Question

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[Problem 7-63] If 8% is considered the minimum attractive rate of return, which alternative should be selected using an incremental analysis? Year 0 1 х -$5000 -3000 4000 4000 4000 -$5000 2000 2000 2000 2000

Answer 1

MARR = 8%

Calculating the incremental cash flow between X – Y

EOY	X	Y	X – Y
0	-5000	-5000	0
1	-3000	2000	-5000
2	4000	2000	2000
3	4000	2000	2000
4	4000	2000	2000

Calculating the Incremental IRR of X – Y using the Trial and Error Method.

Calculate the Present Worth of the incremental cash flow at MARR of 8%

PW = -5,000 (P/F, 8%, 1) + 2,000 (P/A, 8%, 3) (P/F, 8%, 1)

PW = -5,000 (0.92593) + 2,000 (2.57710) (0.92593) = 142.78

The present worth is positive. Increase the MARR to 10% to get negative PW. Calculate the PW using interest rate = 10%

PW = -5,000 (P/F, 10%, 1) + 2,000 (P/A, 10%, 3) (P/F, 10%, 1)

PW = -5,000 (0.90909) + 2,000 (2.48685) (0.90909) = -23.90

Using interpolation to calculate the Incremental IRR

IRR = 8% + [142.78 – 0 ÷ 142.78 – (-23.90)]*2% = 9.7%

IRR of Incremental Cash flow (X – Y) > MARR, Select Alternative X