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Session 1339

Rate of Return – Must We Bother? Robert H. Mayer United States Naval Academy

Abstract

Rate of return (ROR) is a widely accepted criterion for determining the economic viability of an engineering project or other investment alternative. Similarly, incremental rate of return (IROR) is often used to choose the best alternative among several. Accordingly, most engineering economy textbooks provide appreciable instruction in ROR and IROR applications, often covering one or two chapters of text. As a result, computation of the ROR is certainly within the grasp of most engineering economy students. Even so, the underlying methodologies of ROR assessment and IROR selection are computationally more difficult than other economic methods, and results can be ambiguous, indeterminate and, unless used with care, misinterpreted. For example, students will often apply, without discernment, the oft-quoted decision rule, “If the ROR > MARR, accept the alternative …” and they are sometimes wrong.

Since our engineering economic textbooks offer such a variety of topics, it begs the question “How much ROR (and IROR) instruction is necessary and truly beneficial for the undergraduate engineering student?” This paper explores possible answers to that question and its more pointed companion, “ROR – Must We Bother?” Advantages and potential disadvantages (and dis- benefits) of “staying the course” with the current ROR/IROR emphasis are considered. Alter- natively, a more innovative trail is suggested that seeks a better balance between engineering economy fundamentals and (applied) economic decision analysis.

Introduction

The fundamental purpose of a course in engineering economy is to provide students with the tools to (i) make effective assessments of engineering projects and other investment alternatives, and to (ii) select the best project from a mutually exclusive set. As suggested in Figure 1, (engineering) economic decision making requires but a few basic steps. But, there are various methods for making project assessments and selection including Present Worth, Annual Worth, Benefit-Cost Ratio and Rate of Return analyses.

Provided the cash flow diagram of a project opportunity is available, its present worth may be determined by solving the following equation:

PW[i] = S [ St /(1 + i)t ] (1)

Here “i” is an appropriate interest rate, the S t are cash vectors (some positive, some negative) at time t, and the summation extends over the life of the project, i.e., for t = 0, 1, … N.

Proceedings of the 2002 American Society for Engineering Education Annual Conference & Exposition Copyright © 2002, American Society for Engineering Education

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Mayer, R. (2002, June), Rate Of Return Must We Bother? Paper presented at 2002 Annual Conference, Montreal, Canada. 10.18260/1-2--10825