Question

). Use incremental analysis to compare the two project options shown below. The number of periods is 10 and the MARR is 7%

	Option A	Option B	∆A-B
Initial Cost	$275,000	$195,000
Annual Benefit	$35,000	$25,000
Salvage Value	$60,000	$50,000

1. Use NPW analysis to determine the internal rate of return for the incremental cash flow (15 points).
   1. Calculate the incremental cash flow and show your results in the column provided above.
   2. Write an equation for NPW for the delta column.
   3. Solve for NPW of the delta column using a variety of interest rates. Tabulate your results. Continue solving for NPW until you find the two particular interest rates (using the interest tables in the back of your textbook) where one interest rate yields a negative NPW and the interest rate on the next page yields a positive NPW.
   4. Based on the results from part iii, state the range of interest rates for ∆IRR. For example, x% < ∆IRR < y%.

Determine which option should be selected, based on the incremental analysis. State why (

Answer 1

Option B has a lower initial cost therefore consider it as the defender and option A has a higher initial cost therefore it will be considered as the Challenger to the the option B. In order to calculate incremental cash flow we are required to to subtract the cast of option B from option A.

	A	B	∆(A -B)
Initial cost	- $ 275,000	- $ 195,000	- $ 80,000
Annual benefit	$ 35,000	$ 25,000	$ 10,000
Salvage Value	$ 60,000	$ 50,000	$ 10,000

ii. The incremental cash flows Net Present worth can be expressed as

iii. Now, we are required to determine the incremental IRR using the trial and error method. Assume rate = 7% (=MARR)

At an interest rate of 7% the net present worth is negative therefore the required interest rate must be less than 7%. Now, assume rate equal to 5%

At an interest rate of 5% the NPW = $ 3,356.48 thus the required rate is greater than 5% and less than 7%.

The ∆IRR is in the range

Now we can determine the ∆IRR using the linear interpolation techniques as follows

The incremental IRR is less than the MARR thus the option A must be rejected and option B must be selected.

Select Option B. (Since, ∆IRR is less than MARR).

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