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Internal Rate Of Return Essay

682 words - 3 pages

Lecture No. 25 Chapter 7 Contemporary Engineering Economics Copyright © 2010

Contemporary Engineering Economics, 5th edition, © 2010

Net Investment Test
 What it is: A process to determine whether or not a firm

borrows money from a project during the investment period.  How to test: A project is said to be a net investment when the project balances computed at the project’s i* values, PB(i*)n, are either less than or equal to zero throughout the life of the investment.  Meaning: The investment is net in the sense that the firm does not overdraw on its return in any point and hence is not indebted to the project
Contemporary Engineering Economics, 5th edition, © 2010

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 If IRR > MARR, accept the

project.  If IRR = MARR, remain indifferent.  If IRR < MARR, reject the project.

 Decision Criterion for Mutually

Exclusive Projects:
 Use the incremental analysis

(See Lecture No. 26)

Contemporary Engineering Economics, 5th edition, © 2010

Decision Rule for Mixed Investments
 Need for an external interest rate for mixed investments. We will use the MARR as established external interest rate—the rate earned by money

invested outside of the project.  Calculate a rate of return on the portion of capital that remains invested internally—commonly known as the return on invested capital (RIC)  Select the investment if RIC > MARR.

Contemporary Engineering Economics, 5th edition, © 2010

Procedure to Calculate the RIC

Contemporary Engineering Economics, 5th edition, © 2010

Computational Logic for RIC

Borrowing from project

Lending to project

Contemporary Engineering Economics, 5th edition, © 2010

Example 7.8 RIC for a Mixed Investment

$260 $168 $100   0 2 (1  i*) (1  i*)
* * i1  20% and i2  40%


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