Engineering Economic Analysis

1
230 RATEOF RETURNANALYSIS

The Going Aircraft Company has an opportunity to supply a large airplane to Interair, a foreign

airline. Interair will pay $19 million when the contract is signed and $10 million one year later.

Going estimates its second- and third-year costs at $50 million each. Interair will take delivery

of the airplane during Year 4 and agrees to pay $20 million at the end of that year and the $60

million balance at the end of Year 5. Compute the rate ofretum on this project.

SplUTION

The PW of each cash flow can be computed at various interest rates. For example, for Year 2 and

i=10%: PW=-50(P /F,10%,2)=-50(0.826) =-41.3.

10.00

8.00

6.00

~Q., 4.00

. 2.00

0.00

-2.00

-4.00

0% 10% 20% 30% 40% 50%

FIGURE 7A-l PW plot.

The PW plot-for this cash flow is represented in Figure 7 A-LWe see theftthis cash flow produces

twopointsat whichPW=0: one at 10.24%and the otherat 47.30%.

Year Cash Flow 0% 10% 20% 40% 50%

0 +$19 +$19 +$19 +$19 +$19 +$19

(^1) +10 +10 +9.1 +8.3 +7.1 +6.7
2 -50 -50 -41.3 -34.7 -25.5 -22.2
"3 -50 -50 -37.6 -28.9 -18.2 -14.8
(^4) +20 +20 +13.7 +9.6 +5.2 +3.9
(^5) +60 +60 +37.3 +24.1 +11.2 +7.9

• PW= +$9 +$0.1 -$2.6 -$1.2 +$0.5