molmAD Ame biN PMLAN

I U 2 KIKsol

CHAPTER5

RATE OF RETURN

Exercise 1: Determination ofROR-One Project

P&G sold its prescription drug business to Warner-Chilcott, Ltd. for $3.1 billion.
If income from product sales is $2 billion per year and net profit is 20% of sales,
what rate of return will the company make over a 10-year planning horizon?

314 2
(oo (Pi,lo)- O
i 175
47eie

Exercise 2: DeterminationofROR-One Project

For the cash flows shown, determine the rate of return.

Year 0 2 3 4 5
Expense,$ -17,000 -2,500 -2,500 -2,500 2,500 2,500
Revenue, $ 0 5,000 6,000 7,000 8,000 12,000
1706 426o
(i,5) tjosois}t 3 i5)o
12

ENGINEERING ECONOMY 31
Exercise3:Multiple ROR Values- One Project
According to Descartes' rule of signs, how many possible i* values are there for
the cash flows shown?

2 3 4 5 6
|Year 1
Net Cash +4100 -2000 -7000 +12000 -700 +800
Flow, $

f possb2 vaue

Exercise 4: Multiple ROR Values-One Project

According to Descartes' rule of signs, how many i* values are possible for the
cash flows shown?

Year 2 4
Revenue, $ 25,000 13,000 4,000 70,000
Costs, $ -30,000-7,000 -6,000-12,000
possot 2 valge

Exercise5: IncrementalCash Flows for ROR Analysis

A tool and die company in Hanover is considering the purchase of a drill press
with fuzzy-logic software to im prove accuracy and re duce to ol wear. The
company has the opportunity to buy a slighty used machine for $15,000 or a
new one for $21,000. Because the new machine is a more sophisticated model,
its operating cost is expected to be $7000 per year, while the used machine is
expected to require $8200 per year. Each machine is expected to have a 25-year
lifewith a5% salvage value. Tabulate theincrementalcash flow.
Cash flo) muremen
year Used press rew pvegS
-L50oCD

25 200

25

32
Exercise6: Rate of Return Evaluation Using PW: Incremental and Breakeven

As Ford Motor Company retools an old truck assembly plant in Michigan to

produce a fuel-efficient economy model, the Ford Focus. Ford and its suppliers
are seeking additional sources for light, long-life transmissions. Automatic
transmission component manufacturers use highly finished dies for precision
forming of internal gears and other moving parts. Two United States-based
vendors make the required dies. Use the per unit estimates below and a MARR of
12% per year to select the more economical vendor bid. Show both hand and
spreadsheet solutions.

Vendor A Vendor B

Initial Cost, $ -8000 -13000

Annual Costs, $ per year -3500 -1600

Salvage Value,S 0 2000
Life, years 10 5
herene
year A B-A
-5000
5 -l&oo t 190d
350

-13000

-3 190

96D

78 9 lo
2 t5 6

ENGINEERING ECONOMY 33
 S000 1900 (

assame 1- 1D
HO0D(o.5619) 4 ooo (o.3220)
-
1392
(G.G5b2)
-

SdoD4 19oD

5aoD l90b C5 1bl) A1d0° Co.S194) 4 2o00l0e91) ->2

31.90 2

- %3 147
7 12 687. > ma2

Exercise 7: Rate of Return Evaluation Using AW

Compare the alternatives of vendors A and B for Ford in Exercise 6, using an

AWm based incremental ROR method and the same MARR of 12% per year.

50o0 1900A ai, ) -|\ C i , 5 (prai o)4pooo( ito) +129) -0

aSsum@i 2
- 0 o t 19a0-H698)-Hma 5 61)Xo.1He98)+ oDO Cab%99) + 1903 =24

oo0 t |900 (0 A917))- u09o (-S19Y) o-19171)}uoo (o.0ot1) 190 5d

34
 Exercise 8: Incremental ROR Analysis of Multiple Alternatives

Caterpillar Corporation wants to build a spare part storage facility in the

Phoenix, Arizona, and vicinity. A plant engineer has identified four different
location options. The initial cost of earthwork and prefab building and the annual
net cash flow estimates are detailed in Table. The annual net cash fl ow series
vary due to differences in maintenance, labor costs, transportation charges, etc,
If the MARR is 10%, use incremental ROR analysis to select the onc econonically
best location.

A B C D
Initial Cost, $ 200,000 -275,000 -190,000 -350,000
Annual Cash Flow, $ per year +22,000 +35,000 +19,500 +42,000
Life, years 30 30 30 30

PNC> A >D

DNC
-190 0000
0
+ 19500 + 195 co 190000 + 1s50o (Pi13o)
DN A io) =9744; 1x 9.66'/<mner
-0o0UD
2o wo t 2 ovo C i , 0 ) = 0

A-
+39bvd 5169

D
-275 000 250 000

2850 + 2 ooD tHosd

peleete

ENGINEERING ECONOMY 35
 PROBLEMS

1. You have the option to start a home painting business to cover some of
the costs of going to college. You can setup your business three ways as shown
below. Assume that the business will last 3 years with no salvage value. Your
minimum attractive rate of return (MARR) is 8%.

Option 1 Option 2 Option 3

Investment (RM)_ 3,000 8,000 12,000
1425 3333 5170
Net Annual Revenues (RM) 12 14
20
Rate ofReturn (%)_
(a) Which of the options are financially acceptable?
(b) Which of the option would you choose by using:
Present Worth Analysis (PW)
(i) Incremental Rate of Return Analysis

(oDPov MAeR Hnancialy acceptable

pw opt.I -3000 4 1425 C°lA 8,3)
3 o o t 1415 C2.5TH)= 672
op2 - B00d + 333 Ca 57+1) = s69

H oet s -12000 t 5140 (25741): 1923

Hhigher Pu

-
3000 -8500 -5000
2833 19o8

-3000 -2o0D -9UDU -90s0 37us (PÁ 113)=0

25 3S CAi8)=2.4032
1 27.z mAER

ENGINEERING ECONOMY 37
 Given
following
2. a MARR of
alternatives 10%, be
should useselected
incremental analysis
(if any). to determine
Each has which
an expected life of
of the
ten

years.

Plan 1 2 3 Null
First Cost, $ 220,000 100,000 265,000 180,000
Annual Benefit, $ 39,000 15,000 51,000 26,000
NuL >0-)
-DN loo cob +15000A
-100 0000
5000
- IUD ODo

ISDoD
(PTAT1 6-666
i- 81.2mRR
4-DN)
-180 000 - 18U DUo

UDO
(PAio) 6922
77<MARR
-200Oo 20000
t39 aoo f Phro) 0
3 0D
39 000
O i 0 ) -5 GHlD
l2. >MALR
- -45 0+1puo (PAi 1= o

39ouo 2 000
Parin)2 (8)

38
 3. Given the alternatives below

A B C D E
First cost $5,000 $6,000 $8,000 $9,000 $12,000
Annual cost 1,700 1,600 1,200 1,000 700
Life in years 10 10 10 10 10

One of the 5 must be chosen. Use incremental rate of return analysis to

determine the best choice. MARR = 10%.

-1000 lo0 ( 1 b) =O
A
o00
+100
= 0 7,< MARR
C-A -2oo0 4soo (1/l6) -o
-2oUD

PAi)- 6
JeS> MAeR

~looo
f r o )«5
I S >MAeR
-3000 30oCPa Ji,l=0
000
1200 P41/)= 10
1 0 LMARR

40
4. Given the alternatives below

DN A B C D
Firstcost $4,000 $3,000 $6,000 $5,000
Annual 0 $623 $531 $1,020 $712
benefit
Life yrs
ROR 9% 12% 11% 7%
Select the one best alternative if MARR = 8%. Use incremental rate of return
analysis.

A- -l000 t94 (Pla'il10)=0

0 5 / < mAP

C-b-3000 489 (rAio) 0

-

(a D) =613
1=107 MAPR

ENGINEERING ECONOMY 41
 PX-o-p00415 00 (Ai0)-suo (im)4a9o (Perio)-o
Eoot loD0o CP -i k)+ 2900 CPiyo) Fo
Os&umel=s;-50000 Ioo0D CG b 88) 43900 Co 2472)-46152>0
>mAPR (Pt)V
P-95000 +11 o0o (s01& ) +1o6 (o 2y2) -
39 33 D
MARR

5. The CROC Co. is considering a new milling machine. They have narrowed
the choices down to three alternatives in addition to the Null alternative:

Alternative
EconomyY Regular Deluxe ECo-DN ELoD -R
95 Odd
-75000 -50
o00
First Cost $75,000 $125,000 $220,000
Annual Benefit 28,000 43,000 79,000 +2460 36 oD
M&0 Costs 8,000 13,000 38,000 -5000
Salvage Value 3,000 6,900 16,000 | 3600 3900 90o/

All machines have a life of ten years. Using incremental rate of return analysis,
which alternative should the company choose? Use a MARR of 15%.

Eo-25 000 4200oi-800oiro4 300oio) *o

-35 a0D 4 200o
(P/a 110)+3e PA1o)0
astume 1 15, ; -75 o0o + 2000 (5 o I)+ 200o
asaume 1
Co ) =
2elf
29°|. 3 - 5 000t sdo (
3,5qo5)
+ 3000 Co.l074) - 3 K
Pw 42

a5 -3264
6. Lee and Partners Sdn. Bhd. is considering 2 alternatives of nutraceutical
manufacturing facilities. ption 1 will cost RM3 million to instal and
RM135,000 per year to maintain. Option 2 will cost RM3.7 million to install and
RM70,000 per year to maintain. Calculate the rate of return and determine which
option is preferred if Lee and Partners Sdn. Bhd. uses a MARR of 6 % per year
and a 20 years project period.

- 00000-65 o0o (iy) -0

- 04m
3m -34m

-135 000 -t0 0oo

44