QUESTION 1

Alternative 1 2 3 4 5
Initial Cost ($) -750 -400 0 -1000 -1500
Estimated Annual Expenses ($) -800 + 6% per year
-1400 (Year 1 to 5) -
2000 (Year 6 to 10)
-1250 (Year 1 to 5) -3000 -500
Estimated Annual Revenues ($) 1000 + 4% per year 1400 + 5% per year 1150 (Year 1 to 5) 3500 1000
Sale Of Business Revenue ($) 500 (Year 5 to 8)
Life (Year) 10 10 10 10 10
Table 1
Alternative 1 2 3 4 5
Incremental ROR Comparison Year Actual CF Actual CF Actual CF Actual CF Actual CF 4-to-3 5-to-4
Incremental Investment ($) 0 -750 -400 0 -1000 -1500 -1000 -500
Incremental Cash Flow($) 1 200 0 -100 500 500 600 0
2 192 70 -100 500 500 600 0
3 183 144 -100 500 500 600 0
4 172 221 -100 500 500 600 0
5 160 302 400 500 500 100 0
6 146 -213 500 500 500 0 0
7 131 -124 500 500 500 0 0
8 113 -30 500 500 500 0 0
9 93 68 0 500 500 500 0
10 72 172 0 500 500 500 0
Table 2
In Table 2, incremental investment refers to the initial cost of the alternatives while the
incremental cash flow for each year is calculated as below:
(i) For option 1 and 2,
Actual CF at year n = Estimated annual revenues at year n Estimated annual
expenses at year n
(ii) For option 4 and 5, the actual cash flow is simply the difference between estimated
annual revenues and estimated annual expenses since these values are constant
throughout 10 years time.
(iii) For option 3, the actual cash flows from year 1 to 5 are calculated using the same
formula stated in part (ii). However, there will be a sale of business revenue in year 5.
At year 5, the actual cash flow is the difference between sum of revenues and
estimated annual expenses. Since the new owner pays the same amount, which is
$500000 for the next 3 years, the only cash flows from year 6 to 8 are $500000 and
there will be no cash flows in year 9 and 10.
QUESTION 2
Multiple i* values only exist when there is more than one sign change in net cash flow (CF)
series. Referring to the tabulated data, all the alternatives have only one sign change except for
alternative 2. Alternative 2 has three sign changes in both cash flow and cumulative cash flow
series. Therefore, there are no multiple rates in the range of 0% to 100% but only one single
rate which is 10.1%.



QUESTION 3
From the table, it can be seen that out of the 5 options suggested by John, only options 3, 4 and
5 are possible to be chosen by his father, Mr Kettler. This is because out of the 5 options, only
the 3 highlighted options overall i* larger than the MARR of 25% and also a PW and AW larger
than zero. MARR is the minimum attractive rate of return which means it is the minimum amount
of revenue that has to be generated from a project or an investment in order for it to be
economically justified while i* is the internal rate of return for a specified project or an
investment. The overall i* values are calculated by using IRR function which is
=IRR(first_cell:last_cell). Hence, the overall i* of a project has to be larger or equal to the MARR
for the project to be economically justified. Since the stated MARR in question 3 is 25%, option
1 and 2 are eliminated. The table below shows the summary of the calculation whereby
alternative 4 has the highest i* followed by alternative 3 and 5:
Alternative 1 2 3 4 5
Overall i* 17.45% 10.12% 46.41% 49.08% 31.11%
Retain/Eliminate Eliminate Eliminate Retain Retain Retain
Table 3
However, the overall i* analysis may not always provide the same ranking as with AW and PW
analysis. Therefore, an incremental cash flow analysis has to be done so that the best
alternative among the 5 alternatives can be determined. In this calculation, the IRR function is
used again to calculate the incremental i*. Since the incremental i* value for 4-to-3 is 49.85%
and the value for 5-to-4 is error, which might be caused by zero or negative value, option 4 is
selected. Furthermore, it is found that the PW for option 3, 4 and 5 are $214.73, $785.25 and
$285.25 respectively. The AW for option 3, 4 and 5 were also calculated and the values are
$60.14, $219.93 and $79.89 respectively. The PW for all options are calculated using NPV
function which is =NPV(rate,second_cell:last_cell)-initial cost and the AW is also calculated
using spreadsheet function which is PMT function. From the observation of the PW and
AW values, option 4 is chosen as it has the highest positive value of PW and AW out of the 3 possible options. The table below
shows the summary of all the calculation:
Alternative 1 2 3 4 5
Incremental ROR Comparison Year Actual CF Actual CF Actual CF Actual CF Actual CF 4-to-3 5-to-4
Incremental Investment ($) 0 -750 -400 0 -1000 -1500 -1000 -500
Incremental Cash Flow($) 1 200 0 -100 500 500 600 0
2 192 70 -100 500 500 600 0
3 183 144 -100 500 500 600 0
4 172 221 -100 500 500 600 0
5 160 302 400 500 500 100 0
6 146 -213 500 500 500 0 0
7 131 -124 500 500 500 0 0
8 113 -30 500 500 500 0 0
9 93 68 0 500 500 500 0
10 72 172 0 500 500 500 0
Incremental i* 49.85% #NUM!
Incremental Justified? Yes No
Alternative Selected 4
PW at MARR ($) -146.63 -151.27 214.73 785.25 285.25 -500
AW at MARR ($) 60.14 219.93 79.89
Alternative Acceptable? No No Yes Yes Yes
Alternative Selected 4
Table 4

QUESTION 4

Graph 1
Option
Combination
Estimated Breakeven Rate of Return
(%)
1 and 2 26
1 and 5 42
2 and 5 37
3 and 4 50
3 and 5 27
Table 5








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Rate of Return, i (%)
Graph of Present Worth of Actual Cash Flow, PW against Rate of
Return, i
Option 1
Option 2
Option 3
Option 4
Option 5
REFERENCE
B. Leland, T. Anthony. Engineering Economy, 7
th
Edition. McGraw-Hill, 2012.