Question

Consider the two mutually exclusive investment projects given in the table below. E Click the icon to view the cash flows for the projects. (a) To use the IRR criterion, what assumption must be made in comparing a set of mutually exclusive investments with unequal service lives? Select all that apply. A. The required service period is infinity B. Project A1 can be repeated at the same cost in the future. C. Project A2 can be repeated at the same cost in the future. D. The required service period is 3 years. (b) With the assumption made in part (a), determine the range of MARRs which will indicate that project A1 should be selected. Select the correct choice below and fill in the answer box to complete your choice. (Round to one decimal place.) Х O A. MARR % More Info OB. MARR = % OC. MARR> % n 0 Net Cash Flow Project A1 Project A2 - $10,000 - $15,000 5,000 20,000 5,000 5,000 1 2 3 Print Done

Answer 1

a) A set of mutually exclusive projects imply that choosing any one project will imply that the other project can't be chosen. So, if we compare two such projects with unequal service life. There are certain assumptions which are taken into account. It assumes that each project can be repeated as many times necessary in order to reach a common life span. We also assume that the project's cost and annual cash inflows will not change, if we repeat the service life. So, as the service life of project A1 = 3 and projcet A2 = 1, we take the lowest common factor = 3 years, so the required service period = 3 years. Also, project A2 needs to be repeated thrice at the same cost in the future. So, statements C and D are those apply.

b) So, when project A2 is repeated thrice, the cash flow of year 1 = 20,000 - 15,000 = 5000, year 2 = 20,000-15,000 = 5000, year 3 = 20,000 -15000 = 5,000.

So, the NPV of project A2= -15,000+5000(P/A,i%,3)

NPV of project A1 = -10,000 +5000(P/A,i%,3)

So, the project A1 will be selected only if the NPV of A1> NPV of A2,

The project A1 needs to be selected for a MARR that makes its PW >0

0 = -10,000 + 5000(P/A, i%,3)

10,000/5000 = 2 = (P/A,i%,3)

So, i = MARR =  20% , as P/A factor = 2.106 for 3 years and i =20%.At this i = 20%, PW =530>0.

So, for i = 20%

NPV or PW of project A2 :

= -15,000+5000(P/A,i%,3) ,

= -15,000 + 5000 * 2.106

= -15,000 + 10,530 = -4470 <0,

So, as NPV is greater for project A1 as comapred to A2, the former will be selected.

So, MARR has to be lesser than 20%. Lesser the MARR, higher the PW.

So, option A, MARR <20%