For the alternatives shown, determine the sum of the incremental cash flows for
ID: 2753906 • Letter: F
Question
For the alternatives shown, determine the sum of the incremental cash flows for alternative B- Alternative A. Solve the problem using a 6- year LCM analysis. Assume 40% tax rate. Use 5 year MACRS depreciation on the equipment. Calculate book value and capital loss/depreciation recapture. Determine the best investment using incremental IRR analysis with MARR = 20%. (please show your work and use excel)
Alternative A
Alternative B
Fist cost $
-50000
-85000
Annual operating cost $ per year
-8600
-2000
Annual revenue $ per year
22000
45000
Salvage value $
3000
8000
Life, years
3
6
Alternative A
Alternative B
Fist cost $
-50000
-85000
Annual operating cost $ per year
-8600
-2000
Annual revenue $ per year
22000
45000
Salvage value $
3000
8000
Life, years
3
6
Explanation / Answer
LCM Analysis: Select a 6-year analysis period, the least common multiple of 3 and 6. The appropriate criterion is to select the Alternative with the lowest PW (cost) over the 6-year analysis period, assuming that A is identically replaced at EOY 3 & EOY 6 ; that B is identically replaced at EOY 6.
A: PW (cost) = $50k + $50k (P/F,20%,3) + $50k (P/F,20%,6)
PW (cost) = $50k [ 1 + (P/F,20%,3) + (P/F,20%,6) ]
PW (cost) = $50k [ 1 + 0.579 + 0.335 ]
= $50k ( 1.914 ) = $95,700
B: PW (cost) = $85k [ 1 + (P/F,20%,6) ]
= $85k [ 1 + 0.335 ] = $85k ( 1.335 ) = $113,475
Select Alternate A because it has the lowest PW (cost).
INCREMENTAL ANALYSIS:
Alternative A
Alternative B
Fist cost $
-50000
-85000
Annual operating cost $ per year
-8600
-2000
Annual revenue $ per year
22000
45000
Salvage value $
3000
8000
Life, years
3
6
SO, ALTERNATIVE B HAVE A EDGE OVER THE ALTERNATIVE A, THEREFORE 'B' SHOULD BE OPTED AS PER INCREMENTAL ANALYSIS.
IRR ANALYSIS OF BOTH ALTERNATIVE:
A: net inflow = 22000 - 8600-10000=3400 - tax 1360 =2040 + 10000= 12040
cash flow at 5% for 5 years = 52121.16 and at 7% for 5years = 49364
so, IRR = 6.54%
B: net inflow = 45000-2000-15600=27400 - tax 10960=16440 + 15600=32040
cash flow at 24% for 5 years = 87949.80 and at 28% for 5years = 81125.28
so, IRR = 25.73%
Comparing both the alternative with MARR = 20%, alternative B should be opted because IRR is more than the MARR = 20%.
Alternative A
Alternative B
Incrementals NCFFist cost $
-50000
-85000
-35000Annual operating cost $ per year
-8600
-2000
6600Annual revenue $ per year
22000
45000
23000Salvage value $
3000
8000
5000Life, years
3
6
3 incremental ROR 97% > MARR 20%