ISE 220
Engineering Economics
Rate-Of-Return Analysis – Ch. 7
Izmir University of Economics
Halil POSACI
2012, İzmir
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Agenda
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•
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Rate Of Return Analysis
Decision Rule
Simple and non-simple cash flows
Comparing Mutually Exclusive Projects
– Incremental Analysis
• Class work
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Rate Of Return Analysis
Interest earned (or Lost) on a project cash flow
Marginal Efficiency Of Capital
Rate Of Return (ROR)
Yield
Internal Rate of Return (IRR)
PW(i) = 0
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Rate Of Return Analysis
Decision Rule
Solve for i
Accept if i > MARR
PW = -10 + 1.8(P/A, i, 8) + 2.8(P/F, i, 8) = 0
= IRR(cell range)
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Rate Of Return Analysis
Simple Versus Non-simple Cash Flows
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Rate Of Return Analysis
Simple Versus Non-simple Cash Flows
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Rate Of Return Analysis
Simple Versus Non-simple Cash Flows
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Example 7.3
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Example 7.3
Exact Solution
PW = -10 + 1.8(P/A, i, 8) + 2.8(P/F, i, 8) = 0
= IRR(cell range)
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7.4 Real Bond Yield
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7.4 Real Bond Yield
-996.25 + 48.13(PIA, i, 20) + 1000 (P/F, i, 20)
Solve for i
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IRR Decision Rule
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7.5
Economics of Wind
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7.5
Economics of Wind
 Number of wind turbines to
be built: 200 units
 Power capacity: 310,000kW
 Capital investment required:
$338,000,000
 Project life: 20 years
 Salvage value of the wind
turbines after 20 years: $0
 Annual net cash flows (after
all deductions): $41,391,160
A = $41,391,160
0
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MARR = 10%
$338,000,000
-338000000 + 41391160(P/A, i,20) = 0 Solve for i
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7.6
Non-simple Project
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7.6
Non-simple Project
$2,300 $1,320
PW (i)  $1,000 

1 i
(1  i)2
0
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7.6
Non-simple cash flows
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Mutually Exclusive Projects
Incremental Analysis
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Mutually Exclusive Projects
Incremental Analysis
Step 1:
Compute the cash flows for the difference
between the projects (A,B) by subtracting
the cash flow of the lower investment
cost project (A) from that of the higher
investment cost project (B).
Step 2:
Compute the IRR on this incremental
investment (IRRB-A ).
Step 3:
Accept the investment B if and only if
IRR B-A > MARR
NOTE: Make sure that both IRRA and IRRB are greater than MARR.
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Example 7.7
Incremental Analysis
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Example 7.8
Three Alternatives
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Example 7.9 – Cost Only Project
Cellular or Flexible Manufacturing system
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Example 7.9 – Cost Only Project
Cellular or Flexible Manufacturing system
Although we cannot compute the
IRR for each option without
knowing the revenue figures,
we can still calculate the IRR on
incremental investment.
IRRFMS-CMS = 12.43% < 15%,
Select the CMS option.
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Example 7.10
Unequal Service Lives
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Example 7.10
Unequal Service Lives
MARR = 12%
Option 2 is better
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Classwork / Homework
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