Well... yes and no. Yes, you are doing a good job thinking about how to best manage your money (!), but you've actually changed the problem's parameters by buying two of the same things. The key assumptions underlying the Incremental IRR method are: 1) the options are "mutually exclusive" (you choose one -only), and 2) the difference in the dollar amount of the investments is assumed to earn a return equal to the MARR (i.e.- if you don't use all of your 'budget', the left-over money is assumed to be invested somewhere else and it is assumed to earn the MARR). I have other videos on Incremental-IRR that might be helpful. It might seem like a strange way to evaluate investments but there is some good logic behind it! Perhaps it would be useful to think of this method as something used by large companies making lots of investment decisions. Good luck.
How would you calculate Incremental IRR if one option has an annual savings that INCREASES each year? (e.g. year 1 annual savings = 100, year 2 = 300, year 3 = 500, so annual savings start 100 on the first year and increases additional 200 following years).
Good question! Incremental IRR can still be used for the situation you describe. You need to evaluate the the option with increasing annual savings using other time-value of-money techniques. There is a formula for patterns of cash flows that increase by a constant amount (an arithmetic gradient), or a constant rate (a geometric gradient). I have videos on these methods if you want to explore my channel, HOWEVER, I will warn you that solving for the "rate" is never easy in these types of problems. I would recommend using the built-in IRR function in excel - I also have a video on that! Good luck!
What an insightful explanation.Thank you so much.
Glad you liked it! Thanks for the comment!
These are great, thank you so much.
Given 200k budget, buying two lathe 1s would be the best based on 50k > 46k, right?
Well... yes and no. Yes, you are doing a good job thinking about how to best manage your money (!), but you've actually changed the problem's parameters by buying two of the same things. The key assumptions underlying the Incremental IRR method are: 1) the options are "mutually exclusive" (you choose one -only), and 2) the difference in the dollar amount of the investments is assumed to earn a return equal to the MARR (i.e.- if you don't use all of your 'budget', the left-over money is assumed to be invested somewhere else and it is assumed to earn the MARR). I have other videos on Incremental-IRR that might be helpful. It might seem like a strange way to evaluate investments but there is some good logic behind it! Perhaps it would be useful to think of this method as something used by large companies making lots of investment decisions. Good luck.
How would you calculate Incremental IRR if one option has an annual savings that INCREASES each year? (e.g. year 1 annual savings = 100, year 2 = 300, year 3 = 500, so annual savings start 100 on the first year and increases additional 200 following years).
Good question! Incremental IRR can still be used for the situation you describe. You need to evaluate the the option with increasing annual savings using other time-value of-money techniques. There is a formula for patterns of cash flows that increase by a constant amount (an arithmetic gradient), or a constant rate (a geometric gradient). I have videos on these methods if you want to explore my channel, HOWEVER, I will warn you that solving for the "rate" is never easy in these types of problems. I would recommend using the built-in IRR function in excel - I also have a video on that! Good luck!
WOW OWO OWOW Thanksssss!!!!!!!!
You're welcome!