Question

A company considers two mutually exclusive 2-year projects. Project A requires $2,500 in equipment investment, with annual revenues of $1,600 in year 1 and $1,840 in year 2. Project B requires purchasing $3,600 worth of equipment, and its annual revenues will be at $2,600 in year 1 and $2,200 in year 2. If company’s MARR = 15%, which project should be selected based on the ERR criterion?

1 - A and B

2 - B

3 - A

4 - Do nothing

Answer 1

Solution:

Year	Project A Amount($)	Project B Amount($)	PVF@15%	Project A NPV Amount($)	Project B NPV Amount($)
0	(2500)	(3600)	1	(2500)	(3600)
1	1600	2600	0.870	1392	2262
2	1840	2200	0.756	1391	1663
TOTAL NPV				283	325

Profitability Index = PV of the future cash flow/Initial Investmet of the project

For Project A

Profitabilty Index = 2783/2500 = 1.1132

For Project B

Profitabilty Index = 3925/3600 = 1.0903

On the basis of Economic Rate of Return.

Project A = 283/2500*100 = 11.32%

Project B = 325/3600*100 = 9.03%

Hence, Project has higher return than Project B,

Investor should invest in Project A