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

Question

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 III having the same installed cost and net annual revenues. If MARR is 10% per year, which alternative (if any) should be chosen? Use the incremental IRR procedure. Alternative III is chosen as a base.

I II III

Installed cost $35,000 $30,000 $20,000

Net annual revenue $6,400 $5,650 $5,300

Salvage value 0 0 0

Useful life 20 years 20 years 10 years

Calculated IRR 17.6% 18.2% 23.2%

IRR (II-III)= _%

IRR (I-II)= _%

Which alternative should be chosen?

Explanation / Answer

Let's calculate NPV using MARR or Huddle Rate for all three alternatives

NPV for Alternatives I as per above information

NPV I = 19,486.81

NPV for Alternatives II as per above information

NPV II = 18,101.64

NPV for Alternatives III as per above information

NPV III = 12,566.21

Based on the NPV calculations using MARR as an acceptable rate for accepting any project, it is recommended that Alternative I. Whenever there is a conflict between IRR and NPV is choosing any project, NPV should be considered over IRR for selecting any project. Therefore, Alternative I is the best choice.

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