Engineering Economic Analysis

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222 RATEOF RETURNANALYSIS

Rate of return analysis: Rate of return analysis is the most frequently used method iJ

industry, as the resulting rate of return is readily understood. Also, the difficultie

in selecting a suitable interest rate to use in present worth and annual cash flov

analysis are avoided.

Criteria

Two Alternatives

Computethe incrementalrate of return-~IRR-on the incrementofinvestmentbetweel

the alternatives.Then,

· if ~IRR 2: MARR,choosethehigher-costalternative,or,

·if ~IRR < MARR, choose the lower-cost alternative

When an increment ofborrowingis examined, where ~IRR is the incremental interes.

rate,

· if ~IRR ::::MARR, the increment is acceptable, or

·if ~IRR > MARR, the increment is not acceptable

Three or More Alternatives

Incremental analysis is needed, which is described in Chapter8.

Looki ng Ahead

Rate of return is further described in Appendix 7A. This material.concentrates on the

difficulties that occur with some cash flows that yield more than one root for the rate of

return equation.

Problems

7-1 For the following diagram, compute the IRR to

within112%..

7-2 For the following diagram, compute the interest rate

at which the costs are equivalent to the benefits.

80 80 80 80 80 80

t t t t t t

0-1-2-3-4-5-6

11' 1

(^200200200)
50
(^60) (Answer: 50%)