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Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR Lecture No. 62 Chapter 15 Contemporary Engineering Economics Copyright © 2006.

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Presentation on theme: "Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR Lecture No. 62 Chapter 15 Contemporary Engineering Economics Copyright © 2006."— Presentation transcript:

1 Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR Lecture No. 62 Chapter 15 Contemporary Engineering Economics Copyright © 2006

2 Contemporary Engineering Economics, 4 th edition, © 2007 Review – What is MARR? MARR – Minimum Attractive rate of Return: The required return necessary to make a capital budgeting project such as building a new factory worthwhile (profitable).

3 Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR - Overview  Choice of MARR when Project Financing is Known: Use i e as your MARR.  Choice of MARR when Project Financing is Unknown: Use k as your MARR  Choice of MARR under Capital Rationing: It depends on the lending and borrowing opportunities

4 Contemporary Engineering Economics, 4 th edition, © 2007 Example 15.8 Choice of MARR when Project Financing is Known To calculate the net present worth of the project, use the cost of equity (i e ) as the discount rate. Explicit accounts for debt flows

5 Contemporary Engineering Economics, 4 th edition, © 2007 Example 15.9 Choice of MARR when Project Financing is Unknown Without explicitly treating the debt flows, make a tax adjustment to the discount rate, using the weighted cost of capital k.

6 Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR under Capital Rationing

7 Contemporary Engineering Economics, 4 th edition, © 2007 Example 15.10 Determining an Appropriate MARR as a Function of the Budget Project Cash Flow IRR AOAO A1 1-$10,000$12,00020% 2-10,00011,50015 3-10,00011,00010 4-10,00010,8008 5-10,00010,7007 6-10,00010,4004 Borrowing rate (k) = 10% Lending rate (l) = 6%

8 Contemporary Engineering Economics, 4 th edition, © 2007 An Investment Opportunity Schedule Ranking Alternatives by the ROR

9 Contemporary Engineering Economics, 4 th edition, © 2007 MARR as a Function of Budget Available Budget Project Selected Correct MARR to Use $40,0001,2,3, and 48% $60,0001,2,3, 4 and 5 MARR = l = 6% $01 and 2MARR = k = 10% k = 10% l = 6%

10 Contemporary Engineering Economics, 4 th edition, © 2007 A Choice of MARR under Capital Rationing

11 Contemporary Engineering Economics, 4 th edition, © 2007 Summary  The selection of an appropriate MARR depends generally upon the cost of capital—the rate the firm must pay to various sources for the use of capital.  1. The cost of equity (i e ) is used when debt-financing methods and repayment schedules are known explicitly.  2. The cost of capital (k) is used when exact financing methods are unknown, but a firm keeps it capital structure on target. In this situation, a project’s after-tax cash flows contain no debt cash flows such as principal and interest payment


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