Question

You are deciding between two mutually exclusive investments, whether to renovate or rebuild your warehouse. Both require the same initial investment of $4 million. Renovating will generate $3 million per year (starting at the end of the first year) in perpetuity. Rebuild will generate $2.5 million at the end of the first year and its revenues will grow at 2% per year for every year after that. Use the incremental IRR rule to correctly choose between the investments when the cost of capital is 10%.

Answer 1

Incremental IRR of renovating:
+3/x-2.5/(x-2%)=0
=>x=12.00%

As incremental IRR is more tha the cost of capital, renovate