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1
Event 7 – Rate of Return
Lessons 14 and 15
Methods for Comparing Projects
Present Worth Method
: Select a study period, usually the least common multiple of the
lives. Find the NPW of each alternative over the study period and select the best. The
interest rate for the NPW computation is the MARR.
Annual Worth Method
: Compute the net annual worth of each alternative and select the
best. The interest rate for the NAW computation is the MARR.
Rate of Return Method
: Do incremental analysis.
1.
Rank the alternatives in order of increasing investment.
2.
The defender is the alternative with the smallest investment and the challenger is
the alternative with the second lowest investment.
3.
Find the IRR of the challenger over the defender. If the IRR is greater than or
equal to the MARR accept the challenger and discard the defender. If the IRR is
less than the MARR accept the defender and discard the challenger. The
remaining alternative becomes the defender.
4.
If some alternatives have not been considered, let the one with the next greater
investment be the challenger and return to step 3.
5.
If all alternatives have been considered, stop. Select the defender as the best
alternative.
1.
Consider Pedro’s 3truck and 1truck options considered in Event 6. The
Economic
addin
analysis forms for the two options are included in the E7_student.xls
workbook.
For this problem, we add the option for Pedro to make no investment.
This is called the “Do Nothing” option.
a.
Compare the two options on a cash basis.
What interest rate do you use to compare the options on a cash basis? ______
0%
Which should Pedro select? __________________
3Truck
Option
Profit for 5 years
Annual profit
3Truck Option
$78,650
$15,730
1Truck Option
$39,550
$7,910
Do Nothing
0
0
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Project Definition
Periods
Rates (%)
Worth($)
Name Pedro
Life (yrs)
5 MARR(/yr)
0.%
Present (Life)
78650
Repetitions
1
Uniform (Life)
15730
Study Period
5
Present (SP)
78650
IRR
Net Investment
Investment Data  Amounts Negative for Investments
Index
Description
Amount($)
Type
Start
End
Salvage
Factor
Fin. NPW($)
1 Truck Cost
(72000)
Investment
0
5
33.33%
0.6667
(48000)
Cash Flow Data  Amounts Negative for Expenditures and Positive for Revenues
Index
Description
Amount($)
Type
Start
End
Parameter
Factor
CF. NPW($)
1 Insurance
(3600)
Uniform
1
5
1
5.0000
(18000)
2L
icense
(300)
Uniform
1
5
1
5.0000
(1500)
3 Fixed Fuel
(900)
Uniform
1
5
1
5.0000
(4500)
4 Maintenance
(1200)
Uniform
1
5
1
5.0000
(6000)
5 Maint Grad.
(600)
Grad
2
5
1
10.0000
(6000)
6Repa
i
rs
(600)
Uniform
3
5
1
3.0000
(1800)
7 Repairs Grad.
(600)
Grad
4
5
1
3.0000
(1800)
8 Shredder
(5000)
Single
0 ***
***
1.0000
(5000)
9Ped
ro
(30000)
Uniform
1
5
1
5.0000
(150000)
10 Shredder
(5000)
Single
2 ***
***
1.0000
(5000)
11 Trimmers
(60000)
Uniform
1
5
1
5.0000
(300000)
12 Overhead
(24000)
Uniform
1
5
1
5.0000
(120000)
13 Supplies
(12500)
Uniform
1
5
1
5.0000
(62500)
14 Variable Fuel
(750)
Uniform
1
5
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 Spring '10
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