7.01_econ_6

# 7.01_econ_6 - Rate of Return Analysis 1 M Pore 7.01 econ 6...

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1   ©M Pore  -  7.01  -  econ 6.ppt Rate of Return  Analysis

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2   ©M Pore  -  7.01  -  econ 6.ppt 0 36 \$9,113,600 \$1,650 Given : P = \$1,650 F = \$9,113,600 N = 36 Find i : \$9,113,600 = \$1,650 (1 + i ) 36 i = 27.04% N i P F ) 1 ( + = Rate of Return Finding the Unknown Interest Rate
3   ©M Pore  -  7.01  -  econ 6.ppt Suppose that you invested that amount (\$1,650) in  a savings account at 6% per year.  Then, you could  have only \$13,443 in September, 2006. What is the meaning of this 6% interest here? This is your  opportunity cost  if putting money in  savings account was the best you can do at that  time!  If you invested the \$1,650 in a savings  account, how much would you have  36 years later?

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4   ©M Pore  -  7.01  -  econ 6.ppt In 1970, as long as you earn more than a 6% interest in another investment, you would take that investment. Therefore, that 6% is viewed as a minimum attractive rate of return (or required rate of return). So, you can apply the following decision rule, to see if the proposed investment is a good one. ROR (27.04%) > MARR(6%) Is this a good investment?
5   ©M Pore  -  7.01  -  econ 6.ppt Why ROR measure is so popular? • This project will bring in a 15% rate of return     on investment. • This project will result in a net surplus      of \$10,000 in NPW. Which statement is easier to understand?

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6   ©M Pore  -  7.01  -  econ 6.ppt Definition 1: Interest earned on a loan balance • Rate of return (ROR) is defined as the interest  rate earned on the  unpaid balance  of an  installment loan. •  Example : A bank lends \$10,000 and receives  annual payment of \$4,021 over 3 years.  The  bank is said to earn a  return of 10%  on its loan  of \$10,000.
Loan Balance Calculation A  = \$10,000 ( A / P , 10%, 3) = \$4,021 Unpaid  Return on Unpaid    balance  unpaid balance at beg.  balance Payment at the end Year of year (10%) received of year +\$4,021 +\$4,021 +\$4,021 -\$10,000 -\$6,979 -\$3,656 0 A return of 10% on the amount  still outstanding  at the  beginning of each year

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8   ©M Pore  -  7.01  -  econ 6.ppt • Rate of return (ROR) is the  break-even interest   rate i * , which equates the present worth of a  project’s cash outflows to the present worth of  its cash inflows.   •  Mathematical Relation : PW i PW i PW i ( ) ( ) ( ) * * * = - = cash inflows cash outflows 0 Definition 2:  Break-Even Interest Rate
9   ©M Pore  -  7.01  -  econ 6.ppt Definition 3: Return on Invested  Capital – Internal Rate of Return • The internal rate of return is the interest rate  earned on the unrecovered project balance of  the investment such that, when the project  terminates, the unrecovered project balance will  be zero.

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7.01_econ_6 - Rate of Return Analysis 1 M Pore 7.01 econ 6...

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