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Minimum Attractive Rate of Return (MARR) Minimum Attractive Rate of Return (MARR)
To be attractive, a capital project must provide a return that Many elements contribute to determining the MARR.
exceeds a minimum level established by the organization.
This minimum level is reflected in a firm’s Minimum Attractive
Amount, source, and cost of money available
Rate of Return (MARR).
Number and purpose of good projects available
Type of organization
The most-used method is the present worth method. Present worth example
The present worth (PW) is found by discounting all cash inflows Consider a project that has an initial investment of $50,000 and
and outflows to the present time at an interest rate that is that returns $18,000 per year for the next four years. If the
generally the MARR. MARR is 12%, is this a good investment?
1
Present Worth Method Present Worth Method
Evaluation of New Equipment Purchase Using PW
A piece of new equipment has been proposed by engineers to Assumptions of the present worth method.
increase the productivity of a certain manual welding operation.
The investment cost is $25,000, and the equipment will have a
market value of $5,000 at the end of a study period of five years. 1. It is assumed we know the future with certainty.
Increased productivity attributable to the equipment will amount
to $8,000 pear year after extra operating costs have been 2. It is assumed we can borrow or lend money at the same
subtracted from the revenue generated by the additional interest rate.
production. A cash-flow diagram for this investment opportunity
is given below. If the firm’s MARR is 20% per year, is this proposal
a sound one? Use the PW method.
$5,000
1 2 3 4 5
$25,000
2
Present Worth Method Future Worth Method
Capitalized worth example Future Worth (FW) Method is an alternative to the PW Method.
Looking at FW is appropriate since the primary objective is to
maximize the future wealth of owners of the firm.
Suppose that a firm wishes to endow a laboratory at a
university. The endowment principal will earn interest that FW is based on the equivalent worth of all cash inflows and
averages 8% per year, which will be sufficient to cover all outflows at the end of the study period at an interest rate that
expenditures incurred in the establishment and maintenance of is generally the MARR.
the laboratory for an indefinitely long period of time. Cash
Decisions made using FW and PW will be the same.
requirements of the laboratory are estimated to be $100,000
now, $30,000 per year indefinitely, and $20,000 at the end of A positive FW for an investment project means that the project
every 4th year for equipment replacement. is acceptable (it satisfies the MARR).
1 2 3 4 5
$25,000
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Annual Worth (AW) Annual Worth (AW)
Annual worth example Annual worth example
A project requires an initial investment of $45,000, has a A corporate jet costs $1,350,000 and will incur $200,000 per
salvage value of $12,000 after six years, incurs annual expenses year in fixed cost (maintenance, …) and $277 per hour variable
of $6,000, and provides an annual revenue of $18,000. Using cost (fuel, …). The jet will be operated 1200 hours per year for 5
a MARR of 10%, determine the AW of this project. years and then sold for $650,000. The jet revenues $1,000 per
hour. The MARR is 15% per year.
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Internal Rate of Return Internal Rate of Return
Internal Rate of Return example Internal Rate of Return example
ABC, Inc. is considering the purchase of an equipment. The A piece of new equipment has been proposed by engineers to
capital investment requirement is $345,000 and the estimated increase the productivity of a certain manual welding
market value of the system after a 6 year study period is operation. The investment cost is $25,000 and the equipment
$115,000. Annual revenues attributable to the new system will will have a market value of $5,000 at the end of its expected
be $120,00, whereas additional annual expenses will be life of 5 years. Increased productivity attributable to the
$22,000. You have been asked by management to determine equipment will amount to $8,000 per year after extra
the IRR of this project and to make a recommendation. The operating costs have been subtracted from the value of the
corporation’s MARR is 20% per year. Solve first by using linear additional production. Is the investment a good one? The
interpolation and then by using a spreadsheet. MARR is 20% per year.
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Payback Period Method Payback Period Method
The payback period is the smallest value of θ (θ ≤ N) for which It doesn’t reflect any cash flows occurring after θ, or θ'.
the relationship below is satisfied.
It doesn’t indicate anything about project desirability except
the speed with which the initial investment is recovered.