Rate of Return for a Single
Project
Lecture Objectives:
• Understand the Concept of Rate of Return (ROR):
• Mathematically Express the IRR:
• Calculate the IRR for a Project:
• Evaluate Project Viability Using IRR:
• Relate to Real-World Applications:
Example 1: Energy-Efficient Lighting System
• Background:
• A company is considering installing an energy-efficient lighting system in its office. The initial
investment required is $20,000. The projected cash inflows from savings in energy costs are:
• Year 1: $5,000
• Year 2: $5,500
• Year 3: $6,000
• Year 4: $6,500
• Year 5: $7,000
• The company's required rate of return is 8%.
• Tasks:
1. Calculate the IRR for the project.
2. Determine if the project should be accepted based on the IRR.
Example 2: Manufacturing Equipment Upgrade
• Background:
• A manufacturing firm needs to upgrade its equipment to improve efficiency. The cost of the
upgrade is $50,000. The expected additional cash inflows due to increased efficiency are:
• Year 1: $10,000
• Year 2: $12,000
• Year 3: $14,000
• Year 4: $16,000
• Year 5: $18,000
• Year 6: $20,000
• The firm's required rate of return is 10%.
• Tasks:
1. Calculate the IRR for the project.
2. Decide whether the firm should proceed with the upgrade based on the IRR.
Example 3: Renewable Energy Project
• Background:
• A renewable energy company is planning to invest in a small wind turbine project. The initial cost
is $120,000. The expected annual revenues from the project are:
• Year 1: $20,000
• Year 2: $22,000
• Year 3: $24,000
• Year 4: $26,000
• Year 5: $28,000
• Year 6: $30,000
• The company’s required rate of return is 9%.
• Tasks:
1. Calculate the IRR for the project.
2. Assess whether the project should be undertaken based on the IRR.
Example 4: Software Development Project
• Background:
• A software company is considering developing a new application. The development cost
is $100,000. The projected cash inflows from the application are:
• Year 1: $25,000
• Year 2: $30,000
• Year 3: $35,000
• Year 4: $40,000
• Year 5: $45,000
• The company’s hurdle rate is 11%.
• Tasks:
1.Calculate the IRR for the project.
2.Evaluate if the project should be accepted based on the IRR.
Case Study 1: Solar Power Installation Project
• Background:
• An electrical engineering firm is considering investing in a solar power
installation project. The project requires an initial investment of $150,000.
The expected cash inflows from the project are as follows:
• Year 1: $30,000
• Year 2: $35,000
• Year 3: $40,000
• Year 4: $45,000
• Year 5: $50,000
• The firm's required rate of return is 10%.
• Discussion Points:
1.Calculate the IRR:
1. Use the cash inflows and initial investment to calculate the IRR manually or using Excel.
2. Discuss the process and any challenges encountered.
2.Decision Making:
1. Compare the calculated IRR with the required rate of return.
2. Determine whether the firm should proceed with the investment based on the IRR.
3.Sensitivity Analysis:
1. Discuss how changes in cash inflows or the initial investment might affect the IRR.
2. Explore the impact of different scenarios (e.g., lower-than-expected inflows or additional
unforeseen costs).
• Questions for Discussion:
• How does the IRR compare to the required rate of return?
• What factors could cause deviations in the projected cash inflows?
• What are the risks and benefits associated with this solar power installation
project?
Case Study 2: New Product Development
in Consumer Electronics
• Background:
• A consumer electronics company is planning to develop a new smart home
device. The initial investment required is $500,000. The projected cash
inflows over the next six years are:
• Year 1: $100,000
• Year 2: $120,000
• Year 3: $140,000
• Year 4: $160,000
• Year 5: $180,000
• Year 6: $200,000
• The company's hurdle rate is 12%.
• Discussion Points:
1.IRR Calculation:
1. Calculate the IRR for the project using the provided cash flows.
2. Use financial software (e.g., Excel) to streamline the calculation process.
2.Project Evaluation:
1. Assess whether the project should be accepted based on the IRR and the company's
hurdle rate.
2. Discuss any potential risks associated with the cash flow projections.
3.Comparison with NPV:
1. Calculate the NPV of the project at the hurdle rate.
2. Compare the decision-making outcomes based on NPV and IRR.
• Questions for Discussion:
• How do the IRR and NPV compare in terms of project viability?
• What could be the potential risks and uncertainties in developing a new
product?
• How might changes in market conditions affect the project's success?
