Question

A large company has the opportunity to select one of four projects: A, B, C, D, or the null (Do nothing) alternative. Each project requires a single initial investment as shown in the table below. Information on each alternative was fed into a computer program that calculated the IRR for each project as well as the pertinent incremental IRR(s) as shown in the table below.

Project	Initial Investment	Project IRR	Incremental Rate of Return of “Row” – “Column”
		Null	A	B	C	D
A	$12,000	14%			7.5%	8%
B	$15,000	12%	6%		10%	9%
C	$10,000	9%	2%			7%
D	$9,000	7%

For each value of MARR below indicate which project is preferred and the evaluations you made to arrive at this conclusion.

a. MARR = 15%

b. MARR = 6%

c. MARR = 8.5%

Please don't use excel functions, just show condensed formulas, ex: (P/F,i(%),n) , etc. Thank you!

Answer 1

Internal Rate of Return (IRR) is used in capital budgeting to estimate the profitability of potential investments.

Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

IRR calculations rely on the same formula as NPV does.
If a project's internal rate of return is higher, it is more desirable to undertake.

IRR can be used to rank multiple prospective projects a firm is considering on a relatively even basis.

Assuming the costs of investment are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

The minimum acceptable rate of return, often abbreviated MARR, or hurdle rate is the minimum rate of return on a project a manager or company is willing to accept before starting a project, given its risk and the opportunity cost of forgoing other projects.

The hurdle rate is frequently used as synonym of cut off rate, benchmark and cost of capital.

It is used to conduct preliminary analysis of proposed projects and generally increases with increased risk.

(a) When MARR = 15%

Project B is preferred to project A.

The Initial investment for Project B is more and it generates more return.

Higher the risk, higher the return.

The incremental rate of return of Project B is higher as compared to A.

(b). MARR = 6%

(c). MARR = 8.5%

For both (b) and (c), we make an assumption that the initial investment is maximum $10,000.

In that case we have to analyse project C and D.

Project C is preferred to project D.

• It has a higher IRR as compared to Project D
• It has a higher return as compared to Project D.
• Project C has a higher Incremental rate of return as compared to Project D.