Question

Alternatives A and B require investments of $10,310 and $13,400, respectively. Their respective net annual cash inflows are $3,300 and $4,000.

a) What is the rate of return for each alternative and for the incremental difference? (Do not use Excel, and please show all steps)

b) If the interest rate is 10%, which alternative should be selected? (Do not use Excel, and please show all steps)

Answer 1

Solution: Part-1) Alt-A Cost $10310 Benefit $4000/year Life 5 years Alt-B $13,400 $4000/year Increment $3,090 $700/year 5 years 5 years PW ALT-A = -$10,310 + $3300(PIA,1,5) PW ALT-B = $13,400 + $4000(PIA,1,5) PWhigh-low = $3090 + $700(PIA, I, 5) IRRIncrement = 4.3% $8,000 IRRIncrement = 4.3% $6,000 Part-2) IRR Alt-B $4,000 IRR Alt-A $2,000 Alt-B — Alt-A -Diff $0 Interest rate Best Choice 0% sis 4.3% ALT-B 4.3% si s 18% ALT-A 18% Si Do Nothing If the interest rate is 10%, thus choose Alt-A 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% ($2,000) ($4,000)