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Comparison and Selection Among Alternatives

The document discusses methods for comparing and selecting among mutually exclusive investment alternatives. It describes comparing internal rates of return (IRRs) to the minimum acceptable rate of return (MARR), but not comparing IRRs of mutually exclusive alternatives. The inconsistent ranking problem can occur when ranking alternatives based on IRR. Incremental investment analysis procedure involves analyzing the differences in cash flows between alternatives. An example compares alternatives for a compressor project using IRR and net present value (NPV) at the MARR to get the same decision. A second example compares packaging device alternatives over 10 years at an 18% MARR to determine the preferred option.

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Novita Frisilia
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56 views

Comparison and Selection Among Alternatives

The document discusses methods for comparing and selecting among mutually exclusive investment alternatives. It describes comparing internal rates of return (IRRs) to the minimum acceptable rate of return (MARR), but not comparing IRRs of mutually exclusive alternatives. The inconsistent ranking problem can occur when ranking alternatives based on IRR. Incremental investment analysis procedure involves analyzing the differences in cash flows between alternatives. An example compares alternatives for a compressor project using IRR and net present value (NPV) at the MARR to get the same decision. A second example compares packaging device alternatives over 10 years at an 18% MARR to determine the preferred option.

Uploaded by

Novita Frisilia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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COMPARISON AND

SELECTION
AMONG ALTERNATIVES
COMPARISON AMONG ALTERNATIVES

Project A
• Capital Investment
• Annual Revenue
Company Project B • Annual Cost
• Useful Life

Project C

“do the added benefits from a more-expensive


Mutually Exclusive alternative bring a positive return relative to the
added costs?”
INVESTMENT & COST ALTERNATIVES
INTERNAL RATE OF RETURN

Do not compare the IRRs of mutually exclusive alternatives (or IRRs of the
differences between mutually exclusive alternatives) against those of other
alternatives. Compare an IRR only against MARR (IRR ≥ MARR) in determining the
acceptability of an alternative.

The Inconsistent Ranking Problem


THE INCONSISTENT RANKING PROBLEM
INCREMENTAL
INVESTMENT
ANALYSIS
PROCEDURE
EXERCISE
Suppose that we are analyzing the following six mutually exclusive alternatives for
a small investment project, using the IRR method. The useful life of each alternative
is 10 years, and the MARR is 10% per year. Also, net annual revenues less expenses
vary among all alternatives. If the study period is 10 years, and the market
(salvage) values are zero, which alternative should be chosen? Notice that the
alternatives have been rank-ordered from low capital investment to high capital
investment.
EXAMPLE
EXAMPLE
The estimated capital investment and the annual expenses (based on 1,500 hours of operation per
year) for four alternative designs of a diesel-powered air compressor are shown, as well as the
estimated market value for each design at the end of the common five-year useful life. The study
period is five years, and the MARR is 20% per year. One of the designs must be selected for the
compressor, and each design provides the same level of service. On the basis of this information,
(a) determine the preferred design alternative, using the IRR method
(b) show that the PW method (i = MARR), using the incremental analysis procedure, results in the
same decision.
EXAMPLE
In the Rawhide Company (a leather products distributor), decisions regarding approval of proposals
for capital investment are based upon a stipulated MARR of 18% per year. The five packaging
devices listed in Table were compared, assuming a 10-year life and zero market value for each at
that time. Which one (if any) should be selected?

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