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Learn the step-by-step process of performing incremental analysis to evaluate alternatives based on their cash flows, PW, AW, FW, and IRR. Determine the best alternative with the highest NPW, EAW, or NFW.
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Steps of the Incr. Analysis Process • Order alternatives from lowest to highestinitial investment. • Let Alternative A0(do nothing) be considered the current best. • Consider next Alternative ( j = j+ 1) • Determine cash flows for “current best” and Alternative j. • Determine incremental cash flows between “current best” and Alternative j. • Calculate PW, AW, FW, IRR (or Benefit/Cost) • of only the incremental cash flows.
Steps of the Incr. Analysis Process • If incremental investment yields NPW, EAW, or a NFW > 0*, then the new “current best” becomes Alternative j. • * (B/C ratio > 1, or IRR > MARR) • If there are remaining alternatives, go to Step 3. • If all alternatives have been considered, select the “current best” alternative as the preferred alternative.
Internal Rate of Return Internal Rate of Return (IRR): The interest rate i* at which NPW = 0 Note: This is the same as finding the roots of a polynomial equation. If there is more than one sign change in the net annual cash flows over the life of the project, then there is more than one internal rate of return (root)! We may find the IRR by either the manual method we used for the bond yield, or we may use the computer to find the roots by either plots or numerical methods
