Minggu 6 Chapter 07 Rate of Return Analysis - 12e XE-REV

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ENGINEERING
Newnan, Lavelle, and Eschenbach
ECONOMIC
ANALYSIS, 12/e Copyright © 2014 by Oxford University Press
Chapter 7
Rate of Return Analysis
Copyright Oxford University Press 2014

Chapter Outline
• Definition of “Internal Rate of Return”

• Rate of Return Calculation
• Incremental Rate of Return Analysis
• Decision Criteria using Rate of Returns
• Solving Rate of Returns using
Spreadsheets

Learning Objectives
• Understand and calculate internal rate of

return
• Apply rate of return in decision making
process
• Develop and use spreadsheet in solving
rate of returns

• Rate of return is the most frequently used

measure in industry
• Major advantages
• Rate of return is a single figure of merit that is
readily understood.
• Calculation of rate of return is independent
from the minimum attractive rate of return
(MARR).

Internal Rate of Return
• The interest rate at which the present worth and

equivalent uniform annual worth are equal to 0.
• (For borrowing) The interest rate paid on the
unpaid balance of a loan such that the payment
schedule makes the unpaid loan balance equal to
0 when the final payment is made.
• (For investment) The interest rate earned on the
un-recovered investment such that the payment
schedule makes the un-recovered investment
equal to 0 at the end of the investment life.

Rate of Return in Investment
$5000 investment in 5 yrs at rate of return of 8%

Unrecovered
8% Return on Investment Unrecovered
Investment at
Yr Cash Flow Unrecovered Repayment at Investment at
Beginning of
Investment End of Year End of Year
Year
0 -$5,000.00 $5,000.00
1 $1,252.28 $5,000.00 $400.00 $852.28 $4,147.72
2 $1,252.28 $4,147.72 $331.82 $920.46 $3,227.25
3 $1,252.28 $3,227.25 $258.18 $994.10 $2,233.15
4 $1,252.28 $2,233.15 $178.65 $1,073.63 $1,159.52
5 $1,252.28 $1,159.52 $92.76 $1,159.52 $0.00
Subtotal $1,261.41 $5,000.00

Calculating Rate of Return
1. Convert various consequences of investment into a

cash flow
2. Use one of the following equations to find the
unknown value of the internal rate of return (IRR):
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 − 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 0 (7-1)
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏

=1 (7-2)
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑠𝑠
𝑁𝑁𝑁𝑁𝑁𝑁 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤 = 0 (7-3)
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0 (7-4)
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑡𝑡𝑡𝑡 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑡𝑡𝑡𝑡 (7-5)

Example 7-1
Rate of Return Calculation
An engineer invests $5000 at the end of every year for 40
year career. If the engineer wants $1 million in savings at
retirement, what interest must the investment earn?
𝑁𝑁𝑁𝑁𝑁𝑁 = 0 = −5000(𝐹𝐹 ⁄𝐴𝐴, 𝑖𝑖, 40) + 1,000,000

(𝐹𝐹 ⁄𝐴𝐴, 𝑖𝑖, 40) = 1,000,000⁄5000 = 200
From the compound interest tables,
(𝐹𝐹/𝐴𝐴, 7%, 40) = 199.636
thus the required rate of return for the investment is 7%

Example 7-2
Year Cash Flow
250 325
0 -$700 175
100
1 +100
0 1 2 3 4
2 +175
3 +250
700
4 +325
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0 = 100 + 75(𝐴𝐴⁄𝐺𝐺, 𝑖𝑖, 4) − 700(𝐴𝐴⁄𝑃𝑃, 𝑖𝑖, 4)

Try 𝑖𝑖 = 5%, 100 + 75(𝐴𝐴⁄𝐺𝐺, 5%, 4) − 700(𝐴𝐴⁄𝑃𝑃, 5%, 4) = 11
Try 𝑖𝑖 = 8%, 100 + 75(𝐴𝐴⁄𝐺𝐺, 8%, 4) − 700(𝐴𝐴⁄𝑃𝑃, 8%, 4) = −6
Try 𝑖𝑖 = 7%, 100 + 75(𝐴𝐴⁄𝐺𝐺, 7%, 4) − 700(𝐴𝐴⁄𝑃𝑃, 7%, 4) = 0

Example 7-3
Maria borrowed a student loan of $9000 each year for 4 years. No
interest is charged until graduation, then the interest rate is 5%. If Maria
makes 5 equal annual payments, what is each payment? What is the
internal rate of return for Maria’s loan?
9000 9000 9000 9000
0 1 2 3 4 5 6 7 8 9
A A A A A
𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 = 𝐴𝐴 = (9000)(4)(𝐴𝐴⁄𝑃𝑃, 5%, 5) = $8316

𝑁𝑁𝑁𝑁𝑁𝑁𝑖𝑖 = 0 = 9000 + 9000(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 3) − 8316(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 5)(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 4)
𝑁𝑁𝑁𝑁𝑁𝑁2% = −1251; 𝑁𝑁𝑁𝑁𝑁𝑁3% = 620.50
Use interpolation 𝑖𝑖 = 2.67%

Example 7-3
Rate of Return in Student Loan
Amount
Interest at Cash Flow at Amount Owed
Yr Owed at
2.66% End of Year at End of Year
Start of Year
0 $9,000.00 $9,000.00
1 $9,000.00 $239.17 $9,000.00 $18,239.17
2 $18,239.17 $484.69 $9,000.00 $27,723.86
3 $27,723.86 $736.74 $9,000.00 $37,460.59
4 $37,460.59 $995.48 0 $38,456.07
5 $38,456.07 $1,021.93 -$8,315.09 $31,162.91
6 $31,162.91 $828.13 -$8,315.09 $23,675.95
7 $23,675.95 $629.17 -$8,315.09 $15,990.02
8 $15,990.02 $424.92 -$8,315.09 $8,099.85
9 $8,099.85 $215.25 -$8,315.09 $0.00

Example 7-3
Rate of Return in Student Loan
$18,000
Net Present Worth
$12,000
$6,000
$-
0% 5% 10% 15% 20%
$(6,000)
Interest Rate

Plot of NPW versus Interest Rate
Borrowing Cases
Year Cash Flow

0 +P
1 -A +
2 -A
3 -A
NPW
0 i
4 -A
: :
: : − IRR
: :

Plot of NPW versus Interest Rate
Investment Cases
Year Cash Flow

0 -P
1 +A +
2 +A
3 +A
NPW
4 +A 0 i
: :
−
: : IRR
: :

Example 7-4
A new corporate bond was initially sold to an investor for
$1000. The issuing corporation promised to pay the
bondholder $40 interest every 6 months, and to repay the
$1000 face value at the end of 10 years. After 1 year, the
bond was sold by the original buyer for $950. (a) What rate
of return did the original buyer receive on this investment?
950
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏
40
40 1000 = 40(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 2) + 950(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 2)
0 1 2 Try 𝑖𝑖 = 1.5%, 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 = 1000.41
Nominal interest rate = 1.5% × 2 = 3%
1000 Effective interest rate = (1 + 0.015)2 −1 = 3.02%

Example 7-4
(b) What rate of return can the new buyer expect if he/she
keeps the bond for its remaining 9-year life?
1000
40
0 1 2 3 4 17 18
𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏

950
950 = 40(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 18) + 1000(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 18)
Try 𝑖𝑖 = 5%, 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 = 883.10
Try 𝑖𝑖 = 4%, 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 = 999.96
By interpolation, 𝐼𝐼𝐼𝐼𝐼𝐼 = 4.43%
Nominal interest rate = 4.43% × 2 = 8.86%
Effective interest rate = (1 + 0.0443)2 −1 = 9.05%
Example 7-5
If the issuing corporation paid a 1% fee to sell the bond, what
is the effective interest rate that the firm is paying on the
bond?
𝑁𝑁𝑁𝑁𝑁𝑁 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 − 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 0
𝑁𝑁𝑁𝑁𝑁𝑁𝑖𝑖 = 990 − 40(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 20) − 1000(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 20)
Try 𝑖𝑖 = 4.5%, 𝑁𝑁𝑁𝑁𝑁𝑁4.5% = 55.08
Try 𝑖𝑖 = 4.0%, 𝑁𝑁𝑁𝑁𝑁𝑁4.0% = −10.00
By interpolation, 𝐼𝐼𝐼𝐼𝐼𝐼 = 4.077%
Effective interest rate = (1 + 0.04077)2 −1 = 8.32%

Example 7-6
Two options to acquire a property priced at $300,000:
• Finance through the seller with 20% down and the balance
due in 5 annual payments at 12%
• Pay cash with 10% discount
What is the IRR for the loan offered by the seller?
Option 1
Annual payment = 300,000(80%)(𝐴𝐴⁄𝑃𝑃, 12%, 5) = $66,576
𝑁𝑁𝑁𝑁𝑁𝑁 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 1 = 𝑁𝑁𝑁𝑁𝑁𝑁(𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 2)
−270,000 = −60,000 − 66,576(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 5)
(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 5) = 3.154
(𝑃𝑃⁄𝐴𝐴, 15%, 5) = 3.352; (𝑃𝑃⁄𝐴𝐴, 18%, 5) = 3.127
By interpolation 𝐼𝐼𝐼𝐼𝐼𝐼 = 17.6%

Example 7-7
Two options to buy parking permit:
• Buy annual parking permit on August 15th at $180; or
• Buy semester permits on August and January 15th at $130 each
What is the IRR for buying the annual permit?
A S O N D J 𝑁𝑁𝑁𝑁𝑁𝑁 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
= 𝑁𝑁𝑁𝑁𝑁𝑁(𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝)
180
−180 = −130 − 130(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖𝑚𝑚𝑚𝑚 , 5)
A S O N D J 𝑖𝑖𝑚𝑚𝑚𝑚 = 21.06%
-
130 130 Annual effective rate =
130 (1 + 21.06%)12 −1 = 891%
=A S O N D J
50

Example 7-8
Two options to pay for liability insurance:
0 1 2 3 4
• Pay quarterly at $10000 per quarter; or
• Pay annually at $35000
35000
What is the IRR for paying on annual basis?
0 1 2 3 4
𝑁𝑁𝑁𝑁𝑁𝑁 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
= 𝑁𝑁𝑁𝑁𝑁𝑁(𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝) 10000
−35,000 = −10,000 − 10,000(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖𝑞𝑞𝑞𝑞𝑞𝑞 , 3) 10000
(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖𝑞𝑞𝑞𝑞𝑞𝑞 , 3) = 2.5 0 1 2 3 4
(𝑃𝑃⁄𝐴𝐴, 9%, 3) = 2.531; (𝑃𝑃⁄𝐴𝐴, 10%, 3) = 2.487 25000
By interpolation, 𝑖𝑖𝑞𝑞𝑞𝑞𝑞𝑞 = 9.705%
Annual effective rate
= (1 + 9.705%)4 −1 = 44.8%

Example 7-9
Buy or Lease options (for 2 years):
• Buy equipment at $40000 with salvage value of $6000; or
• Lease equipment at $2500 per month
What is the IRR of the lease?
𝑁𝑁𝑁𝑁𝑁𝑁 𝐵𝐵𝐵𝐵𝐵𝐵 = 𝑁𝑁𝑁𝑁𝑁𝑁(𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿)
−40,000 + 6,000(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖𝑚𝑚𝑚𝑚 , 24) = −2,500 − 2,500(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖𝑚𝑚𝑚𝑚 , 23)
−37,500 + 6,000(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖𝑚𝑚𝑚𝑚 , 24) + 2,500(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖𝑚𝑚𝑚𝑚 , 23) = 0
−37,500 + 6,000(𝑃𝑃⁄𝐹𝐹, 4%, 24) + 2,500(𝑃𝑃⁄𝐴𝐴, 4%, 23) = $1983
−37,500 + 6,000(𝑃𝑃⁄𝐹𝐹, 5%, 24) + 2,500(𝑃𝑃⁄𝐴𝐴, 5%, 23) = −$1917
By interpolation, 𝑖𝑖𝑚𝑚𝑚𝑚 = 4.51%
Annual effective rate = (1 + 4.51%)12 −1 = 69.8%

Rate of Return (ROR) Analysis
• Most frequently used measure of merit in

industry
• More accurately called Internal Rate of
Return (IRR)
• In making decision, compare IRR with
MARR (Minimum Attractive Rate of
Return) decision
• When IRR ≥ MARR, select the alternatif
Engineering
23
Economic
Calculating ROR
• Where two mutually exclusive alternatives

will provide the same benefit, ROR is
performed using an incremental rate of
return-ΔROR-on the difference between
the alternatives.
Two-alternative situation Decision
∆ROR ≥ MARR Choose higher-cost alternative
∆ROR < MARR Choose lower-cost alternative
Engineering
24
Economic
Incremental Analysis
• When there are two or more alternatives, rate of

return analysis is performed by computing the
incremental rate of return, ΔIRR, on the
difference between two alternatives.
• The cash flow of the incremental investment is
computed by taking the higher initial-cost
alternative minus the lower initial-cost alternative.
• If ΔIRR≥MARR, choose the higher-cost alternative.
• If ΔIRR<MARR, choose the lower-cost alternative.

The Minimum Attractive Rate of
Return (MARR)
• The MARR is a minimum return the
company will accept on the money it
invests
• The MARR is usually calculated by
financial analysts in the company and
provided to those who evaluate projects
• It is the same as the interest rate used for
Present Worth and Annual Worth analysis.
26
Example 7-10
Incremental Rate of Return
An equipment can save $1200/year, has no salvage value at
the end of 5 years useful life. Two suppliers:
• Leaseco: 3 beginning-of-year payment of $1000 each
• Saleco: 1 payment of $2783
A=1200 A=1200
1000
0 1 2 3 4 5 - 0 1 2 3 4 5 = 0 1 2 3 4 5
1000 1783
2783
Saleco Leaseco Incremental
∆IRR = 8%

ROR on Alternatives With Equivalent
Benefits
Example 7-5: Consider the lease vs. buy situation. MARR = 10%
• Leasco: Lease for 5 years for 3 annual payments of $1000 each
• Saleco: Purchase up front for $2783
• Both alternatives have a $1200/year benefit for 5 years
Cash flow - Cash flow - Cash flow -
Year alternative alternative alternative
A (Leaseco) B (Saleco) B-A
0 -$1,000.00 -$2,783.00 -$1,783.00
1 $200.00 $1,200.00 $1,000.00
2 $200.00 $1,200.00 $1,000.00
3 $1,200.00 $1,200.00 $0.00
4 $1,200.00 $1,200.00 $0.00
5 $1,200.00 $1,200.00 $0.00
IRR/period 48.72% 32.60% 8.01%

Example 7-5 (Cont’d)
• Cannot simply pick the highest IRR if alternatives
have different investment costs
• Must examine the incremental cash flows!!
• Subtract the cash flows for the “Lower First Cost”
alternative from the cash flows of the “Higher First
Cost” alternative to obtain the “Incremental Cash
Flow” or ∆.
• Compute the IRR on the incremental cash flow.
This is the ∆ROR.
• For this problem the ∆ROR is 8.01% which is <
MARR, therefore choose the lower cost alternative.
29
EGR 403 - Cal Poly Pomona - SA9
Example 7-5 (Cont’d)
• Q. Why did we do this?

• A. Both alternatives were acceptable compared only to the
MARR. Since either alternative will work, the question is
whether we want to spend the additional $1783 to go from
the lower cost to the higher cost alternative. The benefit for
doing so is the savings of two years of $1000 lease
payments. Essentially we are getting an 8.01% return on
that $1783 investment. The company can get 10% ROR on
its money elsewhere, so reject the increment. That is,
spend $1000 now on Leaseco and invest the other $1783
for a higher return.
30
Example 7-11
Two mutually exclusive alternatives (MARR=6%):
2800
1500 1300
0 1 - 0 1 = 0 1
1000 1000
2000
Alt.2 Alt.1 Incremental
Year Alt.1 Alt.2 Alt.2-Alt.1
0 -$1000 -$2000 -$1000
1 +1500 +2800 +1300
IRR 50% 40% ΔIRR=30%
NPW $415 $642 $227

Example 7-13
Two mutually exclusive alternatives (MARR=6%):
28
15
10
0 1 - 0 1 = 0 1
10 13
20
Alt.1 Alt.2 Incremental
Year Alt.1 Alt.2 Alt.1-Alt.2
0 -$1000 -$2000 +$1000
1 +1500 +2800 -1300
IRR 50% 40% 30% borrowing rate
NPW $415 $642 -$227

Example 7-14
A device can be installed to reduce cost. It has no salvage value at the
end of 5 years useful life. Two options:
• Device A: Costs $10000 and saves $3000 annually
• Device B: Costs $13500 and saves $3000 the 1st year and increases
$500 annually
3500400045005000
3000 A=3000
1500 2000
500 1000
0 1 2 3 4 5 - 0 1 2 3 4 5 =0 1 2 3 4 5
3500
13500
Device B 10000 Device A Incremental
𝑁𝑁𝑁𝑁𝑁𝑁𝑖𝑖 = 0 = −3500 + 500(𝑃𝑃⁄𝐺𝐺, 𝑖𝑖, 5), ∴ (𝑃𝑃⁄𝐺𝐺, 𝑖𝑖, 5) = 7
(𝑃𝑃⁄𝐺𝐺, 9%, 5) = 7.111; (𝑃𝑃⁄𝐺𝐺, 10%, 5) = 6.862
By interpolation, ∆𝐼𝐼𝐼𝐼𝐼𝐼 = 9.45%
Example 7-15
Machine X Machine Y
Initial Cost $200 $700
Uniform annual benefit 95 120
End-of-useful-life salvage value 50 150
Useful life, in years 6 12
A=95 50
Machine X 0 1 2 3 4 5 6
200
A=120 150
Machine Y 0 1 2 3 4 5 6 7 8 9 10 11 12
700

Example 7-15
A=120 150
Machine Y 0 1 2 3 4 5 6 7 8 9 10 11 12
700 50 50
A=95 A=95
Machine X 0 1 2 3 4 5 6 7 8 9 10 11 12
200 200
A=25 150 100
Incremental 0 1 2 3 4 5 6 7 8 9 10 11 12
500
𝑃𝑃𝑃𝑃 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑃𝑃𝑃𝑃(𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏)
500 = 25(𝑃𝑃⁄𝐴𝐴, 𝑖𝑖, 12) + 150(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 6) + 100(𝑃𝑃⁄𝐹𝐹, 𝑖𝑖, 12)
Solving 𝑖𝑖, ∆𝐼𝐼𝐼𝐼𝐼𝐼 = 1.3%
Spreadsheet and
Excel Functions Purpose
Rate (n, A, -P, [F], [Type], [guess]) To find rate of return given n, P, and A
IRR (CF0..CFn, [guess]) To find internal rate of return of a
series of cash flow (period 0 to n)

Minggu 6 Chapter 07 Rate of Return Analysis - 12e XE-REV

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Minggu 6 Chapter 07 Rate of Return Analysis - 12e XE-REV

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Note: These PowerPoints were developed to

support the US edition of the text. In some

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• Definition of “Internal Rate of Return”

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• Understand and calculate internal rate of

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• Rate of return is the most frequently used

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• The interest rate at which the present worth and

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$5000 investment in 5 yrs at rate of return of 8%

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1. Convert various consequences of investment into a

𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏

𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0 (7-4)

𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑡𝑡𝑡𝑡 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑡𝑡𝑡𝑡 (7-5)

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𝑁𝑁𝑁𝑁𝑁𝑁 = 0 = −5000(𝐹𝐹 ⁄𝐴𝐴, 𝑖𝑖, 40) + 1,000,000

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𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = 0 = 100 + 75(𝐴𝐴⁄𝐺𝐺, 𝑖𝑖, 4) − 700(𝐴𝐴⁄𝑃𝑃, 𝑖𝑖, 4)

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𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 = 𝐴𝐴 = (9000)(4)(𝐴𝐴⁄𝑃𝑃, 5%, 5) = $8316

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Year Cash Flow

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Year Cash Flow

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𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏

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• Most frequently used measure of merit in

• Where two mutually exclusive alternatives

• When there are two or more alternatives, rate of

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IRR/period 48.72% 32.60% 8.01%

• Q. Why did we do this?

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