Rate of Return Analysis

Rate of Return Analysis - Rate of Return Analysis ME 434...

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1 ME 434 Rate of Return Analysis 1 Rate of Return Analysis ME 434 Han P. Bao Department of Mechanical Engineering ME 434 Rate of Return Analysis 2 Preliminaries Various names have been used in reference to this analysis: Rate of Return Analysis (RR) Internal Rate of Return (IRR) Marginal Efficiency of Capital Minimum Attractive Rate of return (MARR): Basic rate against which all RRs are compared MARR is an internal decision criterion The more risky the project the higher the MARR IRR is the interest rate at which the benefits are equivalent to the costs IRR is solved by making PW(Benefits) = PW(Costs)
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2 ME 434 Rate of Return Analysis 3 Example 1 An investment that requires $1000 will yield a revenue of $450 per year for the next 4 years. What is the internal rate of return (IRR) for this investment? Answer : PW(Benefits) =A(P/A,i%,n) = 450( P/A,i%,n) and PW (Costs) = 1000 Solve for i by putting PW(Benefits) = PW(Costs): (P/A, i%,4) =1000/450 = 2.223 Using a trial and error approach: i (P/A, i%,4) 25 % 2.362 IRR 2.223 30 % 2.166 By interpolation: IRR = 28.545%
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