Question

We covered various methods to identify the preferred alternative. For example, the rate-of-return (ROR) method states that the base alternative is the one that instructs us to use incremental analysis to compare the base alternative to the next smallest investment cost alternative. Meaning, if the change in IRR is greater than or equal to MARR, eliminate the base and move on to the next comparison. If the change in IRR is less than MARR, keep the base and move on to the next comparison. Discuss this decision rule.

Answer 1

Answer:

The rate of return (RoR) of an investment calculates the net gain or loss of the investment over a period of time.  Then this gain or loss is expressed as a percentage of the investment's initial cost.  This return of return can be calculated as either the Internal Rate of Return (IRR) or the Minimum Acceptable Rate of Return.

The decision rule is based on ascertaining the economic attractiveness of a project.  The rule states that if the IRR exceeds the MARR, it shows that the investment is economic and beneficial.  If the IRR is less than the MARR, the investment is not economically beneficial.  When the IRR equals the MARR, it implies that the benefits from the investment equal the costs.

The purpose of this decision rule is to ensure that beneficial economic decisions are during investment planning.

Explanation:

The IRR (internal rate of return) of a project calculates the discount rate at which the net present value (NPV) of all cash flows from a project equals zero. The MARR (minimum acceptable rate of return) or the hurdle rate is the lowest rate of return that the project must earn to offset the investment costs of the project. Therefore, the rate of return is a determination of the percentage change in the value of the investment at the beginning of the period and at the end.