Question

Two mutually exclusive proposals, each with a life of 5 years, are under consideration. MARR is 12%. Each proposal has the following cash flow profile:

EOY	NCF(A)	NCF(B)
0	-$30,000	-$42,000
1	$9,300	$12,625
2	$9,300	$12,625
3	$9,300	$12,625
4	$9,300	$12,625
5	$9,300	$12,625

Determine which alternative the decsion maker should select using the internal rate of return method.

Note: Need to use uncremental IRR analysis to calculate exact IRR

Please give the written answer, not the excel version.

Answer 1

Two mutually exclusive proposals, each with a life of 5 years, are under consideration. MARR is 12%. Each proposal has the following cash flow profile:

EOY	NCF(A)	NCF(B)	Incremental Cash Flow Cash Flows B – Cash Flows A
0	-$30,000	-$42,000	= -42,000 – (-30,000) = -12,000
1	$9,300	$12,625	12,625 – 9,300 = 3,325
2	$9,300	$12,625	12,625 – 9,300 = 3,325
3	$9,300	$12,625	12,625 – 9,300 = 3,325
4	$9,300	$12,625	12,625 – 9,300 = 3,325
5	$9,300	$12,625	12,625 – 9,300 = 3,325

Calculating the NPW of the Incremental Cash Flow of B – A, at MARR of 12%

NPW = -12,000 + 3,325 (P/A, 12%, 5)

NPW = -12,000 + 3,325 (3.6048) = -14

As the NPW is negative, decrease the MARR to get positive NPW

Calculating the NPW at MARR of 11%

NPW = -12,000 + 3,325 (P/A, 11%, 5)

NPW = -12,000 + 3,325 (3.6959) = 289

IRR = 11% + (289 – 0 / 289 – (-14) ) x 1%

IRR for B – A = 11.95%

IRR pf B – A(11.95%) < MARR (12%) – Select A