Rate of return analysis: multiple alternatives

Exercise
I Several high-value parts for NASA’s reusable space
exploration vehicle can be either anodized or
powder-coated. Some of the costs for each process are
shown below.
I The incremental AW cash flow equation associated with
(powder coat − anodize) is:
I 0 = −14,000(A/P, i, 3) + 5000 + 2000(A/F, i, 3)
I What is (a) the first cost for anodizing, (b) the annual cost
for powder coating, and (c) the resale (salvage) value of the
anodized parts?
Solution

I (a) −14,000 = −65,000 − PAnodize

I PAnodize = $ − 51,000
I (b) AP C − (−21,000) = 5000
I AP C = $ − 16,000
I (c) 6000 − SAnodize = 2000
I SAnodize = $4000
Exercise

I The manager of Liquid Sleeve, Inc., a company that makes

a sealing solution for machine shaft surfaces that have been
compromised by abrasion, high pressures, or inadequate
lubrication, is considering adding metal-based
nanoparticles of either type Al or Fe to its solution to
increase the product’s performance at high temperatures.
The costs associated with each are shown below. The
company’s MARR is 20% per year.
Exercise

I Do the following using a PW-based rate of return analysis:

I (a) Determine which nanoparticle type the company should
select using the ∆i∗ value.
I (b) On the same graph, plot the PW versus different i
values for each alternative. Indicate the breakeven i∗ value
and the MARR value on the plot.
I (c) Use the plot of PW versus i values to select the better
alternative with MARR = 20% per year. Is the answer the
same as in part (a)?
Solution

I (a) 0 =
−130 + 18(P/A, ∆i∗ , 4) + 120(P/F, ∆i∗ , 2) + 40(P/F, ∆i∗ , 4)
I ∆i∗Al−F e = 27.35% > MARR = 20%.
I Select type Al.
Solution
I (b-c)
Exercise

I A manufacturer of hydraulic equipment is trying to

determine whether it should use monoflange double block
and bleed (DBB) valves or a multi-valve system (MVS) for
chemical injection. The costs are shown below. Use an
AW-based rate of return analysis and a MARR of 18% per
year to determine the better of the two options.
Solution

I Find ROR for incremental cash flow over LCM = 4 years.

I 0 = −31,000(A/P, ∆i∗ , 4) − 5000 +
40,000(P/F, ∆i∗ , 2)(A/P, ∆i∗ , 4) + 18,000(A/F, ∆i∗ , 4)
I Solve for ∆i∗ by trial and error or spreadsheet:
I ∆i∗M V S−DBB = 7.95% < MARR = 18%
I Select DBB valves.
Solution

I Alternatively:
I AWM V S − AWDBB = 0 (each over its own life cycle)
I [−71,000(A/P, i∗ , 4) − 65,000 + 18,000(A/F, i∗ , 4)] −
[−40,000(A/P, i∗ , 2) − 60,000] = 0
I Solve for i∗ by trial and error or spreadsheet:
I i∗ = 7.95% < MARR = 18%
I Select DBB valves.
Exercise
I Ashley Foods, Inc. has determined that any one of five
machines can be used in one phase of its chili canning
operation. The costs of the machines are estimated below,
and all machines are estimated to have a 4-year useful life.
If the minimum attractive rate of return is 20% per year,
determine which machine should be selected on the basis of
a rate of return analysis.
Solution

I These are all cost alternatives. There is no DN alternative

in this case.
I Rank alternatives according to increasing initial investment
and compare incrementally: 2, 1, 3, 5, 4.
I 1 vs 2: 0 = −2000 + 3300(P/A, ∆i∗ , 4)
I ∆i∗1−2 = 161% > MARR; eliminate 2
Solution

I 3 vs 1: 0 = −3500 − 1000(P/A, ∆i∗ , 4)

I RHS is always < 0; eliminate 3 (first cost and AOC both
are higher than alternative 1)
I 5 vs 1: 0 = −10,000 + 500(P/A, ∆i∗ , 4)
I ∆i∗5−1 = −43.3% < 0%; eliminate 5
I 4 vs 1: 0 = −18,000 + 3800(P/A, ∆i∗ , 4)
I ∆i∗4−1 = −6.4%; eliminate 4
I Select machine 1.
Exercise

I Five revenue projects are under consideration by General

Dynamics for improving material flow through an assembly
line. The initial cost in $1000 and the life of each project
are as follows (revenue estimates are not shown):
Exercise
I An engineer made the comparisons shown below. From the
calculations, determine which project, if any, should be
undertaken if the company’s MARR is (a) 11.5% per year
and (b) 13.5% per year. If other calculations are necessary
to make a decision, state which ones.
Solution

I Rank alternatives according to increasing initial investment

(including DN): DN, D, A, C, E, B
I (a) DN vs D: ∆i∗D−DN = 11% < MARR; eliminate D
I DN vs A: ∆i∗A−DN = 10% < MARR; eliminate A
I DN vs C: ∆i∗C−DN = 7% < MARR; eliminate C
I DN vs E: ∆i∗E−DN = 12% > MARR; eliminate DN
I E vs B: ∆i∗B−E = 15% > MARR; eliminate E
I Therefore, select B.
Solution

I (b) DN vs D: ∆i∗D−DN = 11% < MARR; eliminate D

I DN vs A: ∆i∗A−DN = 10% < MARR; eliminate A
I DN vs C: ∆i∗C−DN = 7% < MARR; eliminate C
I DN vs E: ∆i∗E−DN = 12% < MARR; eliminate E
I DN vs B: ∆i∗B−DN = 13% < MARR; eliminate B
I Therefore, select DN.
Exercise

I The five alternatives shown here are being evaluated by the

rate of return method.
Exercise

I (a) If the alternatives are mutually exclusive and the

MARR is 26% per year, which alternative should be
selected?
I (b) If the alternatives are mutually exclusive and the
MARR is 15% per year, which alternative should be
selected?
I (c) If the alternatives are independent and the MARR is
15% per year, which alternative(s) should be selected?
Solution

I (a) None have an overall ROR ≥ to MARR = 26%

I Select Do-Nothing.

I (b) Retain B, D and E since their ROR > MARR=15%

I Rank by increasing initial investment: B, D, E.
I B vs. D: ∆i∗D−B = 38.5% > MARR; eliminate B
I D vs. E: ∆i∗E−D = 6.8% < MARR; eliminate E
I Therefore, select D.

I (c) Select B, D, and E since each has an ROR ≥

MARR=15%.
Exercise

I The U.S. Bureau of Reclamation is considering five

national park projects shown below, all of which can be
considered to last indefinitely. At a MARR of 7.5% per
year, determine which should be selected, if they are (a)
independent and (b) mutually exclusive.
Solution

I (a) Select projects A and B since each has an ROR >

MARR=7.5%
I (b) Incremental analysis between A and B:
I ∆i∗A−B = ?
I −10,000 + 700(P/A, ∆i∗ , ∞) = 0
I −10,000 + 700(1/∆i∗ ) = 0
I ∆i∗A−B = 700/10,000 = 7% < MARR = 7.5%
I Eliminate A, select project B.