Ch8 Lecture Notes

Ch8 Lecture Notes - Rate of Return Analysis: Multiple...

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1 Rate of Return Analysis: Multiple Alternatives Chapter 8
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2 Learning Objectives
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3 WHY INCREMENTAL ANALYSIS IS NECESSARY This chapter presents methods where 2 or more alternatives can be evaluated using a rate of return (ROR) comparison based on methods of the previous chapter. The ROR evaluation correctly performed will result in the same selection as the PW, AW and FW analyses , but the computational procedure is considerably different for ROR evaluations.
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4 Assume that a company uses a MARR of 16% per year , has $90,000 available for investment, and that two alternatives (A and B) are being evaluated. Alternative A requires an investment of $50,000 and has an internal rate of return i A* of 35% per year . Alternative B requires $85,000 and has an i B* of 29% per year . Intuitively we may conclude that the better alternative is the one that has the larger return, A in this case. However, this is not necessarily so. While A has the higher projected return, it requires an initial investment that is much less than the total money available ($90,000). What happens to the investment capital that is left over? It is generally assumed that excess funds will be invested at the company’s MARR. Using this assumption, it is possible to determine the consequences of the alternative investments. If alternative A is selected, $50,000 will return 35% per year. The remaining $40,000 will be invested at the MARR of 16% per year. The rate of return on the total capital available, then, will be the weighted average.
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5 A tool and die company in Pittsburgh is considering the purchase of a drill press with fuzzy-logic software to improve accuracy and reduce tool wear. The company has the opportunity to buy a slightly used machine for $15,000 or a new one for $21,000 . Because the new machine is a more sophisticated model, its operating cost is expected to be $7000 per year , while the used machine is expected to require $8200 per year . Each machine is expected to have a 25-year life with a 5% salvage value . Tabulate the incremental cash flow.
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6 Solution Incremental cash flow is tabulated in Table 8–2. Using Equation [8.1], the subtraction performed is (new - used) since the new machine has a larger initial cost. The salvage values in year 25 are separated from ordinary cash
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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.

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Ch8 Lecture Notes - Rate of Return Analysis: Multiple...

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