27108273-Chapter-8x

27108273-Chapter-8x - ENGINEERING ECONOMY Sixth Edition...

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02/19/10 1 CHAPTER 8 Rate of Return Analysis: Multiple Alternatives M c Gra w Hill ENGINEERING ECONOMY Sixth Edition Blank and Tarquin
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02/19/10 2 Learning Objectives 1. Why Incremental Analysis? 2. Incremental Cash Flows 3. Interpretation 4. Incremental ROR by PW 5. Incremental ROR by AW 6. Multiple Alternatives
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02/19/10 3 Section 8.1 Why Incremental Analysis is Necessary Assume we have two or more mutually exclusive alternative Objective: Which, if any of the alternatives is preferred? Prior Chapters: Use the PW or AW approach This chapter: We apply the ROR approach Present Worth: Equal service lives must apply
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02/19/10 4 8.1 Ranking Inconsistency For some problems, PW and ROR may rank the same problems differently. Why? PW assumes reinvestment at the MARR or discount rate. ROR assumes reinvestment at the i* or i’ rate Two different reinvestment rate assumptions apply
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02/19/10 5 8.1 Review of Problem Types INDEPENDENT AND MUTUALLY EXCLUSIVE ALTERNATIVES INDEPENDENT - Selection of one alternative does not effect the selection of others. Example: select all projects with a ROR> 20 % MUTUALLY EXCLUSIVE - Selection on one alternative precludes the selection of others. Example: select the project with the highest ROR.
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02/19/10 6 8.1 An Example – Shows Ranking Inconsistency Problem From Solomon {1956/59} Two Investments A and B Discount rate = 10% Each investment requires $100 at t = 0 A is a 1-year investment B is a 5- year investment
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02/19/10 7 8.1 Two Projects; A and B A $100 0 1 2 3 4 5 $120 B $100 0 1 2 3 4 5 $201.14
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02/19/10 8 8.1 Example Problem i* A = 0.20 = 20% i* B = 0.15 = 15% PW A (10%) = +$9.09 PB B (10%) = +24.89 Using ROR, A is superior to B Using PW, B is superior to A Inconsistent Rankings!
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02/19/10 9 8.1 Example Problem - Rankings Using ROR Ranking A is superior to B (20% > 15%) Using a PW(10%) approach B is superior to A ($24.89 > $9.09) The two methods do not rank the same?
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02/19/10 10 8.1 Look at A and assume Reinvestment forward to t = 5 Reinvest the $120 out to t = 5 $100 0 1 2 3 4 5 $120 Assume the +$120 can be reinvested forward at the firm’s MARR rate of 10%/year out to the end of year 5.
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11 8.1 Look at A and assume Reinvestment forward to t = 5 Find F 5 for Alt. A $100 0 1 2 3 4 5 $120 F 5 = ? F
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27108273-Chapter-8x - ENGINEERING ECONOMY Sixth Edition...

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