Last week Eduardo calculated the overall project ROR values for two alternatives A and B using the estimates below. He calculated iA* _ 34.2% and iB* _ 31.2% and recommended acceptance of A since its rate of return exceeded the established MARR of 30% by a greater amount than project B. Yesterday, the general manager of the company announced a major capital investment program, which includes a large drop in the MARR from 30% to 20% per year. Do the following to help Eduardo better understand the rate of return method and what this reduction in MARR means.
(a) Explain the error that Eduardo made in performing the rate of return analysis.
(b) Perform the correct analysis using each MARR value.
(c) Illustrate the ranking inconsistency problem using the two MARR values, and determine the maximum MARR that will justify alternative B.
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Alternative A
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Alternative B
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First cost, $
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40,000
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85,000
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Annual operating cost, $ per year
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5,500
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15,000
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Annual revenue, $ per year
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22,000
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45,000
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Salvage value, $
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0
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20,000
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Life, years
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6
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6
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i *, %
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34.2
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29.2
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