ative designs are being considered for a potential improvement project related t

Question

ative designs are being considered for a potential improvement project related to the operation of a engineering department, in addition to the "do nothing" option. The prospective net cash flows for atives are shown in the following table and the MAR is 15% per year. Use the incremental IRR etermine the recommended design. At most half credit will be given if the ineremental IRR method Alternative Net Cash Flows End of Year, k -$180,000 $210,000 61,000 61,000 61,000 61,000 61,000 61,000 79,000 79,000 79,000 79,000 79,000 79,000 2 4

Explanation / Answer

ANSWER:

When we are finding which alternative to use via incremental irr we will subtract the alternative with lower initial cost from the higher initial cost.

and the present worth will be zero.

n = 6

pw (b -a) = initial cost of b - initial cost of a + annual cash flow of b - annual cash flow of a(p/a,i,n)

0 = -210,000 - (-180,000) + (79,000 - 61,000)(p/a,i,6)

0 = -210,000 + 180,000 + 18,000(p/a,i,6)

210,000 - 180,000 = 18,000(p/a,i,6)

30,000 = 18,000(p/a,i,6)

30,000 / 18,000 = (p/a,i,6)

1.667 = (p/a,i,6)

finding i via trial and error we get i = 55.81%

since the incremental irr > marr that is 55.81% > 15% , therefore we select option b.

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