W10_Hassan Albarrami_ (ERR)


W10_Hassan Albarrami_ (ERR)

 

1. Problem Definition

Continue talking about my construction building project mentioned in W8 and W9 blogs, this time I’m going to explore ERR method to make sure the project still recommended. Like IRR, ERR is used to evaluate the economic justification of project. But this time ERR is taken into account the interest rate external at which cash flow generated over the lifecycle of project.

2. Identify the Feasible Alternative

Either to go ahead with the project (ERR > MARR), or to cancel the project (ERR< MARR).

Where; MARR is the minimum attractive rate of return. MARR was calculated by one of my collages as stated below (1).

For the most risky project

MARR = 12.81%

For the least risky project

MARR = 8.62%

My project is not that much risky but I will consider MARR=10 %

3. Development of the outcome for alternative

There are 3 steps to calculate ERR:

  1. First, all net cash outflows are discounted into present at ɛ % per compound period
  2. Second, all net cash inflows are compounded to period N at ɛ %
  3. Third, the External Rate of Return which is the interest rate that establishes equivalence between the two quantity can be determined

1

Figure 1 ERR calculation

 where ɛ % is the project external rate (5%). The table below shows ERR calculation in EXCEL

 

2

Table 1 ERR calculation

got this link to learn how to calculate ERR (http://www.youtube.com/watch?v=-Mx8FR3Wtt0)

4. Selection Criteria

the project will be accepted if ERR> MARR

5. Analysis and Comparison of the Alternative

Even though the most risky project is considering MARR = 12.81% we got ERR= 13% which making us more confident.

6. Selection of the Preferred Alternative

It is clear from the table that ERR= 13% which means > MARR hence the project is accepted

7. Performance Monitoring and the Post Evaluation of Result

It is recommended to apply both methods in future  to be more confidant before starting any project.

Reference

  1. PMI-Oman 2014 , W5_AlShehhi_Calculating MARR Using Analytical Hierarchy Methodology, Retrieved on 07.08.2014 from https://pmioman14.wordpress.com/2014/07/09/w5_alshehhi_calculating-marr-using-analytical-hierarchy-methodology/#more-1172
  2. PMI-Oman 2014 , W9_Hassan Albarrami_ (IRR), Retrieved on 07.08.2014 from https://pmioman14.wordpress.com/2014/08/02/w9_hassan-albarrami_-irr/
  3. Iinvestopedia , Internal Rate Of Return – IRR on   01.08.2014 from http://www.investopedia.com/terms/i/irr.asp
  4. Planwithintegrity , Internal Rate of Return (IRR), External Rate of Return (ERR) and What Matters Most, Retrieved on 07.08.2014 fromhttp://www.planwithintegrity.com/internal-rate-of-return-irr-external-rate-of-return-err-and-what-matters-most/
Advertisements

3 thoughts on “W10_Hassan Albarrami_ (ERR)

  1. Excellent, Hassan!!! Nice case study and your analysis was spot on!!! You could have explained the advantages of using ERR vs using IRR but I think you’ve got sufficient understanding at this point.

    The real challenge will come if/when you get a project that is a “Go” based on IRR and a “NO GO” based on ERR. Then what? Which is the more “realistic” model for your organization? Why?

    Anyway, nice job and looking forward to more high quality blogs like this in the remaining weeks…

    BR,
    Dr. PDG, Jakarta

  2. Pingback: W11_Hassan Albarrami_ (IRR,ERR,MARR) | PMI-Oman 2014

  3. Pingback: W12_Hassan Albarrami_ (IRR,ERR,MARR) (2) | PMI-Oman 2014

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s