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ME 291 Engineering Economy: Rate of Return Analysis: Single Alternative

The document discusses rate of return analysis for a single alternative. It provides examples of calculating rate of return using 10% on the unrecovered balance versus 10% on the initial amount. It also discusses how to calculate the rate of return, i*, that makes the net present worth equal to zero using trial and error.

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Ehsan Ur Rehman
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43 views9 pages

ME 291 Engineering Economy: Rate of Return Analysis: Single Alternative

The document discusses rate of return analysis for a single alternative. It provides examples of calculating rate of return using 10% on the unrecovered balance versus 10% on the initial amount. It also discusses how to calculate the rate of return, i*, that makes the net present worth equal to zero using trial and error.

Uploaded by

Ehsan Ur Rehman
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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ME 291

Engineering

ME-291 Engineering Economy


Economy
Lecture 19

Chapter 7

Rate of Return Analysis: Single alternative

Faculty of Mechanical Engineering


Ghulam Ishaq Khan Institute, Topi, Swabi
© Faculty of Mechanical Engineering, GIKI
Rate of Return

• Rate of return (ROR) is the rate paid on the

ME-291 Engineering Economy


unpaid balance of borrowed money, or the
rate earned on the un-recovered balance of
an investment so that the final payment or
receipts brings the balance to exactly zero
with interest considered.
• Interest can be -100% < i < ∞
• i = - 100% means the entire amount is lost.

© Faculty of Mechanical Engineering, GIKI


Example 7.1

ME-291 Engineering Economy


© Faculty of Mechanical Engineering, GIKI
Solution Using the 10% ROR on Un-
recovered Balance

ME-291 Engineering Economy


Using 10% ROR on Initial Amount

© Faculty of Mechanical Engineering, GIKI


c) A total of $ 400 in interest must be earned if

ME-291 Engineering Economy


10% return each year is based on the intial
amount of $1000. However, only $ 261.88 in
interest must be earned if a 10% return on
un-recovered balance is used. See figure on
next slide.

© Faculty of Mechanical Engineering, GIKI


ME-291 Engineering Economy
© Faculty of Mechanical Engineering, GIKI
Rate of Return Calculation Using the
PW or AW equation

• 0 = - PWD + PWR

ME-291 Engineering Economy


• 0 = - AWD + AWR
• Then “i ” is the value that makes these equations
numerically correct and is called i*.
• It is the root of the ROR relation.
• To determine if the alternative’s cash flow series is
viable, compare i* with the established MARR
– If i* ≥ MARR, accept the alternative as
economically viable
– If i* < MARR, the alternative is not viable
economically.

© Faculty of Mechanical Engineering, GIKI


Example

• If we deposit $1000 now and are promised payments

ME-291 Engineering Economy


of $500 three years from now and $1500 five years
from now, the rate of return relation using the PW
factors is
1000 = 500(P/F,i*,3) + 1500(P/F,i*,5)
• The value of i* to make the equality correct is to be
computed. If the $1000 is moved to the right side of
equation, we have
0 = - 1000 + 500(P/F,i*,3) + 1500 (P/F,i*,5)
• The equation gives i* = 16.9%, by using Trial and
error method.
• The rate of return will always be greater than zero if
the total amount of receipts is greater than the amount
of disbursements, when the time value of money is
considered.

© Faculty of Mechanical Engineering, GIKI


i* calculation by Trial and Error

• Draw a cash flow diagram

ME-291 Engineering Economy


• Setup the rate of return equation
• Select values of i by trial and error until the
equation is balanced.

© Faculty of Mechanical Engineering, GIKI

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