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530 RATIONING CAPITAL AMONG COMPETING PROJECTS
20
100 150 250 300 350
CumulativeCost of InvestmentIncrements(thousandsof dollars)
FIGURE 17-4 Cumulative cost versus incremental rate of return.
o 400
For a budget of $250,000, the selected projects arelA, 2A, and3A.Note that if a budget of
$300,000 were available,IB would replacelA, making the proper set of projectsIB,2A,
and3A. At a budget of $400,000, lC would replaceIB; and3B would replace3A,making
the selected projects lC, 2A, and 3B. These answers agree with the computations in
Example 17-4.
RANKINGPROJECTPROPOSALS
Closely related to the problem of capital budgeting is the matter of rankingprojectproposals.
We will first examine a method of ranking by present worth methods and then show that
project rate of return is not a suitable method of ranking projects.
Anyone who has ever bought firecrackersprobably used the practical ranking criterion
of "biggest bang for the buck" in making a selection. This same criterion-stated more
elegantly-may be used to correctly rank independent projects.
Rank independent projects according to their value of net present worth divided by the
present worth of cost. The appropriate interest rate is MARR (as a reasonable estimate
of the cutoff rate ofreturn).
Example 17-6 illustrates the method of computation.
15.0%
10.6%
8.6% 8.3%
lA 2A 3A IB- 1A lC- IB 3B-3A
.-..
15
e
!....
0
10
"0B
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