For an incremental analysis, projects are ordered by

Question

BlackTom AI · Accepted Answer

Their IRRs — ordering projects by their internal rates of return is the standard first step in incremental analysis for choosing among mutually exclusive alternatives.

1. Relevant knowledge points and concepts
- Internal Rate of Return (IRR): the discount rate that makes the net present value (NPV) of a project’s cash flows equal zero.
- Incremental analysis (for mutually exclusive projects): compare the extra (incremental) cash flows of a larger project versus a smaller one and compute the IRR of those incremental cash flows to decide if the larger project adds value relative to the smaller.
- Time value of money: IRR incorporates timing and magnitude of cash flows, unlike a simple initial investment or total outflows.

2. Complete reasoning process (step-by-step)
- Step 1: Compute each project’s IRR.
- Step 2: Order projects by IRR (typically from lowest to highest).
- Step 3: Take two adjacent projects in that order (e.g., project i and project i+1 where i+1 has higher IRR).
- Step 4: Construct incremental cash flows: ΔCFt = CFt(project i+1) − CFt(project i) for each period t (initial outflow and subsequent inflows).
- Step 5: Calculate the IRR of the incremental cash flows by solving 0 = Σt ΔCFt / (1 + IRR_incremental)^t.
- Step 6: Compare IRR_incremental to the required rate (hurdle rate). If IRR_incremental > required return, choose the larger (i+1) project; otherwise choose the smaller (i).

3. Intermediate calculation form
- Incremental IRR equation: 0 = ΔCF0 + ΔCF1/(1+IRR_inc) + ΔCF2/(1+IRR_inc)^2 + ... Solve for IRR_inc.

4. Why the correct answer is correct
- Ordering by IRRs ensures comparisons are made in a consistent sequence so the incremental project represents the additional returns from moving to the next-higher IRR alternative. IRR incorporates timing and return rates, which are central to incremental decisions.

5. Why other options are incorrect
- Initial investment amounts or total cash outflows ignore timing and subsequent inflows (time value of money), so they can mislead selection.
- “Any of these could be used” is wrong because only IRR ordering directly addresses return rates needed for incremental IRR comparisons.

Conclusion: Ordering projects by their IRRs is the correct approach for incremental analysis, matching the provided answer: their IRRs.

For an incremental analysis, projects are ordered by单项选择题

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