Chapter 8 Rate of Return Analysis: Multiple Alternatives

Solutions to Problems 8.1 (a) The rate of return on the increment has to be larger than 18%. (b) The rate of return on the increment has to be smaller than 10%. 8.2 Overall ROR: 30 000(0.20) ! "0 000(0.1#) $ 100 000(%) % $ 1&.8% 8.3 There is no income associate' (ith service alternatives. Therefore the onl) (a) to obtain a rate of return is on the increment of investment. 8.# The rate of return on the increment of investment is less than 0. 8.& *) s(itching the +osition of the t(o cash flo(s the inter+retation changes com+letel). The situation (oul' be similar to receiving a loan in the amount of the 'ifference bet(een the t(o alternatives if the lower cost alternative is selecte'. The rate of return (oul' re+resent the interest paid on the loan. ,ince it is higher than (hat the com+an) (oul' consi'er attractive (i.e. 1&% or less) the loan shoul' not be acce+te'. Therefore select the alternative (ith the higher initial investment -. 8.. (a) *oth +rocessors shoul' be selecte' because the rate of return on both e%cee's the com+an)/s 0-RR. (b) The micro(ave mo'el shoul' be selecte' because the rate of return on increment of investment bet(een the t(o is greater than 23%. 8." (a) 1ncremental investment anal)sis is not re2uire'. -lternative 3 shoul' be selecte' because the rate of return on the increment is 4no(n to be lo(er than 20% (b) 1ncremental investment anal)sis is not re2uire' because onl) -lt 5 has ROR greater than the 0-RR (c) 1ncremental investment anal)sis is not re2uire'. 6either alternative shoul' be selecte' because neither one has a ROR greater than the 0-RR. (') The ROR on the increment is less than 2.% but an incremental investment anal)sis is re2uire' to 'etermine if the rate of return on the increment e2uals or e%cee's the 0-RR of 20% (e) 1ncremental investment anal)sis is not re2uire' because it is 4no(n that the ROR on the increment is greater than 22%.
7ha+ter 8 1

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

8.8 Overall ROR: 100 000(i) $ 30 000(0.30) ! 20 000(0.2&) ! &0 000(0.20) i $ 2#% 8.< (a) ,i=e of investment in 5 $ &0 000 > 20 000 $ ?30 000 (b) 30 000(i) ! 20 000(0.1&) $ &0 000(0.#0) i $ &.."% 8.10 5ear 0achine * 0 1 2 3 # & . 8.11 *>:2& 000 :#00 :#00 :#00 :#00 :#00 !.000 > #00 0achine :10 000 !1200 !1200 !13 200 !1200 !1200 !#200 -

:1& 000 :1 .00 :1.00 :1& 000 >1.00 ! 3000 :1.00 :1.00 !3000 >1.00

The incremental cash flo( e2uation is 0 $ :.& 000 ! %(@A- 2&% #) (here % is the 'ifference in the o+erating costs of the +rocesses. % $ .& 000A2.3.1. $ ?2" &2# O+erating cost of +rocess * $ .0 000 > 2" &2# $ ?32 #".

8.12 8.13

The one (ith the higher initial investment shoul' be selecte' because it )iel's a rate of return that is acce+table that is the 0-RR. (a) Bin' rate of return on incremental cash flo(. 0 $ :3000 >200(@A- i 3) ! #"00(@AB i 3) i $ 10.#% (C%cel) (b) 1ncremental ROR is less than 0-RRD select Bor'.

8.1#

(a) 0 $ :200 000 ! &0 000(@A- i &) ! 130 000(@AB i &) ,olve for i b) trial an' error or C%cel i $ 20.3% (C%cel) (b) i E 0-RRD select +rocess 5.

7ha+ter 8

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

8.1& 0 $ :2& 000 ! #000(@A- i .) ! 2. 000(@AB i 3) > 3< 000(@AB i #) ! #0 000(@AB i .) ,olve for i b) trial an' error or C%cel i $ 1".#% (C%cel) i E 0-RRD select machine re2uiring e%tra investment: variable s+ee' 8.1. 0 $ :10 000 ! 1200(@A- i #) ! 12 000(@AB i 2) ! 1000(@AB i #) ,olve for i b) trial an' error or C%cel i $ 30.3% (C%cel) ,elect machine *. 8.1" 0 $ :1" 000 ! #00(@A- i .) ! 1" 000(@AB i 3) ! 1"00(@AB i .) ,olve for i b) trial an' error or C%cel i $ ..8% (C%cel) ,elect alternative @. 8.18 0 $ :<0 000 ! 10 000(@A- i 3) ! 20 000(@A- i .) (@AB i 3) ! &000(@AB i 10) ,olve for i b) trial an' error or C%cel i $ 10.&% (C%cel) i F 0-RRD select alternative G. 8.1< Bin' @ to )iel' e%actl) &0% an' the ta4e 'ifference. 0 $ :@ ! #00 000(@AB i 1) ! .00 000(@AB i 2) ! 8&0 000(@AB i 3) @ $ #00 000(0....") ! .00 000(0.####) ! 8&0 000(0.2<.3) $ ?"8& 1"& Hifference $ <00 000 > "8& 1"& $ ?11# 82& 8.20 Iet % $ 0 J O costs. @erform an incremental cash flo( anal)sis. 0 $ :"& 000 ! (:% ! &0 000)(@A- 20% &) ! 20 000(@AB 20% &) 0 $ :"& 000 ! (:% ! &0 000)(2.<<0.) ! 20 000(0.#01<) % $ ?2" .0< 0 J O cost for , $ ?:2" .0<

7ha+ter 8

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

8.21

0 $ :22 000(-A@ i <) ! #000 ! (12 000 > #000)(-AB i <) ,olve for i b) trial an' error or C%cel i $ 1#.3% (C%cel) i E 0-RRD select alternative 6

8.22

Bin' ROR for incremental cash flo( over I70 of # )ears 0 $ :&0 000(-A@ i #) ! &000 ! (#0 000 > &000)(@AB i 2)(-A@ i #) ! 2000(-AB i #) ,olve for i b) trial an' error or C%cel i $ ..1% (C%cel) i F 0-RRD select semiautomatic machine

8.23

0 $ :.2 000(-A@ i 2#) ! #000 ! (10 000 > #000)(-AB i 2#) ,olve for i b) trial an' error or C%cel i $ #.2% +er month is E 0-RR $ 2% +er month ,elect alternative 5 (C%cel)

8.2#

0 $ :#0 000(-A@ i 10) ! 8&00 > &00(-A9 i 10) ,olve for i b) trial an' error or C%cel i $ 10.&% is F 0-RR $ 1"% (C%cel) ,elect K1

8.2& Bin' ROR on increment of investment. 0 $ :&00 000(-A@ i 10) ! .0 000 i $ 3.&% F 0-RR ,elect 'esign 18.2. Hevelo+ a cash flo( tabulation. 5ear 0 1 2 3
7ha+ter 8

Iease ? :108 000 :108 000 :108 000 0

*uil' ? :&0 000 > 2"0 000 0 0 !&& 000 ! .0 000

#

*>I ? :212 000 !108 000 !108 000 !11& 000

0 $ :212 000(-A@ i 3) ! 108 000 ! (11& 000 : 108 000) (-AB i 3)

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

,olve for i b) trial an' error or C%cel i $ 2&.8% F 0-RR Iease s+ace 8.2" ,elect the one (ith the lo(est initial investment cost because none of the increments (ere Lustifie'. 8.28 (a) - vs H6: 0 $ :30 000(-A@ i 8) ! #000 ! 1000(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 2.1% (C%cel) 0etho' - is not acce+table * vs H6: 0 $ : 3. 000(-A@ i 8) ! &000 ! 2000(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 3.#% (C%cel) 0etho' * is not acce+table 7 vs H6: 0 $ : #1 000(-A@ i 8) ! 8000 ! &00(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 11.3% (C%cel) 0etho' 7 is acce+table H vs H6: 0 $ : &3 000(-A@ i 8) ! 10 &00 : 2000(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 11.1% (C%cel) 0etho' H is acce+table (b) - vs H6: 0 $ :30 000(-A@ i 8) ! #000 ! 1000(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 2.1% (C%cel) Climinate * vs H6: 0 $ : 3. 000(-A@ i 8) ! &000 ! 2000(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 3.#% (C%cel) Climinate * 7 vs H6: 0 $ : #1 000(-A@ i 8) ! 8000 ! &00(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 11.3% (C%cel) Climinate H6
7ha+ter 8 &

(C%cel)

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

7 vs H: 0 $ : 12 000(-A@ i 8) ! 2 &00 : 2&00(-AB i 8) ,olve for i b) trial an' error or C%cel i $ 10.#% (C%cel) Climinate H ,elect metho' 7 8.2< Ran4 alternatives accor'ing to increasing initial cost: 2 1 3 & # 1 vs 2: 0 $ :3000(-A@ i &) ! 1&00 (-A@ i &) $ 0.&000 i $ #1.0% (C%cel) Climinate 2 3 vs1: 0 $ :3&00(-A@ i &) ! 1000 (-A@ i &) $ 0.28&" i $ 13.2% (C%cel) Climinate 3 & vs 1: 0 $ :10 000(-A@ i &) ! 2&00 (-A@ i &) $ 0.2&00 i $ ".<% (C%cel) Climinate & # vs1: 0 $ :1" 000(-A@ i &) ! .000 (-A@ i &) $ 0.3&2< i $ 22.&% (C%cel) Climinate 1 ,elect machine # 8.30 (a) -lternatives are revenue alternatives. Therefore a'' H6 H6 vs 8: 0 $ :30 000(-A@ i &) ! (2. &00 > 1# 000) ! 2000(-AB i &) ,olve for i b) trial an' error or C%cel i $ 31."% (C%cel) Climinate H6 8 vs 10: 0 $ :#000(-A@ i &) ! (1# &00 > 12 &00) ! &00(-AB i &) ,olve for i b) trial an' error or C%cel i $ #2.#% (C%cel) Climinate 8 10 vs 1&: 0 $ :#000(-A@ i &) ! (1& &00 > 1# &00) ! &00(-AB i &)
7ha+ter 8 .
PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

,olve for i b) trial an' error or C%cel i $ 10.<% (C%cel) Climinate 1& 10 vs 20: 0 $ :1# 000(-A@ i &) ! (1< &00 > 1# &00) ! 1000(-AB i &) ,olve for i b) trial an' error or C%cel i $ 2#.2% (C%cel) Climinate 10 20 vs 2&: 0 $ :<000(-A@ i &) ! (23 000 > 1< &00) ! 1100(-AB i &) ,olve for i b) trial an' error or C%cel i $ 2<.0% (C%cel) Climinate 20 @urchase 2& m3 truc4 (b) Bor secon' truc4 +urchase truc4 that (as eliminate' ne%t to last: 20 m3 8.31 (a) ,elect all +roLects (hose ROR E 0-RR of 1&%. ,elect - * an' 7 (b) Climinate alternatives (ith ROR F 0-RRD com+are others incrementall): Climinate H an' C Ran4 survivors accor'ing to increasing first cost: * 7 * vs 7: i $ 800A&000 $ 1.% E 0-RR 7 vs -: i $ 200A&000 $ #% F 0-RR ,elect +roLect 7 8.32 (a) -ll machines have ROR E 0-RR of 12% an' all increments of investment have ROR E 0-RR. Therefore select machine #. (b) 0achines 2 3 an' # have ROR greater than 20%. 1ncrement bet(een 2 an' 3 is Lustifie' but not increment bet(een 3 an' #. Therefore select machine 3. 8.33 (a) ,elect - an' 7. (b) @ro+osal - is Lustifie'. - vs * )iel's 1% eliminate *D - vs 7 )iel's "% eliminate 7D - vs H )iel's 10% eliminate -. Therefore select +ro+osal H (c) @ro+osal - is Lustifie'. - vs * )iel's 1% eliminate *D - vs 7 )iel's "% eliminate 7D - vs H )iel's 10% eliminate H. Therefore select +ro+osal "

Climinate * Climinate -

7ha+ter 8

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

8.3#

(a) Bin' ROR for each increment of investment: C vs B: 20 000(0.20) ! 10 000(i) $ 30 000(0.3&) i $ .&% C vs 9: 20 000(0.20) ! 30 000(i) $ &0 000(0.2&) i $ 28.3% C vs ;: 20 000(0.20) ! .0 000(i) $ 80 000(0.20) i $ 20% B vs 9: 30 000(0.3&) ! 20 000(i) $ &0 000(0.2&) i $ 10% B vs ;: 30 000(0.3&) ! &0 000(i) $ 80 000(0.20) i $ 11% 9 vs ;: &0 000(0.2&) ! 30 000(i) $ 80 000(0.20) i $ 11."% (b) Revenue $ - $ @i C: - $ 20 000(0.20) $ ?#000 B: - $ 30 000(0.3&) $ ?10 &00 9: - $ &0 000(0.2&) $ ?12 &00 ;: - $ 80 000(0.20) $ ?1. 000 (c) 7on'uct incremental anal)sis using results from +art (a): C vs H6: i $ 20% E 0-RR eliminate H6 C vs B: i $ .&% E 0-RR eliminate C B vs 9: i $ 10% F 0-RR eliminate 9 B vs ;: i $ 11% F 0-RR eliminate ; Therefore select -lternative B (') 7on'uct incremental anal)sis using results from +art (a). C vs H6: i $ 20% E0-RR eliminate H6 C vs B: i $ .&% E 0-RR eliminate C B vs 9: i $ 10% F 0-RR eliminate 9 B vs ;: i $ 11% $ 0-RR eliminate B ,elect alternative ; (e) 7on'uct incremental anal)sis using results from +art (a). C vs H6: i $ 20% E 0-RR eliminate H6 C vs B: i $ .&% E 0-RR eliminate C B vs 9: i $ 10% F 0-RR eliminate 9

7ha+ter 8

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

B vs ;: i $ 11%

F 0-RR eliminate ;

,elect B as first alternativeD com+are remaining alternatives incrementall). C vs H6: i $ 20% E 0-RR eliminate H6 C vs 9: i $ 28.3% E 0-RR eliminate C 9 vs ;: i $ 11."% F 0-RR eliminate ; Therefore select alternatives B an' 9 8.3& (a) ROR for B: 10 000(0.2&) ! 1& 000(0.20) $ 2& 000(i) i $ 22% ROR for 9: 2& 000(0.22) ! &000(0.0#) $ 30 000(i) i $ 1<% 1ncrement bet(een C an' 9: 10 000(0.2&) ! 20 000(i) $ 30 000(0.1<) i $ 1.% 1ncrement bet(een C an' ;: 10 000(0.2&) ! &0 000(i) $ .0 000(0.30) i $ 31% 1ncrement bet(een B an' ;: 2& 000(0.22) ! 3& 000(i) $ .0 000(0.30) i $ 3&."% 1ncrement bet(een 9 an' ;: 30 000(0.1<) ! 30 000(i) $ .0 000(0.30) i $ #1% (b) ,elect all alternatives (ith ROR M 0-RR of 21%D select C B an' ;. (c) 7on'uct incremental anal)sis using results from table an' +art (a). C vs H6: i $ 2&% E 0-RR eliminate H6 C vs B: i $ 20% F 0-RR eliminate B C vs 9: i $ 1.% F 0-RR eliminate 9 C vs ;: i $ 31% E 0-RR eliminate C ,elect alternative ;. !E Revie" Solutions 8.3. 8.3" 8.38 8.3<
7ha+ter 8

-ns(er is (a) -ns(er is (c) -ns(er is (c) -ns(er is (b)

<

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

8.#0 8.#1 8.#2 8.#3

-ns(er is (') -ns(er is (b) -ns(er is (b) -ns(er is (b)

E#ten$e$ E#er%ise Solution 1. @N at 12% is sho(n in ro( 2<. ,elect O2 (n $ 8) (ith the largest @N value. 2. O1 (n $ 3) is eliminate'. 1t has iP F 0-RR $ 12%. @erform an incremental anal)sis of O1 (n $ #) an' O2 (n $ &). 7olumn ; sho(s iP $ 1<.#<%. 6o( +erform an incremental com+arison of O2 for n $ & an' n $ 8. This is not necessar). 6o e%tra investment is necessar) to e%+an' cash flo( b) three )ears. The iP is infinit). 1t is obvious: select O2 (n $ 8). 3. @N at 2000% E ?0.0&. iP is infinit) as sho(n in cell Q#& (here an error for 1RR(Q#:Q##) is in'icate'. This anal)sis is not necessar) but sho(s ho( C%cel can be use' over the I70 to fin' a rate of return.

7ha+ter 8

10

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

7ha+ter 8

11

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

Case Stu$y & Solution 1. 7ash flo(s for each o+tion are summari=e' at to+ of the s+rea'sheet. Ro(s <:1< sho( annual estimates for o+tions in increasing or'er of initial investment: 3 2 1 # &.

2. 0ulti+le iP values: Onl) for o+tion O2D there are 3 sign changes in cash flo( an' cumulative cash flo( series. 6o values other than 10.0"% are foun' in the 0 to 100% range. 3. Ho incremental ROR anal)sis after removing O1 an' O2. ,ee ro( 22. #:to:3 com+arison #:to:3 )iel's &<.8&% &:to:# has no return because all incremental cash flo(s are 0 or negative. @N at 2&% is ?"8&.2& for O# (hich is the largest @N. 7onclusion: ,elect o+tion O# > tra'e:out (ith frien'.

7ha+ter 8

12

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

#. @N vs. i charts for all & o+tions are on the s+rea'sheet.

O+tions com+are' 1 an' 2 3 an' & 2 an' & 1 an' & 3 an' #

-++ro%imate brea4evenRRRR 2.% 2" 38 #2 &0

&. Borce the brea4even rate of return bet(een o+tions O# an' O3 to be e2ual to 0-RR $ 2&%. Sse trial an' error or ,olver on C%cel (ith a target cell of 922 (to be 2&% or . 2& on the ,olver (in'o() an' changing cell of 7.. 0a4e the values in )ears & through 8 of o+tion O3 e2ual to the value in cell 7. so the) reflect the changes. The ans(er obtaine' shoul' be about ?10<0 (hich is actuall) ?1 0<0 000 for each of # )ears. Re2uire' minimum selling +rice is #(10<0 000) $ ?#.3. million.

7ha+ter 8

13

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

Case Stu$y ' Solution 1. *) ins+ection onl): ,elect @lan - since its cash flo( total at 0% is ?300 (hile @lan * +ro'uces a loss of the same amount (?:300). 2. 7alculations for the follo(ing are sho(n on the s+rea'sheet belo(. @N at 0-RR a++roach: @N at 1&%: @N- $ :?81.38 an' @N* $ !?81.38. @lan * is selecte' @N at &0%: @N- $ !?1..0& an' @N* $ :?1..0&. @lan - is selecte'. The 'ecisions contra'ict each other (hen the 0-RR is 'ifferent. 1t 'oes not seem logical to acce+t +lan - at a higher interest rate (&0%) an' at 0% but reLect it at a mi':+oint interest rate (1&%). The @N at 0-RR metho' is not (or4ingT ROR a++roach: The cash flo( series have t(o sign changes so a ma%imum of t(o roots ma) be foun'. -n ROR anal)sis using C%cel functions for the t(o +lans +ro'uce t(o i'entical roots for each +lan: iP1 $ <.&1% an' iP2 $ #8.1<% There are t(o iP valuesD it is not clear (hich value to use for a 'ecision on +roLect acce+tabilit). Burther (hen there are multi+le iP values the @N anal)sis Uat the 0-RR/ 'oes not (or4 as 'emonstrate' above.

7ha+ter 8

1#

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

3. 1ncremental ROR anal)sis is sho(n on the s+rea'sheet belo(. @lan * has a larger initial investment than -. The incremental cash flo( series (*: -) has t(o sign changes. The use of the 1RR function fin's the same t(o roots: <.&1% an' #8.1<%. 1ncremental ROR anal)sis offers no 'efinitive resolution.

7ha+ter 8

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PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

#. 7om+osite rate of return a++roach @lan (a) 0-RR $ 1&% an' c $ 1&%

B0 $ 1<00D B1 $ 1<00(1.1&) :&00 $ 1.8&D B2 $ 1.8&(1.1&) :8000 $ :.0.2.2&D B3 $ :.0.2.2&(1! iV) !.&00 $ #3"."& >.0.2.2&iV B# $ 0 $ B3(1! iV) !#00 ,o iV $ 13.0.% F 0-RR $ 1&%. ReLect @lan -. (b) 0-RR $ 1&% an' c $ #&% B0 $ 1<00D B1$1<00(1.#&) :&00 $ 22&&D B2 $ 22&&(1.#&) :8000 $ :#"30.2&D B3 $ :#"30.2&(1! iV) !.&00 $ 1".<."& > #"30.2&iV B# $ 0 $ B3(1! iV) !#00. ,o iV $ #3.31% E 0-RR$ 1&%. -cce+t @lan -. (c) 0-RR $ &0% an' c $ &0% B0 $ 1<00D B1 $ 1<00(1.&0) :&00 $ 23&0D B2 $ 23&0(1.&0) :8000 $ :##"&D B3 $ :##"&(1!iV) !.&00 $ :##"&iV ! 202& B# $ 0 $ B3(1! iV) !#00. ,o i V $ &1.1.% E 0-RR $ &0%. -cce+t @lan -. @lan * (a) 0-RR $ 1&% an' c $ 1&%

B0 $ :1<00D B1 $ :1<00(1! iV) !&00D B2 $ :1<00(1! iV)2 !&00(1! iV) !8000D B3 $ (1.1&)B2 >.&00 B# $ 0 $ B3(1.1&) :#00. ,o iV $ 1"."#% E 0-RR $ 1&%. -cce+t @lan *. (b) 0-RR $ 1&% an' c $ #&% B0 $ :1<00D B1 $ :1<00(1!iV) !&00D B2 $ :1<00(1! iV)2 !&00(1! iV) !8000D B3 $ :1<00(1.#&) (1! iV)2 !&00(1.#&)(1! iV) !8000(1.#&) >.&00 B# $ 0 $ B3(1.#&) : #00. ,o iV $ #..1#% E 0-RR $ 1&%. -cce+t @lan * (c) 0-RR $ &0% an' c $ &0% B0 $ :1<00D B1 $ :1<00(1! iV) !&00D B2 $ :1<00(1! iV)2 !&00(1! iV) !8000D B3 $ :1<00(1. &)(1! iV)2 !&00(1.&)(1! iV) !8000(1.&) > .&00 B# $ 0 $ B3(1.&) : #00. ,o iV $ #<.30% F 0-RR $ &0%. ReLect @lan *.
7ha+ter 8 1.

PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.

') Hiscussion: @lan * is su+erior to @lan - for c values belo( iP2 i.e. */s com+osite rate of return is higher. ;o(ever for c values above iP2 +lan gives a higher (com+osite) rate of return. 7onclusion: The com+osite rate of return evaluation )iel's unambiguous results (hen a reinvestment rate is s+ecifie'.

7ha+ter 8

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PROPRIETARY MATERIA . 8 The 0c9ra(:;ill 7om+anies 1nc. -ll rights reserve'. 6o +art of this 0anual ma) be 'is+la)e' re+ro'uce' or 'istribute' in an) form or b) an) means (ithout the +rior (ritten +ermission of the +ublisher or use' be)on' the limite' 'istribution to teachers an' e'ucators +ermitte' b) 0c9ra(:;ill for their in'ivi'ual course +re+aration. 1f )ou are a stu'ent using this 0anual )ou are using it (ithout +ermission.