NewEnvironments:Suppose you have three indivisible assets

Suppose you have three indivisible assets, A, B and C with internal rates of return 2%, 5% and 10% respectively and initial costs of $1, $3, $5.

Suppose you have $4 at 1% and can borrow at 8%. Which assets do you buy?

Question options:

  • A
  • B
  • C

Solution:

First, arrange the assets in order of descending IRR's: C (10%), B (5%), A (2%)

Second, assess the viability of each asset, beginning with Asset C. Asset C's initial cost of $5 is greater than available retained earnings ($4), but we can borrow the remaining $1 at 8%, an MARR which is still less than the 10% IRR of C. Thus, asset C should be bought.

If we wished to calculate specifically what the blended MARR would be for asset C, blended MARR=(4/5)*.01+(1/5)*.08=0.024, or 2.4%.

For both Asset B (5%) and Asset A (2%), we can utilize only borrowed funds at 8% since all retained earnings have been used to buy asset C. Since the MARR of 8% is higher than both IRR's, Asset B and Asset A should be rejected.

The only asset which should be bought is C.

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