EXTERNAL RATE

OF RETURN
Wednesday, 9 February 2022
Equivalent measures of a project’s profitability
Present Worth (PW)
Future Worth (FW)
Annual Worth (AW)
Internal Rate of Return (IRR)
External Rate of Return (ERR)

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 SOLUTION:

FWINFLOW@MARR = FWOUTFLOW@ERR

2,500(1.25)2+15,000
ERR = 𝟏𝟐,𝟓𝟎𝟎
-1
ERR = 0.5125

∴ Acceptable since the ERR (51.25%) is greater than MARR (25%)

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 Reinvestment rate
𝜺 is the rate at which
an investor can
reinvest cash flows
from an investment.

 The reinvestment rate

is the amount of
interest that can be
earned when money is
taken out of one fixed-
income investment
and put into another.
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Determining the Acceptability of a Project, Using ERR
When ∈ = 𝟏𝟓% 𝐚𝐧𝐝 𝐌𝐀𝐑𝐑 = 𝟐𝟎% per year determine whether the project (whose net cash-flow
diagram appears below) is acceptable. Notice in this example the use of 𝝐% different from the MARR is
illustrated. This might occur if, for some reason, part or all of the funds related to a project are
“handled” outside of the firm’s capital structure.

The 𝒊 % is less than the

MARR = 20%; therefore, the
project would be unacceptable
according to the ERR method.

[10,000 + 5,000 (P/F, 15%, 1) ] (F/P,𝒊 %, 6) = 5,000 (F/A, 15%, 5) 𝒊 = 15.3%

SOLUTION:
[10,000 + 5,000 (P/F, 15%, 1) ] (F/P, ERR %, 6) = 5,000 (F/A, 15%, 5)
[10,000 + 5,000 (0.8696)] (𝟏 + 𝑬𝑹𝑹) 𝟔 = 5,000 (6.742)
(𝟏 + 𝑬𝑹𝑹) 𝟔 = 5,000 (6.742) ÷ [10,000 + 5,000 (0.8696)]
𝟔
ERR = 5,000 (6.742) ÷ [10,000 + 5,000 (0.8696)] − 𝟏
= 0.153

ERR = 15.3% ANSWER

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 CASH FLOW DIAGRAM: 10,000

0 1 2 3 4

7,000 SOLUTION:
15,000
FV OF EXPENSES @ ERR = FV OF REVENUE @ MARR

[15,000 + 7,000 (P/F, 12%, 1)] (F/P, ERR, 4) = 10,000 (F/A, 12%, 3)

[15,000 + 7,000 (0.8929)] (1 + ERR)4 = 10,000 (3.374)

(1 + ERR)4 = 10,000 (3.374) ÷ [15,000 + 7,000 (0.8929)]

𝟒
ERR = 10,000 (3.374) ÷ [15,000 + 7,000 (0.8929)] −𝟏
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ERR = 12.25% (The project is acceptable)
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PAYBACK PERIOD
METHODS