2007 Chapter 7-1

# 2007 Chapter 7-1 - Rate of Return Analysis Chapter 7 1...

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1 Rate of Return Analysis Chapter 7

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2 OUTLINE Definitions Computation of Breakeven Interest Rate Direct Solution Trial and Error Computer Solution IRR Criterion Mutually Exclusive Alternatives
3 Rate of Return (ROR) Internal Rate of Return(IRR); Marginal Efficiency of Capital; Yield are same concept “ROR is the interest rate earned on the unpaid balance of an amortized loan” “ROR is the break-even rate, i*, which equates the PW of a project’s cash outflows to the PW of its cash inflows Cost of capital or target return known as Minimum Acceptable Rate of Return (MARR)

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4 outflows Cash inflows Cash * PW PW ) PW(i - = 0 = = + = N 0 n n n i) (1 A PW(i) cashflows net of worth Present n) i, (P/F, A N 0 n n = = i at calculated NPW PW(i) = n period of end at CF Net A n = (MARR) capital of Cost = i : context ROR the In * i for Solve i * = MARR = Minimum Attractive Rate of Return PW(i*) = A 0 + A 1 A N (1+i*) (1+i*) N +…+ = 0 N = Service life of the project n = Year
5 IRR is the interest rate charged on the unrecovered project balance of the investment such that, when the project terminates, the unrecovered project balance is zero, let i = 10% n Beginning Balance Return on Invested Capital Ending Cash Payment Project Balance 0 \$0 \$0 -\$10,000 -\$10,000 1 -10,000 -1,000 4,021 -6,979 2 -6,979 -697 4,021 -3,656 3 -3656 -365 4,021 0

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6 10% is earned on \$10,000 during year 1 10% is earned on \$6,979 during year 2 10% is earned on \$3,656 during year 3 “the firm earns a 10% ROR on funds that remain internally
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## This note was uploaded on 03/11/2010 for the course CEVE 322 taught by Professor Segner during the Spring '10 term at Rice.

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2007 Chapter 7-1 - Rate of Return Analysis Chapter 7 1...

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