BES 02 ENGINEERING

ECONOMICS
MARR
Basic Economic Study
Methods
Ronel E. Romero, RCE, MCE
Instructor
President Ramon Magsaysay State University
 Minimum Attractive Rate of Return
 MARR is a reasonable
rate of return (percent)
established for evaluating
projects and selecting
alternatives
 An investment is
justified economically if it
is expected to return at
least the MARR
 Also termed hurdle rate,
benchmark rate and cutoff
rate
 Minimum Attractive Rate of Return
 In this lesson, we concentrate on the correct
use of five methods for evaluating the economic
profitability of a single proposed problem solution
(i.e., alternative).
 The five methods described are
Present Worth (PW) convert cash flows resulting from a
proposed problem solution into their
Future Worth (FW)
compute annual rates of
equivalent worth at some point (or
profit, or returns, resulting
points) in time by using an interest
Annual Worth (AW) from an investment
rate known
and are then compared to
as the Minimum Attractive Rate of

Internal Rate of Return (IRR) the MARR.

Return (MARR).

and External Rate of Return (ERR).

PRESENT WORTH METHOD
The PW method is based on the concept of
equivalent worth of all cash flows relative to
some base or beginning point in time called the
present.
To apply the PW method of determining a project’s
economic worthiness, we simply compute the
present equivalent of all cash flows using the
MARR as the interest rate. If the present worth is
greater than or equal to zero, the project is acceptable.

PW =
 A piece of new equipment has been proposed by engineers to
Sample: increase the productivity of a certain manual welding operation.
The investment cost is P25,000, and the equipment will have a
market value of P5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to P8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production.
5,000
If the firm’s MARR is 20% per year, is this proposal a sound one?
Use the PW method. P1 (8000) =
8,000 8,000 8,000 8,000 8,000 = P 23,924.90
0 1 2 3 4 5 P2 (5000) = = P 2,009.39
P = 23,924.90 + 2,009.39 = P25,93
25,000
Because PW(20%) ≥ 0,
PW =
this equipment is
PW (20%) = P 25,934.29 - P 25,000 economically justified.
 office building.
Sample: The system can be purchased and installed for P110,000, and it
will save an estimated 300,000 kilowatt-hours (kWh) of electric
power each year over a six-year period. A kilowatt-hour of
electricity costs P0.10, and the company uses a MARR of 15% per
year in its economic evaluations of refurbished systems. The
market value of the system will be P8,000 at the end of six years,
and additional annual operating and maintenance expenses are
negligible. Use the PW method to determine whether this system
Power savings =
should be installed. 8,000 300,000kWh (0.10/kWh)
P30,000 per yr
P1 (30k) = = P 113,534.
30,000 30,00030,000 30,00030,00030,000

0 1 3 4 5 6 P2 (8000) = = P 3,458.6
2
P = 113,534.5 + 3,458.6 = 116,993.
110,000
Because PW(15%) ≥ 0,
PW =
this should be
PW (15%) = P 116,993.1 - P installed
FUTURE WORTH METHOD
If the FW (Future Worth), using the MARR as the
interest is greater than or equal to zero, then the
project is economically viable.

FW =
 A piece of new equipment has been proposed by engineers to
Sample: increase the productivity of a certain manual welding operation.
The investment cost is P25,000, and the equipment will have a
market value of P5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to P8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production.
5,000
If the firm’s MARR is 20% per year, is this proposal a sound one?
Use the FW method.
8,000 8,000 8,000 8,000 8,000

0 1 2 3 4 5

25,000
 office building.
Sample: The system can be purchased and installed for P110,000, and it
will save an estimated 300,000 kilowatt-hours (kWh) of electric
power each year over a six-year period. A kilowatt-hour of
electricity costs P0.10, and the company uses a MARR of 15% per
year in its economic evaluations of refurbished systems. The
market value of the system will be P8,000 at the end of six years,
and additional annual operating and maintenance expenses are
negligible. Use the FW method to determine whether this system
should be installed. 8,000

30,000 30,00030,000 30,00030,00030,000

0 1 2 3 4 5 6

110,000
ANNUAL WORTH METHOD
If the AW (Annual Worth), using the MARR as the
interest is greater than or equal to zero, then the
project is economically viable.

AW =

AW =
CR =
AW of Investment – AW of market value
(Salvage value)
 A piece of new equipment has been proposed by engineers to
Sample: increase the productivity of a certain manual welding operation.
The investment cost is P25,000, and the equipment will have a
market value of P5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to P8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production.
5,000
If the firm’s MARR is 20% per year, is this proposal a sound one?
CR AW of Investment – AW of market
Use the PW method. value (Salvage value)
8,000 8,000 8,000 8,000 8,000
25,000= A = P 8,359.4
0 1 2 3 4 5
5,000= A = P 671.9
R-E=
25,000
P8,000
CR = P8,359.49-671.9 =
AW =
7687.59 AW =
INTERNAL RATE OF RETURN
METHOD
If the IRR I equal or greater than the MARR, the
project is economically viable.
IRR is the rate of which the present worth of the
investment would be equal to the present worth
of all the expenses.
 A piece of new equipment has been proposed by engineers to
Sample: increase the productivity of a certain manual welding operation.
The investment cost is P25,000, and the equipment will have a
market value of P5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to P8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production.
5,000
If the firm’s MARR is 20% per year, is this proposal a sound one?
Present Worth of Cash inflows =
Use the PW method. Present Worth of Cash outflows
8,000 8,000 8,000 8,000 8,000
25,000= +
0 1 2 3 4 5
i = 0.2158 = 21.58%
25,000
IRR = 21.58% > MARR
= 20%
 EXTERNAL RATE OF RETURN
If theMETHOD
ERR I equal or greater than the MARR, the project is
economically viable.

In general, three steps are used in the calculating

procedure.

1st, all net cash outflows are discounted to time zero (the
present) at ∈% per compounding period.
2nd, all net cash inflows are compounded to period n at ∈%.
3rd, the ERR, which is the interest rate that establishes
equivalence between the two quantities, is determined. (FW of E
= FW of R)

The absolute value of the present equivalent worth of the net cash
outflows at ∈% (first step) is used in this last step.
 A piece of new equipment has been proposed by engineers to
Sample: increase the productivity of a certain manual welding operation.
The investment cost is P25,000, and the equipment will have a
market value of P5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to P8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production. Step 1: Cash outflows to
If the firm’s MARR is 20% per year, is this proposal a sound one?
Present
Use the PW method. 5,000
Step 2: Cash inflows to Future
= 25,000
8,000 8,000 8,000 8,000 8,000
∈% = MARR = + 5,000
20%

0 1 2 3 4 5 = 64,532.8
Step 3:
25,000
25,000 ERR (i) = 20.88% > MARR
= 20%
 When ∈=15% and MARR = 20% per year, determine whether
Sample: the project
(whose net cash-flow diagram appears next) is acceptable.
Notice in this example that the use of an ∈% different from the
MARR is illustrated. This might occur if, for some reason, part or
all of the funds related to a project are “handled” outside the
Step 1: Cash outflows to
firm’s normal capital structure.
Present
= 10,000 + = 14,347.83
5,000 5,000 5,000 5,000 5,000
Step 2: Cash inflows to Future
0 1 2 3 4 5 6
Step 3:
5,000 14,347.83
10,000
ERR (i) = 15.30% < MARR therefore, this project
would be unacceptable
= 20% according to the ERR