Choosing the Best Alternative

Chapter 8: Newnan, Eschenbach, and Lavelle Dr. Hurley’s AGB 555 Course

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Dealing With Multiple Alternatives for Investment

When multiple alternatives exist for investment, it is useful to graph that investment in terms of interest rate and present worth (PW), equivalent uniform annual cost (EUAC), or equivalent uniform annual worth (EUAW) • From this you can develop a choice table that tells you which alternative to choose at a particular rate • When you dealing with PW and EUAW you choose the highest value, while EUAC would require you to choose the lowest value

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Elements in Comparing Mutually Exclusive Alternatives

Identify all alternatives • Make sure to include the status quo or do nothing option in the analysis Graph PW, EUAC, or EUAW for each alternative on the same axis Examine the envelope (best line) for particular ranges of interest rates where the ranges are found by looking at where alternatives cross each other Calculate the changeover points for when one alternative begins to exceed another alternative • You can do this visually or more accurately by calculating the incremental internal rate of return for the two crossing alternatives Create a choice table

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Incremental Challenger Defender Comparisons

Alternatives are ranked from lowest cost to highest cost • The lowest cost alternative starts out as the first defender • Make sure the initial alternative has an IRR greater than MARR Next calculate the incremental internal rate of return between the two lowest cost alternatives that have not been excluded Choose the best alternative based on the rules given in the previous chapter • The one that is considered the best becomes the defender for the next pairwise comparison Continue the comparison until no more can be made

Spreadsheet Tools for Examining Multiple Alternatives • There are two useful tools in Excel to help you graphically examine multiple alternatives • Goal Seek allows you to solve for interest rates that cannot be easily solved for by hand/formula • Data Table allows you to run many different alternative interest rates at a single time which will allow you to develop your graphs more quickly especially when your returns are not constant over the life of the investment