NewEnvironments: Which of the following scenarios

Which of the following scenarios have the potential to cause problems for the increasing cost of funds algorithm with indivisible assets?

Question options:

  • The MARR of retained earnings is 0%.
  • Two of the sources of funds have the same MARR.
  • The indivisible assets are compound assets, such as, asset A is both a truck and a lift instead of just a truck.
  • There are three sources of funds and not just two.

* An asset that requires funds from two sources is rejected by the criteria, but the next asset, with a smaller IRR, can be funded with just the lower MARR funds.

Discussion

  • The MARR of retained earnings is 0%.

This just just makes the comparisons easier.

  • Two of the sources of funds have the same MARR.

This turns the problem back into an unconstrained choice environment.

  • The indivisible assets are compound assets, such as, asset A is both a truck and a lift instead of just a truck.

Assuming you set up the choices so that the assets are separable, this is how you are supposed to handle assets that go together. It is best practice.

  • There are three sources of funds and not just two.

The same rules work. The problem is actually a little easier when the assets and cost of funds are continuous rather than discrete.

* An asset that requires funds from two sources is rejected by the criteria, but the next asset, with a smaller IRR, can be funded with just the lower MARR funds.
What happens is that the average cost of funds function is no longer non-decreasing. That makes it hard to to for sure if you have a local max or local min of the net benefit function when you use the algorithm.

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