Of 2 projects, Project A has the higher annual maintenance cost while Project B
ID: 2742621 • Letter: O
Question
Of 2 projects, Project A has the higher annual maintenance cost while Project B has a higher initial equipment cost, both with similar lifetimes.The rate of return for Project A (high maintenance) is 35%, while the rate of return for Project B (higher equipment cost) is 40%. The incremental rate of return between the two projects is calculated to be 17.6%. If your company has an MARR of 20%, which alternative is preferred? Explain your reasononing on your Worksheet.
A. Project A
B. Project B
C. Neither - Do Nothing
D. Choose Both projects
Explanation / Answer
Project A should be preferred. (Option A)
Explanation:- Project A should be preferred over Project B because Project A will generate higher profits than the Project B. The decision of choosing Project A or Project B can not be taken individually on the basis of comparing the individual rate of return for Project A and Project B. Incremental comparison must be made. As the incremental rate of return between Project A and Project B i.e., (B - A) is less than the MARR of the company (17.6 % < 20 %), accordingly that project will be selected which is having less initial investment cost. Therefore, Project A should be selected because the initial investment cost of Project A is less than the initial investment cost of Project B.
Conclusion:- Project A should be preferred. (Option A)
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