W9_Folakemi_Project Evaluation Using External Rate of Return (ERR)

1.      Problem recognition, definition and evaluation

The case study of the entrepreneur, who is considering different projects for the purpose of generating additional streams of income in 2013, is evaluated again in this write up using the External Rate of Return method. The objective is to compare the result of the IRR and ERR methods in order to determine whether each of the four projects being considered by the entrepreneur is individually economically viable based on both methods.

2.      Development of the feasible alternatives

The four projects being considered are as follows:

Table 1: Alternative Projects

3.      Development of the outcomes for each alternative

·         The Internal rate of Return (IRR) method has already been used to evaluate these projects

·   The External Rate of Return (ERR) method will be used in this write up. The ERR of an acceptable project should be greater than the MARR, i.e. the Minimum Attractive Rate of Return. The ERR is the interest rate that equates the net cash outflows discounted to time zero at E% compounding period to the net cash inflows compounded to period N at E%.

The MARR computed for this organization (in week 8) is 24%. This was computed using the opportunity cost method.

4.      Selection of criteria

For a project to be acceptable, the following equations must be true:

IRR > MARR

ERR > MARR

5.      Analysis and comparison of the alternatives

Table 2. Internal (IRR) and External (ERR) Rate of Return of Projects

 

Both methods show similar results in terms of ranking of the projects. The Clothing Store is projected to have the lowest rate on return, both internal and external. However it is still economically viable as both the ERR and IRR are greater than the MARR (24%).

6.      Selection of the preferred alternative

Based on the two methods used in evaluating the projects, the following table shows the list of projects in order of economic viability from the most viable to the least.

Table 3: IRR and ERR Results

7.      Performance Monitoring & Post Evaluation of Result

It will be useful to also evaluate the projects based on other qualitative factors such as initial investment required versus availability of funds, skills required, etc.

8.      References

1.      Manshu (2010, November 23). What is IRR and how is it calculated? One Mint. Retrieved from: http://www.onemint.com/2010/11/23/what-is-irr-and-how-is-it-calculated/

2.      Obukoeroro J. (2011). Project Economics as a Tool for Evaluation of Viability of Projects: A Case of Palm Oil Milling Plant. Journal of Innovative Research in Engineering and Sciences (2,6), pp. 307-318

3.      Sullivan, W. G., Wicks, E.M., & Koelling, C.P. (2012). Engineering Economy (15th ed.) (pp 200-214) New Jersey, NJ. Pearson Higher Education, Inc.