5200

5600

6400

400

800

16

5200

5600

6400

400

800

17

5200

5600

6400

400

800

18

5200

5600

6400

400

800

19

5200

5600

6400

400

800

20

5200

5600

6400

400

800

IRR

21%

5%

Since the incremental IRR between III and II is greater than MARR of 9 percent, the alternative III needs to be dropped while keeping the alternative II as base alternative. Now with the incremental IRR between alternative II and I is less than MARR of 9 percent, drop alternative I and select the alternative II.

Year

Alternative III

Alternative II

Alternative I

Incremental IRR between III and II

Incremental IRR between II and I

0

-20000

-25000

-35000

-5000

-10000

1

5200

5600

6400

400

800

2

5200

5600

6400

400

800

3

5200

5600

6400

400

800

4

5200

5600

6400

400

800

5

5200

5600

6400

400

800

6

5200

5600

6400

400

800

7

5200

5600

6400

400

800

8

5200

5600

6400

400

800

9

5200

5600

6400

400

800

10

-14800

5600

6400

20400

800

11

5200

5600

6400

400

800

12

5200

5600

6400

400

800

13

5200

5600

6400

400

800

14

5200

5600

6400

400

800

15

5200

5600

6400

400

800

16

5200

5600

6400

400

800

17

5200

5600

6400

400

800

18

5200

5600

6400

400

800

19

5200

5600

6400

400

800

20

5200

5600

6400

400

800

IRR

21%

5%

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