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Economics
Module No. 10
Rate of Return
By
Muhammad Shahid Iqbal
Rate of Return
The first step is to find the net present worth of the cash flows:
PW = - P + R1/(1 + i)1 + R2/(1 + i)2 + .+ Rj/
(1 + i)j +.+ Rn /(1 + i)n + S/(1 + i)n
P = Initial investment
Rj = Net revenue at the end of jth year.
Rate of Return
IRR I L +
Criterion for a
Single Project:
If IRR > MARR,
accept the project.
If IRR = MARR,
remain indifferent.
If IRR < MARR,
reject the project.
PWL
PWL -PWH
(I H -I L )
Decision
PW i =$1,250,000+$731,500 P A, i,15
$80,000(P / F,i,15)
=0
i*
Since i* >MARR(18%), accept the investment.
Period
Cash
flow
100,000
30,000
30,000
30,000
30,000
30,000
Rate of Return
Rate of Return
A2
A3
Investment
1,50,000
2,10, 000
2,55,000
45,570
58,260
69,000
Rate of Return
1,250
150
300
450
600
750
Rate of Return
Yearly revenue
Alternative 1
5,00,000
1,70,000
Alternative 2
8,00,000
2,70,000
Rate of Return
Project A
Quadratic
Project B
Project C
-$1,000
-$2,000
-$75,000
1,300
24,400
1,500
27,340
1,500
55,760
Project B
$1,300 $1,500
PW(i) $2,000
0
2
(1 i) (1 i)
1
Let x
, then
1 i
PW(i) 2,000 1,300x 1,500x2
Solve for x:
x 0.8 or -1.667
Solving for i yields
1
1
0.8
i 25%, 1.667
i 160%
1 i
1 i
Since 100% i , the project's i* 25%.
18%
3,553
i 15% 3%
3,553 749
17.45%