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Rate of Return
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Lecture slides to accompany
Engineering Economy
7th edition
Leland Blank
Anthony Tarquin
PW = 0 or AW = 0 or FW = 0
PWoutflow = PWinflow
i* ≥ MARR
© 2012 by McGraw-Hill All Rights Reserved
7-4
Finding ROR by Spreadsheet Function
Using the RATE function Using the IRR function
= RATE(n,A,P,F) = IRR(first_cell, last_cell)
P = $-200,000 A = $-15,000
n = 12 F = $435,000
Function is
= RATE(12,-15000,-200000,450000)
= IRR(B2:B14)
Display is i* = 1.9%
ROR is the unique i* rate at which a PW, FW, or AW relation equals exactly 0
ROR is the unique i* rate at which a PW, FW, or AW relation equals exactly 0
P= - $35,000
PW = 0
A = +$7200
-35,000 + 7200 (P/A,i*,5) + 4500 (P/F, i*,5)
Salvage (F) = + $4500
n= 5 years
P= - $35,000 PW = 0
A = +$7200 -35,000 + 7200 (P/A,i*,5) + 4500 (P/F, i*,5)=0
Salvage (F) = + $4500
n= 5 years Trial and error
try i = 15%
PW = 0
-35,000 + 7200 (P/A,15%,5) + 4500 (P/F,15%,5)=0
-35,000 + 7200 (3.352) + 4500 (0.4972) = 0
-8628,2 0
Try i = 4%
-35,000 + 7200 (P/A,4%,5) + 4500 (P/F,4%,5)=0
-35,000 + 7200 (4.452) + 4500 (0,8219) = 0
+752,9 0 Do interpolation to find ROR value
© 2012 by McGraw-Hill All Rights Reserved
7-9
ROR Calculation Using PW, FW or AW Relation
ROR is the unique i* rate at which a PW, FW, or AW relation equals exactly 0
P= - $35,000 PW = 0
A = +$7200 -35,000 + 7200 (P/A,i*,5) + 4500 (P/F, i*,5)=0
Salvage (F) = + $4500
n= 5 years
Interpolation
PW i =15% = - 8628,2
PW i = 4% = + 752,9
Pwi = i* = 0
ROR is the unique i* rate at which a PW, FW, or AW relation equals exactly 0
i* values at ~8%
and ~41%
© 2012 by McGraw-Hill All Rights Reserved
7-15
Example: Multiple i* Values
Determine the maximum number of i* values for the cash flow shown below
Year Expense Income Net cash flow Cumulative CF
0 -12,000 - -12,000 -12,000
1 -5,000 + 3,000 -2,000 -14,000
2 -6,000 +9,000 +3,000 -11,000
3 -7,000 +15,000 +8,000 -3,000
4 -8,000 +16,000 +8,000 +5,000
5 -9,000 +8,000 -1,000 +4,000
Solution:
The sign on the net cash flow changes The cumulative cash flow begins
twice, indicating two possible i* values negatively with one sign change
Therefore, there is only one i* value ( i* = 8.7%)
© 2012 by McGraw-Hill All Rights Reserved
7-16
Problems
Cashflow below is a net cashflow of a Viggie
Burger Boy franciser at Missipi.
Year 0 1 2 3 4 5 6
NCF, $ 5000 -10,000 500 2000 2000 2000 2000
(2) Set future worth relation for last year n equal to 0 (i.e., Fn= 0); solve for i’’
Solution:
Year 0: F0 = $+2000 F0 > 0; invest in year 1 at ii = 12%
Year 1: F1 = 2000(1.12) - 500 = $+1740 F1 > 0; invest in year 2 at ii = 12%
Year 2: F2 = 1740(1.12) - 8100 = $-6151 F2 < 0; use i’’ for year 3
Year 3: F3 = -6151(1 + i’’) + 6800 Set F3 = 0 and solve for i’’
A company that makes clutch disk for race cars has the
cash flow for one department :
Year 0 1 2 3 4
Cashflow ($1,000) -65 30 84 -10 -12