Question

In: Economics

Problem 5 (20pts) Consider two investments with the following cash flows: n Project A Project B...

Problem 5 (20pts)

Consider two investments with the following cash flows:

n

Project A

Project B

0

-100,000

-190,000

1

19,000

29,000

2

17,000

27,000

3

15,000

25,000

4

12,000

22,000

5

22,000

32,000

6

100,000

195,000

Suppose A and B are mutually exclusive, the MARR is 12%, the rate of return for project A and B is already given, which is 15% and 13% respectively.

Determine which project should be selected using rate of return on incremental investment. In calculation of the rate of return on incremental investment, use the trial and error method.

(Hint: try to draw the cash flows of the incremental investment, then based on the pattern of the cash flows, use appropriate interest factors in determination of the PW)

Solutions

Expert Solution

n

Project A

Project B

Incremental Cash flow between B - A

0

-100,000

-190,000

-190,000 – 100,000 = -90,000

1

19,000

29,000

29,000-19,000 = 10,000

2

17,000

27,000

27,000-17,000 = 10,000

3

15,000

25,000

25,000 - 15,000 =10,000

4

12,000

22,000

22,000 - 12,000 = 10,000

5

22,000

32,000

32,000 - 22,000 = 10,000

6

100,000

195,000

195,000 - 100,000 = 95,000

NPW of the Incremental cash flow of B – A at MARR of 12%

NPW = -90,000 + 10,000 (P/A, 12%, 5) + 95,000 (P/F, 12%, 6)

NPW = -90,000 + 10,000 (3.6048) + 95,000 (0.5066) = -5,825

Decreasing MARR to 10% and calculating NPW

NPW = -90,000 + 10,000 (P/A, 10%, 5) + 95,000 (P/F, 10%, 6)

NPW = -90,000 + 10,000 (3.7908) + 95,000 (0.5645) = 1,535.5

Using interpolation IRR = 10% + 1,535.5 – 0 / [1535.5 – (-5825)] * 2%

IRR for B – A is 10.41% < MARR (12%) – Select A (lowest cost project)


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