Question

A company is considering two alternatives, one of them must be implemented. Of the two alternatives, A has the higher O&M cost, and B has the higher initial cost. The appropriate (and properly calculated) IRR is 22%. Which alternative is preferred if MARR is 20%?

a) Alternative A

b) Alternative B

c) No difference

d) More information is needed to decide

Answer 1

Internal rate of return (IRR) is the rate at which present value of future cash flows becomes equal to the initial investment cost.

If the IRR is higher than MARR, the alternative has crossed the hurdle rate. Then the highest IRR should be considered for selection.

In this case, both the alternatives have crossed the hurdle rate, since (22% > 20%) and both have the same IRR; therefore, either of these two alternatives could be selected.

O&M costs and initial costs (either higher or lower) have nothing to do with this decision. They are irrelevant here.

Ans. c