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Chapter 8 - Incremental Rate of Return Analysis Click here for.ppt

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Chapter 8 - Incremental Rate of Return Analysis Click here for

Version 8.0 - September 2001 EGR 403 - Cal Poly Pomona - SA11 Chapter 8 - Incremental Rate of Return Analysis Click here for Streaming Audio To Accompany Presentation (optional) EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz Industrial Manufacturing Engineering Department Cal Poly Pomona EGR 403 - The Big Picture Framework: Accounting Breakeven Analysis “Time-value of money” concepts - Ch. 3, 4 Analysis methods Ch. 5 - Present Worth Ch. 6 - Annual Worth Ch. 7,7A,8 - Rate of Return (incremental analysis) Ch. 9 - Benefit Cost Ratio other techniques Refining the analysis Ch. 10, 11 - Depreciation Taxes Ch. 12 - Replacement Analysis Incremental Analysis Required for examining three or more alternatives. Defined as the examination of differences between alternatives to determine if the increased costs are justified by the increased benefits. Elements of Rate of Return Analysis Identify all acceptable alternatives that fulfill similar system outcomes. Arrange the alternatives in ascending order of investment. Compute the rate of return for each alternative. Discard alternatives where ROR MARR. Make a pair-wise analysis of the contender and present selection. For investment: If DROR ￡ MARR select the contender. If DROR 3 MARR keep the present selection. Incremental Rate of Return Analysis Incremental Analysis1. Rank from lowest cost to highest cost2. Start with two lowest cost alternatives3. Compare increments using MARR criteria4. Repeat until a “winner” is determined Graphical SolutionsPWB vs. PWC at MARRAbove the 45 degree line projects are acceptable (NPW0) Graphical Solution Graphical Incremental AnalysisIf line between two alternatives is 45 degrees, accept higher cost alternative. Alternative A wins. Graphical Incremental Analysis Choosing an Analysis Method * High cost alt. - Low cost alt. = Difference between alt. Example 8 - 7 PWB = A (P/A, 6%, 20) = A (11.47) MARR = 6% (given) All projects are initially acceptable because IRR ? MAR