Scribd
Upload
29 views16 pages

Rate of Return Method Comparison - Slides

Uploaded by

yiyaben188
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
29 views16 pages

Rate of Return Method Comparison - Slides

Uploaded by

yiyaben188
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 16

Rate of Return

Method of
Comparison
Bases for Comparison of
Alternatives
There are several bases for comparing the worthiness of the
projects. These bases are:
1. Present worth method
2. Future worth method
3. Annual equivalent method
4. Rate of return method
Rate of Return
• The rate of return of a cash flow pattern is the interest rate at
which the present worth of that cash flow pattern reduces to zero
• In other words, It is the interest rate which equates the cash
inflows/receipts to cash outflows/disbursements

In this method of comparison,


• the rate of return for each alternative is computed.
• Then the alternative which has the highest rate of return is selected
as the best alternative
Rate of Return Method

• The first step is to find the net present worth of the cash flows using the
following expression at a given interest rate, i.
PW(i) = – P + R1/(1 + i)1 + R2/(1 + i)2 + ...
+ Rj/(1 + i) j + ... + Rn/(1 + i)n + S/(1 + i)n
• Now, the above function is to be evaluated for different values of i until the
present worth function reduces to zero
Present Worth function Graph
Example
A person is planning a new business. The initial outlay and cash
flow pattern for the new business are as listed below. The expected life
of the business is five years. Find the rate of return for the new
business.
Solution

Initial investment = Rs. 1,00,000


Annual equal revenue = Rs. 30,000
Life = 5 years
Solution
The present worth function for the business is:
PW(i) = -P + A[(1 + i)n -1]/1(1+i)n

[(1 + i)n -1]/1(1+i)n is Equal-Payment Series Present Worth


Amount (P/A,i,n)

When i = 10%,
PW(10%) = –1,00,000 + 30,000(3.7908)
= Rs. 13,724
Solution
When i = 15%,
PW(15%) = –1,00,000 + 30,000(3.3522)
= Rs. 566.
When i = 18%,
PW(18%) = –1,00,000 + 30,000(3.1272)
= Rs. – 6,184
Rate of Return
i = 15% + [566-0/566-(-6184)] x (3%) ……… Interpolation Method
Solution

i = 15% + [566-0/566-(-6184)] x (3%)

= 15% + 0.252%
= 15.252%
Problem
A firm has identified three mutually exclusive investment
proposals whose details are given below. The life of all the three
alternatives is estimated to be five years with negligible salvage value.
The minimum attractive rate of return(MARR) for the firm is 12%.

Find the best alternative based on the rate of return method of


comparison.
Solution

Initial outlay = Rs. 1,50,000


Annual profit = Rs. 45,570
Life = 5 years
Problem
A person invests a sum of Rs. 2,00,000 in a business and receives equal
net revenue of Rs. 50,000 for the next 10 years. At the end of the 10th
year, the salvage value of the business is Rs. 25,000. Find the rate of
return of the business.
Problem
For the cash flow diagram shown in Figure below, compute the rate of
return. The amounts are in rupees.
Problem
• A shipping firm is considering the purchase of a materials handling
system for unloading ships at a dock. The initial costs and the
operating costs estimated for each system are now tabulated. The life
of each system is estimated to be five years and the firm’s minimum
attractive rate of return is 15%. If the firm must select one of the
materials handling systems, which one is the most desirable?.
• Single-Payment Compound Amount F = P(1 + i)n
• Single-Payment Present Worth Amount P = F/(1 + i)n
• Equal-Payment Series Compound Amount

• Equal-Payment Series Sinking Fund

• Equal-Payment Series Present Worth Amount

• Equal-Payment Series Capital Recovery Amount

• Uniform Gradient Series Annual Equivalent Amount

You might also like