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Page 36
Mutually exclusive projects
These are situa8ons when only one project can
be done because:
any one project will do the job
you can only have one project done
the resul8ng projects, if both (all) were installed
would all do the same thing
Cau8on: preferred alterna8ve is not necessarily
the one with the highest IRR, the INCREMENTAL
METHOD is required
Projects must have or be transformable to have
equal lives

Page 37
Incremental Analysis
This evaluates the difference, or the “increment” between
two or more mutually exclusive alterna8ves
This approach is required to correctly apply IRR (or B/C
ra8o) measures to mutually exclusive alterna8ves.
The steps in incremental analysis are:
1. Order alterna8ves in increasing order of FCs to insure that the
increments have cash flow pa\erns corresponding to
2. Calculate the economic value of the “do nothing“ alterna8ve or
the leastexpensive if donothing is not available
3. One by one evaluate each alterna8ve (challenger) against the
best alterna8ve (defender) found so far.
The IRRs >= MARR and the B/C >= 1 represent investments
that should be made.

Page 38
Incremental Analysis  the Concept
Key principle  MARR is always the default
Goal is to make as much money as possible
Example where MARR = 8% and all lives are 10 y:

Page 39
Incremental Investment
Which investment is preferred, MARR = 70%?
$1 first cost today and 2$ return in one year
$1000 first cost today and $1900 return in one year
First project: 1 + 2 (P/F,i,1) = 0
(P/F,i,1) = 0.5
i= 100%
Second project : 1000 + 1900 (P/F,i,1) =0
(P/F,i,1) = 0.5263
i= 90%
Incremental investment: (10001) + (19002) (P/F,i,1) = 0
IRR (incremental investment) > MARR
second project
should be chosen

Page 40
PW, AW and IRR
PW, AW, AC and B/C have the same reinvestment
assump8ons (we can invest at MARR any8me) and
used as the investment rate – this is DO NOTHING
MARR is also the reinvestment assump8on when IRR is
used, but note that IRR is not the reinvestment rate
IRR uses the same interest rate as other approaches.
In PW, AW, AC and B/C
appears as the interest rate.
But, for IRR calcula8ons
is used as the standard for
For loans, a good IRR<
and for an investment IRR>
They all use the same assump8on, and when applied
correctly, they make the same recommenda8ons

Page 41
More on Comparison Methods
Constrained Project Selec8ons
i.e. ranking of projects, project selec8on under
constrained budgets
ranking by IRR is the best method if the implied
assump8on is repeated lives
ranking by PW or AW only acceptable for projects with the
same life
and similar cash flow structures
Don’t use this method, s8ck to IRR if repeated life assump8on is
Comparing alterna8ves (assuming projects can be
Easiest way is to use PW (over a common 8me horizon) if
lives are different, use EAW or EAC
Can also examine IRR of increments
some ques8ons will have to be done with incremental analysis

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