W12_Hassan Albarrami_ (IRR,ERR,MARR)
- Problem Definition
Continue exploring IRR,ERR and MARR discussed in my previous blog (W11). The portfolio of projects (5 no#) were ranked by IRR and ERR and we ended with only one location which can satisfy the hurdle rate. in this blog we are going to do the same but taking the operating cost in consideration. As the idea is to construct a Building of 12 apartments, my experience the average operating cost for an apartment in Salalah is around 30 OMR per month (electricity and water) .
Identify the Feasible Alternative
Either to go ahead with the project (ERR > MARR), and IRR >0, or to cancel the project (ERR< MARR) or IRR<0.
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%
This time I would say MARR=8.62 % (hurdle rate)
- Development of the outcome for alternative
Okad | New Salalah | Saadah | Taqa | Marbat | |||||||||||
land cost | 35000 | 70000 | 50000 | 20000 | 15000 | ||||||||||
building cost | 130000 | 135000 | 137000 | 140000 | 145000 | ||||||||||
annual incom | 25000 | 36000 | 28000 | 21000 | 18000 | ||||||||||
operating cost | cash flow | operating cost | cash flow | operating cost | cash flow | operating cost | cash flow | operating cost | cash flow | ||||||
Year 0 | -165000 | -4320 | -169320 | -205000 | -4320 | -209320 | -187000 | -4320 | -191320 | -160000 | -4320 | -164320 | -160000 | -4320 | -164320 |
Year 1 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 2 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 3 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 4 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 5 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 6 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 7 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 8 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 9 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 10 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 11 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 12 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 13 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 14 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
Year 15 | 25000 | -4320 | 20680 | 36000 | -4320 | 31680 | 28000 | -4320 | 23680 | 21000 | -4320 | 16680 | 18000 | -4320 | 13680 |
IRR | 9% | 13% | 9% | 6% | 3% | ||||||||||
npv | -864 | -864 | -864 | -864 | -864 | ||||||||||
out flow PV | 165864 | 205864 | 187864 | 160864 | 160864 | ||||||||||
inflow FV | 539464.0897 | 776828.2892 | 604199.78 | 453149.835 | 388414.145 | ||||||||||
1.081800955 | 1.092570932 | 1.08099197 | 1.07148361 | 1.06052867 | |||||||||||
ERR | 8.18 | 9.26 | 8.10 | 7.15 | 6.05 |
Table.1 IRR and ERR calculation with interest rate of 5%
- Selection Criteria
The project will be accepted if ERR> MARR and IRR>0
- Analysis and Comparison of the Alternative
It is clear from the table above that all projects still are getting IRR>0, and projects ERR as following :
Marbat | 6.05 |
Taqa | 7.15 |
Saadah | 8.10 |
Okad | 8.18 |
New Salalah | 9.26 |
- Selection of the Preferred Alternative
Even though the operating cost considered here is around 4320 OMR per year , still New Salalah project is satisfying both IRR>0 and ERR > 8.62 % hence the project is accepted
- 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 and to catch up all incomes and all costs to have rational analyses for your project visibility.
Reference
- PMI-Oman 2014 , W5_AlShehhi_Calculating MARR Using Analytical Hierarchy Methodology, Retrieved on 11.08.2014 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 11.08.2014 from https://pmioman14.wordpress.com/2014/08/02/w9_hassan-albarrami_-irr/
- Iinvestopedia , Internal Rate Of Return – IRR on 11.08.2014 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 11.08.2014 fromhttp://www.planwithintegrity.com/internal-rate-of-return-irr-external-rate-of-return-err-and-what-matters-most/
- PMI-Oman 2014 , W9_Hassan Albarrami_ (ERR), Retrieved on 11.08.2014 from https://pmioman14.wordpress.com/2014/08/07/w9_hassan-albarrami_-err/
- PMI-Oman 2014 , W2.1_Hassan Albarrami_Project location selection, Retrieved on 11.08.2014 from https://pmioman14.wordpress.com/author/sulmanhassan/page/2/
- PMI-Oman 2014 , W11_Hassan Albarrami_ (IRR,ERR,MARR), Retrieved on 11.08.2014 from https://pmioman14.wordpress.com/2014/08/11/w11_hassan-albarrami_-irrerrmarr/
AWESOME…….!!!!! Just doesn’t get any better than this……!!!
Keep up the great work but what I’d really like to see is this same kind of highly professional effort put into getting the weekly report set up and running.
Why? Because once you master the use of applied Earned Value, it becomes VERY easy to adapt the template I’ve given you to your real life projects……
Bottom line- it will be well worth your time and effort to master the use of all the earned value tools……
BR,
Dr. PDG, Jakarta
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