Example Rate of Return Analysis

Reconsider the fabrication investment project in Example 17.3.1. (a) What is the projected IRR on this fabrication investment? (b) If Merco's MARR is known to be 15%, is this investment justifiable?

Solution.

• (a) The net present worth expression as a function of interest rate (i) is

PW(i) = -$1,250,000 + $731,500(P/A, i, 15) + $80,000(P/F^;15) =0

Using Excel's financial function (IRR), we find the IRR to be 58.43%. (See Figure 17.3.2.) Merco will recover the initial investment fully and also earn 58.43% interest on its invested capital.

• (b) If Merco does not undertake the project, the $1,250,000 would remain in the firm's investment pool and continue to earn only 15% interest. The IRR figure far exceeds the Merco's MARR, indicating that the fabrication system project is an economically attractive one. Merco's management believes that, over a broad base of structural products, there is no doubt that the installation of its fabricating system would result in a significant savings, even after considering some potential deviations from the estimates used in the analysis.

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Project Management Made Easy

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