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Q310Fall12

Q310Fall12

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Published by: Jamie Woods on Nov 20, 2012
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EC 314: Public and Private Investment Fall 2012 Q3: Choice #10

PASS Name:

NO PASS

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 -15.00 -15.00 -16.00 -12.00 1 2 3 4 PW(10%) IRR A 0.00 0.00 0.00 40.00 12.32 0.00 30.00 0.00 7.54 25.99 0.00 0.00 32.00 5.86 18.92 0.00 0.00 0.00 7.83 41.42 B Inf C D Life -Inf 19.00 4.00 2.93 8.87 3.00 5.98 4.00 2.00

A B C D

A=P

i(1+i)N (1+i)N −1

,P =A

(1+i)N −1 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 benefit in periods zero and N,
−AN A0
1 N

. This evaluates to 27.79%

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 3.89 3.03 1.85 4.51

AW

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. Remember 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. Keep in mind that this example may have more than one incremental internal rate of return, but if you follow the algorithm: (a) (b) (c) (d) (e) (f) Order the assets as D, A, B, C. Eliminate C since it has an IRR of less than 20% Start with D Do not upgrade from D to A since the incremental IRR is only 19.0%. Do not upgrade from D to B since the incremental IRR is 8.78% D is best.

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