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EC 314: Public and Private Investment Q3: Choice #7: I (1+i) (1+i) 1 (1+i) 1 I (1+i)

This document presents information on 4 assets (A, B, C, D) including their cash flows, present worth values, and internal rates of return. It asks 4 questions: 1) Find the IRR of asset A. 2) At a 10% MARR and 12 year requirement, which asset is best? 3) At a 10% MARR with no time requirement, which asset is best? 4) At a 20% MARR with no time requirement, which asset is best? The key is to use the appropriate capital budgeting technique for each question - net present value, annual worth, or internal rate of return - to evaluate and select the best asset.

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71 views2 pages

EC 314: Public and Private Investment Q3: Choice #7: I (1+i) (1+i) 1 (1+i) 1 I (1+i)

This document presents information on 4 assets (A, B, C, D) including their cash flows, present worth values, and internal rates of return. It asks 4 questions: 1) Find the IRR of asset A. 2) At a 10% MARR and 12 year requirement, which asset is best? 3) At a 10% MARR with no time requirement, which asset is best? 4) At a 20% MARR with no time requirement, which asset is best? The key is to use the appropriate capital budgeting technique for each question - net present value, annual worth, or internal rate of return - to evaluate and select the best asset.

Uploaded by

Jamie Woods
Copyright
© Attribution Non-Commercial (BY-NC)
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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EC 314: Public and Private Investment PASS NO PASS

Q3: Choice
#7 Name:

Consider the following assets.


The far right of the table may be read as the incremental internal rate of return between
the row asset moving to the column asset.

0 1 2 3 4 PW(10%) IRR A B C D Life


A -20.00 0.00 32.00 0.00 0.00 6.45 64.53 -Inf Inf 2.00
B -12.00 0.00 0.00 28.00 7.12 23.59 12.47 24.87 4.00
C -7.00 0.00 0.00 20.00 6.66 30.01 17.22 4.00
D -20.00 0.00 38.00 0.00 8.55 23.86 3.00

   
i(1+i)N (1+i)N −1
A=P (1+i)N −1
, P = A i(1+i)N

1. What is the internal rate of return of asset A?

2. At a MARR of 10% and requirement to provide 12 years of service, which asset would
you chose? Be sure to explain why this is the best asset.

3. At a MARR of 10% and no service requirement, which asset would you chose? Be sure
to explain why this is the best asset.

4. At a MARR of 20% and no service requirement, which asset would you chose? Be sure
to explain why this is the best asset.
Answer Key
1. Answer: You can set the present worth of asset A to zero and solve for the interest
rate or you can use the closed form method for when there is only a cost and
 1
−AN N
benefit in periods zero and N, A0 . This evaluates to 26.49%

2. Answer: This question is set up so that the asset lives are factors of the planning
horizon. The upshot is that you can use the annual worth criteria. For each of
the assets calculate the annual worth, AW (Asset) = P W (Asset)(A|P, i, Lif e).
Please note that the lives of the asset are listed on the far right of the table and
that the present worth values are calculated for you.
The table below gives the annual worth, just pick the big one.

A B C D
AW 3.71 2.25 2.10 3.44

3. Answer: This is the exclusive choice criteria. Just pick the one with the largest
Present Worth.

4. Answer: You should be using the IRR exclusive choice procedure on this one. Remem-
ber the key steps are to order the assets from smallest to largest initial investment
and then eliminate all assets with internal rates of return less than MARR. Don’t
be shocked if that leaves you with no assets. After that stay in the ’while’ loop
of your procedure checking if the incremental internal rates of return are greater
than MARR.

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