Question

the irr method is used to evaluate the following two mutually exclusive alternative investments. the marr is 8% per year
alternative x y y versus x
initial cost $250,000 $400,000 $150,000
net annual revenues $58,977 $82,145 $23,168
service life (years) 10 10 10
irr 19.7% 15.8% 8.8%
which of investment is more economical and how is it determined from the information given above
o a. alternative y because the incremental irr is greater than marr
o b. alternative y because it has higher initial cost and annual revenues
o c. alternative x because it has a higher irr
o d. alternative x because the incremental irr is greater than marr

Explanation:

When comparing mutually - exclusive alternatives using the IRR method, we first check if the IRR of the lower - cost alternative (X has an initial cost of $250,000 and Y has an initial cost of $400,000, so X is the lower - cost alternative) is greater than the MARR. The IRR of X is 19.7% > 8% (MARR). Then we check the incremental IRR (Y versus X). The decision rule for mutually - exclusive alternatives using incremental IRR is: if the incremental IRR ($8.8\%$ for Y versus X) > MARR ($8\%$), we choose the higher - cost alternative. If incremental IRR < MARR, we choose the lower - cost alternative. Here, incremental IRR ($8.8\%$) > MARR ($8\%$), so we choose Y.
Option B is incorrect because having a higher initial cost and revenue is not a valid criterion for economic comparison. Option C is incorrect because when comparing mutually - exclusive alternatives, we cannot just choose based on individual IRR (we need to consider the incremental IRR). Option D is incorrect as the conclusion is wrong (incremental IRR > MARR leads to choosing Y, not X).

Answer:

A. Alternative Y because the incremental IRR is greater than MARR