Question

2. Using a MARR of 8%, a study period of 8 years, and a rate of return method, determine which among the alternatives in the table below is the best choice: Capital Annual Alternative Investment Expenses $12000 $8000 $10,000 $6000 $40,000 $80,000 $60,000 $90,000 ABCD

Answer 1

MARR = 8%

First alternative have to be arranged in increasing order of initial cost

Alternatives in increasing order of initial cost are A < C < B < D

We need to find incremental cash flow between lowest and second-lowest option first, then use the formula of IRR in excel on the incremental cash flow, if incremental IRR is greater than MARR then select the second lowest option if it is less than the MARR then select the lowest option.

Keep repeating the above until the last option is evaluated

Year	A	C	B	D	C-A	B-A	D-A
0	-40000	-60000	-80000	-90000	-20000	-40000	-50000
1	-12000	-10000	-8000	-6000	2000	4000	6000
2	-12000	-10000	-8000	-6000	2000	4000	6000
3	-12000	-10000	-8000	-6000	2000	4000	6000
4	-12000	-10000	-8000	-6000	2000	4000	6000
5	-12000	-10000	-8000	-6000	2000	4000	6000
6	-12000	-10000	-8000	-6000	2000	4000	6000
7	-12000	-10000	-8000	-6000	2000	4000	6000
8	-12000	-10000	-8000	-6000	2000	4000	6000
IRR					-4.7%	-4.7%	-0.9%

We compare first A and C, since A has the lowest cost, and the second lowest option is C, incremental IRR is less than MARR so we select A, and reject C

Now we find incremental cash flow between B & A, we find incremental IRR<MARR, so we select A again and reject B

Now we find incremental cash flow between D & A, we find incremental IRR<MARR, so we select A again and reject D

A option should be selected as per the incremental analysis