Question

Polytec Chemical, Inc. must decide between two additives to improve the dry-weather stability of its low-cost acrylic paint. Additive A will have an equipment and installation cost of $106,000 and an annual cost of $55,000. Additive B will have an installation cost of $175,000 and an annual cost of $28,000. If the company uses a five-year recovery period for paint products and an MARR of 21% per year, which process is favored on the basis of an incremental rate of return analysis? Also, determine the value of Δi*.

1) The value of Δi* is _____%

2) On the basis of an incremental rte of return analysis, process ___ is favored.

Answer 1

Answer-

1) the value of ∆i* is 28%

2) On rhe basis of an Incremental rate of return analysis, process B os favoured.

Explanation--

As per an incremental rate of return analysis a lower installation cost equipment's cash flows are substracted from a higher installation cost equipment's cash flows. This is called incremental cash flows, an internal rate of return (∆i*) of the incremental cash flows is calculated. If incremental rate of return is higher or equals to MARR the higher installation cost equipment can be selected. If the incremental rate of return is less than MARR, the lower installation cost equipment is economically justified.

Cash flow and calculation table is below:

Formula for Incremental rate of return in excel

=IRR ( values, guess)

Where, value refer to the cells or cash flows.

In table reference cell from (D10:D15).