Question

No Excel.

Two mutually exclusive alternatives are bring considered: A and B. Both alternatives cost $1,200 at the present. However, the pattern of revenue from them is different. Alternative A has the potential to bring more revenues later in the project life. The expected revenues of alternative A are: $350, $500, and $850 by the ends of years one to three, respectively. Alternative B promises more immediate cash inflow which is expected to diminish with time: $750, $300, and $100 by the ends of years one to three, respectively. Use MARR=8%.

1. Calculate the Internal Rate of Return of each alternative.

2. Which alternatives are feasible?

3. Calculate the Net Present Worth of each alternative and compare them.

Answer 1

1.

IRR is computed using Excel IRR function as follows.

Alternative - A		Alternative - B
Year	Cash flow ($)		Year	Cash flow ($)
0	-1,200		0	-1,200
1	350		1	750
2	500		2	300
3	850		3	100
IRR =	16.78%		IRR =	-2.91%

2.

Since Alternative A has positive IRR than is higher than MRR, Alternative A is feasible and Alternative B is not.

3.

NPW, Alt A ($) = - 1,200 + 350 x P/F(8%, 1) + 500 x P/F(8%, 2) + 850 x P/F(8%, 3)

= - 1,200 + 350 x 0.9259 + 500 x 0.8573 + 850 x 0.7938

= - 1,200 + 324.07 + 428.65 + 674.73

= 227.45

NPW, Alt B ($) = - 1,200 + 750 x P/F(8%, 1) + 300 x P/F(8%, 2) + 100 x P/F(8%, 3)

= - 1,200 + 750 x 0.9259 + 300 x 0.8573 + 100 x 0.7938

= - 1,200 + 694.43 + 257.19 + 79.38

= - 169

Since Alternative A has positive NPW, this is acceptable.