VII.

The external rate of return (ERR)

For example, MARR is 20% per year and IRR is 42.2% on a project investment, there is a
hestitation of company to reinvest on this project because:
- The higher return on an investment, the greater the inherent risk associated with it, so
company put an effort to find another option with similar or higher returns while
potentially mitigating risks and having unique rate of return. Therefore, ERR appeared to
remedy these weaknesses.
Definition:
- The external rate of return is the minimun rate of return that an investor expects to
receive from an investment project (MARR). It also mean that the net value of cash
inflows equals the net value of cash outflows.
- The ERR takes into account the interest rate which includes reinvestment the money you
earn from a project or the money you borrow from bank or others.
- If the ERR is equal to project’s IRR, then ERR and IRR produce identical results.

The ERR procedure:

1. All net cash outflows are discounted to time zero (the present) at ∈% (MARR) per
compounding period.

2. All net cash inflows are compounded to period N at ∈%

3. Solve for the ERR, the interest rate (i’%) that establishes equivalence between the above
two quantities.

where

Rk = excess of receipts over expenses in period k;

Ek = excess of expenditures over receipts in period k;

N = project life or number of periods for the study;

∈% = external reinvestment rate per period.

This equation illustrates that the expenses in the period k is in its present value for each
period with MARR (external rate) then converted this into equivalent value in future at time
N with interest rate which is unknown. The right hand side is the future revenue that
company will receive in the futute at ∈%.

In addition, the three procedures how to calculate ERR can be genelized in this graph:
To sum up, if the project's i′% of the ERR method is higher than or equal to the firm's
MARR, it is considered acceptable.

ERR advantages:

- There is no need for mentioning retrial and error since it can be resolved immediately.
- It has no possibility of yielding more than one rate of return.