Comparison by Rate of Return

1.   An analyst is given the problem of selecting between two projects using the rate of return method. One and only one of the projects must be selected. The data for the projects is shown below. Also shown is the rate of return for each project based on the data. The minimum acceptable rate of return is 9%.

Is the information provided below sufficient to make a selection with the rate of return method? If it is not sufficient, explain what additional analysis is necessary. You don't have to do any complicated calculations, but show the formulas you would use for additional analysis and describe how you would make the decision.

 

Project A

Project B

Initial Investment

$10,000

$15,000

Annual Benefit

1,944

2,394

Salvage Value

1,000

1,500

Project Life

10 years

10 years

     

Rate of return

12%

11.67%

2.   You are thinking about building an ice cream stand. You are considering three possible sizes. The smallest will cost $5,000, and you can sell 25,000 cones a year. The net revenue is 5 per cone. The next size costs $10,000 to build. With this size you can sell 75,000 cones per year at a net revenue of 5 a cone. The largest ice cream stand is very elaborate and costs $18,000 to build. With this stand you can sell 150,000 cones per year with a net revenue of 4 each. To be conservative, you assume a five-year life and no salvage value for all three sizes.

If your minimum rate of return is 25%, should you build an ice cream stand? If so, what size should you build? Use the rate of return method.

3.  A city government feels that energy production capacity must be expanded to meet anticipated demands for energy. Three alternative sources are being considered.

a. A nuclear facility with an investment of $250 million, operating costs of $3 million per year and life of 20 years.

b. A coal plant with an investment of $200 million, operating costs of 10 million per year and a life of 20 years.

c. A natural gas plant with a cost of $100 million, operating costs of $18 million per year and a life of 20 years.

Use the ROR method to select the best alternative. The cost of capital (MARR) for the city is 10%. Interest rates should only be calculated to the accuracy of the nearest number in the table unless more accuracy is required to make a decision.

4.a

4a. A woman is considering an investment opportunity. Using her MARR to bring all the cash flows associated with the investment to time zero, she discovers that the net present value is zero. What rate of return does this investment yield, and should the woman accept the investment?

4b. Three mutually exclusive alternatives are available: A, B, and C. The company can invest in any one or none of the alternatives. A requires the smallest investment, B has the next smallest, and C requires the largest investment. The following rates of return are computed: A: 12%, B: 11%, C: 10%, B — A: 10.5%, C — A: 9%, C — B: 9.5%. If the company's minimum acceptable rate of return is 10%, which alternative should be chosen? Provide justification for your conclusion.