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Example of choosing alternative project using MARR method

Data A B C D
First Cost (Dollars) 4000 3000 6000 5000
Annual Benefit 623 531 1020 712
Life 10 Years
ROR 9% 12% 11% 7%

Given MARR = 8%

Since the MARR is 8%, Alt. D may be eliminated, as the ROR is less than 8%

Among the remaining alternatives, A, B and C, the two lower cost alternatives are A and B

(A-B) increment:

PW of benefit = PW of cost
(623-531)(P/A, i, 10) = (4000-3000)
(P/A, i, 10) = 1000/92 = 10.86

i (P/A, i, 10)
8% 6.710
7% 7.024
DROR is less than 8%. Therefore, retain the lower-cost alternative, alt. B

(C-B) increment:

PW of benefit = PW of cost
(1020 531)(P/A, i, 10) = (6000-3000)
(P/A, i, 10) = 3000/489 = 6.13

i (P/A, i, 10)
8% 6.710
9% 6.418
DROR is greater than 8%. Therefore, choose the higher-cost alternative, alt. C
It is not uncommon for firms to set two or more MARR levels, according to risk categories. For example,
one major industrial firm defines risk categories for income-producing projects and normal MARR
standards for each of these categories as follows:

1. High Risk (MARR =25%)


New products
New business
Acquisitions
Joint ventures
2. Moderate Risk (MARR = 18%)
Capacity increase to meet forecasted sales
3. Low Risk (MARR=10%)
Cost improvements
Make versus buy
Capacity increase to meet existing orders

To illustrate how the preceding set of MARR standards could be determined, the firm could rank
prospective projects in each risk category according to prospective rates of return and investment
amounts. After tentatively deciding how much investment capital should be allocated to each risk
category, the firm could then determine the MARR for each category.

Based on the given amount of money which is 1 millions, there are several alternative that we can invest
on which is construc a shooping mall, construct and rent houses, build and rent a shop lot, build a
foodcourt, bu a new crane or invest on bank. Table below shows the amount of investment, rate of
return(ROR), period, annual benefits and total benefits of each project that we can invest.

Table 1: Several alternative of Investment

A B C D E F
Project/Data Construct a Construct Construct Build a Buy a new Invest on
Shopping and rent a and rent a Foodcourt Crane Bank
Mall houses shop lot
Cost (RM) 960,000 550,000 350,000 300,000 150,000 100,000
ROR 35% 35% 30% 30% 25% 20%
Period 10 10 10 10 10 10
Annual 353,585 202,575 113,212 97,039 42,010 23,825
Benefits, A
(RM)
Total 19,302,261 11,058,601 4,825,038 4,135,753 1,396,954 618,465
Benefit,F
(RM)
Calculation of Annual Benefits, A : A = P(A/P, i, n)

Project A : 960,000(A/P, 0.35, 10) = RM 353,585


Project B : 550,000(A/P, 0.35, 10) = RM 202,575
Project C : 350,000(A/P, 0.3, 10) = RM 113,212
Project D : 300,00(A/P, 0.3, 10) = RM 97,039
Project E : 150,000(A/P, 0.25, 10 = RM 42,010
Project F : 100,000(A/P, 0.2, 10) = RM 23,825

Calculation of Total Benefit, F : F = A(F/A, i, n)

Project A : 353,585 (F/A, 0.35, 10) = RM 19,302,261


Project B : 202,575(F/A, 0.35, 10) = RM 11,058,601
Project C : 113,212(F/A, 0.3, 10) = RM 4,825,038
Project D : 97,039(F/A, 0.3, 10) = RM 4,135,753
Project E : 42,010(F/A, 0.25, 10) = RM 1,396,954
Project F : 23,825(F/A, 0.2, 10) = RM 618,465

55
50
Annual Rate of Profit (%)

45
40 35%
35 A Interest rate
30
25
20
15
10
5
100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400
Investment Amount (Thousands Ringgit)

Figure 2: Prospective Returns and Investment Amounts of Project A

55
50
Annual Rate of Profit (%)

45
40 35%
35 B 30% 30% Interest rate
30
C D 25%
25 20%
20 E
15 F
10
5
100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400
Investment Amount (Thousands Ringgit)

Figure 3: Figure 2: Prospective Returns and Investment Amounts of Project B, C, D, E and F


Standart MARR for a new product, new bussiness, acquisitions, joint ventures is 25% or High Risk MARR,
while project A gives 35% in rate of return. ROR>MARR shows that the project was a good investment.
Based on bar chart of annual rate of profit versus investment amount, we decided to choose project A
which is constructing a shopping mall due to its high rate of return and the ROR is more than the standard
MARR. Project E and F is rejected because the project rate of return is lower than MARR. On the other
side, project B, C and D can be a good investment too, however, since the project of A and B gives a same
percentage in rate of return, we should choose the higher-cost alternative. In this case, the most high-
cost and high rate of return is Project A.

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