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Unformatted text preview: 1 Chapter 7 Rate of Return Analysis Rate of Return Analysis Week Date Topic Chapters Assignments 1 Jan 23 Introduction to interest rates 1 2 Jan 30 Factors 2 3 Feb 6 Combining Factors 3 Quiz 1 Quiz 1 4 Feb 13 Nominal and Effective Int. Rates 4 5 Feb 20 Present Worth Analysis 5 Quiz 2 Quiz 2 6 Feb 27 Annual Worth Analysis 6 7 Mar 5 Rate of Return Analysis 7 and 8 Project status report 8 Mar 12 Benefit/Cost Ratio Analysis 9 Quiz 3 Quiz 3 9 Mar 26 Replacement Analysis 11 10 10 April 2 April 2 Exam #1 Exam #1 11 April 9 Effect of Inflation 14 12 April 16 Depreciation 16 13 April 23 Aftertax Analysis 17 14 April 30 Aftertax Analysis 17 Final report Final report 15 May 7 Sensitivity Analysis 18 Learning Objectives 4 Rate of Return Although the most commonly quoted measure of economic worth for a project or alternative is the rate of return (ROR), its meaning is easily misinterpreted, and the methods to determine ROR are often applied incorrectly. In this chapter, the procedures to correctly interpret and calculate the ROR of a cash flow series are explained, based on a PW or AW equation. The ROR is known by several other names: internal rate of return (IRR ), return on investment (ROI), and profitability index (PI), to name three. The determination of ROR is accomplished using a manual trialanderror process or, more rapidly, using spreadsheet functions. In some cases, more than one ROR value may satisfy the PW or AW equation. This chapter describes how to recognize this possibility and an approach to find the multiple values. Alternatively, one unique ROR value can be obtained by using a reinvestment rate that is established independently of the project cash flows. Only one alternative is considered here; the next chapter applies these same principles to multiple alternatives. Finally, the rate of return for a bond investment is discussed here. The case study 5 Rate of return (ROR) is the rate paid on the unpaid balance of borrowed money, or the rate earned on the unrecovered balance of an investment, so that the final payment or receipt brings the balance to exactly zero with interest considered. In ROR problems you are trying to find an unknown interest rate (i*) that satisfies the following: PWi*(+ cash flows) – PWi*(  cash flows) = 0 This means that the interest rate (i*) is an unknown parameter. 6 Wells Fargo Bank lent a newly graduated engineer $1000 at i = 10% per year for 4 years to buy home office equipment. From the bank’s perspective (the lender), the investment is expected to produce an equivalent net cash flow of $315.47 for the next 4 years. A = $1000( A/P ,10%,4) = $315.47 This represents a 10% per year rate of return on the bank’s unrecovered balance....
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This note was uploaded on 04/07/2008 for the course MSE 304 taught by Professor Reiner during the Spring '08 term at CSU Northridge.
 Spring '08
 REINER

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