2 mutually exclusive alternatives: N Project 1 Project 2 0 -$10,000 -$13,000 1-3

Question

2 mutually exclusive alternatives:

N                                Project 1                                 Project 2

0                                  -$10,000                                -$13,000

1-3                              $5000                                     $6500

Determine the IRR on the incremental investment in the amount of $3000. You may use appropriate linear interpolation.

i                       (P/A,i,3)

            15%                2.2832

            16%                2.2459

            18                    2.1743

            20                    2.1065

            25                    1.9520

            30                    1.8161

            35                    1.6959

If the firm’s MARR is 20%, which alternative is the better choice?

Explanation / Answer

Answer: Given Incremental cash flow between two alternatives, MARR = 20%

Find: (a) IRR on the increment and (b) which alternative is preferable

(a) To choose the best project, we compute the incremental cash flow for B2-B1.Then we compute the IRR an this increment of investment by solving

- $3000 + $1500(P/F,i,1-3) = 0.

(b) We obtain i*B2-B1=23.49%,as plotted in Figure 4.7. By inspection of incremental cash flow, we know it is a simple investment, so IRR B2-B1 =i*B2-B1. Since IRR B2-B1 > MARR, we select B2, which is consistent with the NPW analysis.

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