Question

Compare the following three alternatives by the IRR method, given MARR of 8%/year. First find if they are feasible and then compare them with the incremental rate of return method (DROR).

Alt.	Construction cost $	Benefits $/yr	Salvage $	Service Life (yrs)
A	510,000	145,000	10,000	5
B	775,000	155,000	15,000	9
C	1,075,000	165,000	20,000	11

Answer 1

Alternative A

Year	Cash Flow	Present value( IRR = 13%)	Present value (IRR = 14%)
0	-510,000	-510,000	-510,000
1	145,000	128,325	127,165
2	145,000	113,535	111,505
3	145,000	100,485	97,875
4	145,000	88,885	85,840
5	145,000	78,735	75,255
6	10,000	4,800	4,560

Net Present Value 4,765 - 7,800

As per above table IRR must be between 13% and 14%

Alternative B

Year	Cash flow	Present value(IRR = 13%)	Present value(IRR = 14%)
0	-775,000	-775,000	-775,000
1	155,000	137,175	135,935
2	155,000	121,365	119,195
3	155,000	107,415	104,625
4	155,000	95,015	91,760
5	155,000	84,165	80,445
6	155,000	74,400	70,680
7	155,000	65,875	62,000
8	155,000	58,280	54,405
9	155,000	51,615	47,740
10	15,000	4,425	4,050
Net Present Value	-	24,730	-4,165

As per above table IRR must be between 13% and 14%.

Alternative C

Year	Cash Flow	Present value (IRR = 10%)	Present Value (IRR = 11%)
0	-1,075,000	-1,075,000	-1,075,000
1	165,000	149,985	148,665
2	165,000	136,290	133,980
3	165,000	123,915	120,615
4	165,000	112,695	108,735
5	165,000	102,465	97,845
6	165,000	93,060	88,275
7	165,000	84,645	79,530
8	165,000	77,055	71,610
9	165,000	69,960	64,515
10	165,000	63,690	58,080
11	165,000	57,750	52,305

12	20,00	6,380	5,720
NPV		2,890	-45,125

As per above table IRR must be between 10% and 11%.

As MARR is 8%, so all the alternatives are feasible as gor all alternative IRR is greater than MARR, whereas alternative A and B is more profitable as compared to alternative C.