Lec%2019_Full(1)

Lec%2019_Full(1) - IE 343 Engineering Economics Lecture 19...

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IE 343 Engineering Economics Lecture 19: Chapter 5 – Evaluating a Single Project Instructor: Tian Ni Oct.7, 2011 IE 343 Fall 2011 1
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Internal Rate of Return method (IRR) IE 343 Fall 2011 2
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IRR is the interest rate that equates the equivalent worth of the cash inflows of a project to the equivalent worth of its cash outflows. Correspondingly, it is the interest rate that makes the PW, FW, and AW of a project equal to zero . IE 343 Fall 2011 Internal Rate of Return (IRR) method 3
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You invest $100 now Your minimum attractive rate of return (MARR) is 10% Suppose you get $120 at EOY 1 What is the Internal Rate of Return i’ ? Are you satisfied under MARR = 10%? IE 343 Fall 2011 (IRR) method – Simple Example 1 4
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PW( i’ ) = -100 + 120(P/F, i’ , 1) = 0 100 = 120(P/F, i’ , 1), i’ = 20% > MARR = 10% Yes, my internal rate of return of this project is 20%, which is higher than my expected MARR = 10% IE 343 Fall 2011 (IRR) method – Simple Example 1 5 0 1 $120 MARR = 10% $100
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You invest $100 now Your minimum attractive rate of return (MARR) is 10% Suppose you get $120 at EOY 2 What is the Internal Rate of Return i’ ? Are you satisfied under MARR = 10%? IE 343 Fall 2011 (IRR) method – Simple Example 2 6
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PW( i’ ) = -100 + 120(P/F, i’ , 2) = 0 100 = 120(P/F, i’ , 2), i’ = 9.6% < MARR = 10% No, my internal rate of return of this project is 9.6%, which is lower than my expected MARR = 10% IE 343 Fall 2011 (IRR) method – Simple Example 2 7 0 1 $120 MARR = 10% $100 2
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Formally, (using the PW formulation), IRR is the such that: Alternatively, IE 343 Fall 2011 Internal Rate of Return (IRR) method = = = N k k N k k k i F P E k i F P R 0 0 ) %, , / ( ) %, , / ( % i period) study (or life project : year for expenses : year for (receipts) revenues : N k E k R k k [ ] 0 ) %, , / ( ) %, , / ( 0 = = = N k k k k i F P E k i F P R PW 8
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Region IRR is intrinsic to the project and does not depend on the interest rates that prevail in capital market, (i.e., it only depends on the project’s cash flows.) Usually computed with trial-and-error (linear interpolation, Excel VBA) and graphical methods. IE 343 Fall 2011
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This note was uploaded on 01/28/2012 for the course IE 343 taught by Professor Vincent,g during the Winter '08 term at Purdue.

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Lec%2019_Full(1) - IE 343 Engineering Economics Lecture 19...

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