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:
- First, all net cash outflows are discounted into present at ɛ % per compound period
- Second, all net cash inflows are compounded to period N at ɛ %
- Third, the External Rate of Return which is the interest rate that establishes equivalence between the two quantity can be determined
Figure 1 ERR calculation
where ɛ % is the project external rate (5%). The table below shows ERR calculation in EXCEL
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.
- 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
- PMI-Oman 2014 , W9_Hassan Albarrami_ (IRR), Retrieved on 07.08.2014 from https://pmioman14.wordpress.com/2014/08/02/w9_hassan-albarrami_-irr/
- Iinvestopedia , Internal Rate Of Return – IRR on 01.08.2014 from http://www.investopedia.com/terms/i/irr.asp
- 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/