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Annuity (Continuous Compounding) and MARR

The minimum annual electrical power savings required is 281,521 kWh.

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Jordan Ronquillo
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© © All Rights Reserved
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464 views

Annuity (Continuous Compounding) and MARR

The minimum annual electrical power savings required is 281,521 kWh.

Uploaded by

Jordan Ronquillo
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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ANNUITY

(CONTINUOUS
COMPOUNDING)
ENGR. JORDAN RONQUILLO
PROBLEMS
1. Php 600 is deposited each year into a savings account that pays
6% nominal interest, compounded continuously. How much will
be in the account at the end of 8 years.

Ans: Php 5,977.77


PROBLEMS
2. Each year a single payment of Php 1,766 is deposited in an
account that earns 6% compounded continuously. What is the
amount in the account immediately after the 5th payment?

Ans: Php 9,991.6


PROBLEMS
3. A man borrows Php 100,000 at a rate of 6% compounded
continuously for 5 years. How much must he pay annually if
money is compounded continuously.

Ans: Php 23,859.87


PROBLEMS
4. A businessman borrowed Php 200,000 and agrees to pay Php
47,719.73 annually for “x” years at the rate of 6% compounded
continuously. Find the value of x.

Ans: 5 years
MARR (MINIMUM ATTRACTIVE
RATE OF RETURN)
ENGR. JORDAN RONQUILLO
WHAT IS MARR?

• All engineering economy studies of capital projects should consider the return that a
given project will or should produce.

• A basic question this chapter addresses is whether a proposed capital investment and its
associated expenditures can be recovered by revenue (or savings) over time in addition to
a return on the capital that is sufficiently attractive in view of the risks involved and the
potential alternative uses.
WHAT IS MARR?

• A Minimum Attractive Rate of Return (MARR) is the minimum profit an investor


expects to make from an investment, taking into account the risks of the investment and
the opportunity cost of undertaking it instead of other investments.

• MARR is a useful way of weighing up whether an investment is worth the risks


associated with it. To calculate the MARR, you need to look at different aspects of the
investment opportunity, including the opportunities for expanding operation and rate of
return on investments.
WHAT IS MARR?

• A Minimum Attractive Rate of Return (MARR) is the minimum


profit an investor expects to make from an investment, taking into account
the risks of the investment and the opportunity cost of undertaking it
instead of other investments.
• MARR is sometimes called as hurdle rate.
• MARR is a useful way of weighing up whether an investment is worth the
risks associated with it. To calculate the MARR, you need to look at
different aspects of the investment opportunity, including the
opportunities for expanding operation and rate of return on investments.
WHAT IS MARR?

• In studying MARR, there are five methods to consider.


a). Present Worth (PW)
b). Future Worth (FW)
c). Annual Worth (AW)
d). Internal Rate of Return (IRR)
e). External Rate of Return (ERR)
PRESENT WORTH METHOD
• The PW method is based on the concept of equivalent worth of all cash
flows relative to some base or beginning point in time called the present.
• That is, all cash inflows and outflows are discounted to the present point
in time at an interest rate that is generally the MARR.
• To find the PW as a function of i %(per interest period) of a series of cash
inflows and outflows, it is necessary to discount future amounts to the
present by using the interest rate over the appropriate study period
(years, for example) in the following manner:
PRESENT WORTH METHOD
PRESENT WORTH METHOD

• To apply the PW method of determining a project’s economic worthiness, we simply


compute the present equivalent of all cash flows using the MARR as the interest rate. If
the present worth is greater than or equal to zero, the project is acceptable.
EXAMPLE 1
ANSWER

PW(20%) = $934.29.

Because PW(20%) ≥ 0, this equipment is economically


justified.
EXAMPLE 2
ANSWER

PW(15%) = $6,993.40.

Since: PW(15%) ≥ 0, we conclude that the retrofitted space-


heating system should be installed
FUTURE WORTH METHOD
• Because a primary objective of all time value of money methods is to
maximize the future wealth of the owners of a firm, the economic
information provided by the FW method is very useful in capital
investment decision situations.

• The FW is based on the equivalent worth of all cash inflows and


outflows at the end of the planning horizon (study period) at an interest
rate that is generally the MARR.
PRESENT WORTH METHOD
EXAMPLE 3

Evaluate the FW of the potential improvement project


described in Example 1. Show the relationship between FW and
PW for this example.

Answer: = $2,324.80.

Again, the project is shown to be a good investment (FW ≥ 0).


EXAMPLE 4
In Example 3, the $110,000 retrofitted space-heating system was
projected to save $30,000 per year in electrical power and be
worth $8,000 at the end of the six-year study period. Use the
FW method to determine whether the project is still
economically justified if the system has zero market value after
six years. The MARR is 15% per year.
FW (15%) = $8,170.

The heating system is still a profitable project (FW ≥ 0) even if it has no market
value at the end of the study period.
ANNUAL WORTH METHOD
• The AW of a project is an equal annual series of dollar amounts, for
a stated study period, that is equivalent to the cash inflows and
outflows at an interest rate that is generally the MARR.
• Hence, the AW of a project is annual equivalent revenues or savings
(R) minus annual equivalent expenses (E), less its annual equivalent
capital recovery (CR) amount,
ANNUAL WORTH METHOD

Where:

R = Savings
E = Expenses
CR = Capital Recovery
ANNUAL WORTH METHOD

• We need to notice that the AW of a project is equivalent to its PW


and FW. That is,AW = PW(A/P, i%,N), and AW = FW(A/F, i%,N).
Hence, it can be easily computed for a project from these other
equivalent values.

• As long as the AW evaluated at the MARR is greater than or equal to zero,


the project is economically attractive.
ANNUAL WORTH METHOD
CAPITAL RECOVERY

The CR amount for a project is the equivalent uniform annual cost


of the capital invested. It is an annual amount that covers the
following two items:

1. Loss in value of the asset


2. Interest on invested capital (i.e., at the MARR)
CAPITAL RECOVERY

As an example, consider a device that will cost $10,000,


last five years, and have a salvage (market) value of $2,000.
Thus, the loss in value of this asset over five years is
$8,000. Additionally, the MARR is 10% per year.
Where:

I – initial capital Investment 𝑖 (1+𝑖)𝑁 𝑖


S – Salvage Value CR = I - S
(1+𝑖)𝑁 −1 (1+𝑖)𝑁 −1
EXAMPLE 1

By using the AW method, determine whether the equipment in


Example 1 should be recommended.

AW(20%) = $312.40
EXAMPLE 2

A corporate jet costs $1,350,000 and will incur $200,000 per year
in fixed costs (maintenance, licenses, insurance, and hangar rental)
and $277 per hour in variable costs (fuel, pilot expense, etc.). The
jet will be operated for 1,200 hours per year for five years and then
sold for $650,000. The MARR is 15% per year.

(a) Determine the capital recovery cost of the jet.


(b) What is the EUAC of the jet? (EUAC(i%) and call it “equivalent
uniform annual cost)
EXAMPLE 2

Answers:

a). $306,320
b). $838,710
EXAMPLE 3

Consider the retrofitted space-heating system described in Example


5-2. Given the investment of $110,000 and market value of $8,000
at the end of the six-year study period, what is the minimum annual
electrical power savings (in kWh) required to make this project
economically acceptable? The MARR = 15% per year and electricity
costs $0.10 per kWh.

Ans: 281,521 kWh

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