ME 291

Engineering
Economy

ME-291 Engineering
Economy
Lecture 22

Removing Multiple i* Values

Faculty of Mechanical Engineering

Ghulam Ishaq Khan Institute, Topi, Swabi
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 Composite Rate of Return

• The concept of un-recovered balance

becomes important when positive net cash

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flows are generated (thrown off) before the
end of a project.

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• A positive cash flow, once generated,
becomes released as external funds to the
project and is not considered further in any
internal rate of return calculation.
• These positive net cash flows may cause a
non-conventional cash flow series and
multiple i* values to develop.

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 Composite rate of return

• If the funds released from a project are considered in

calculating the overall rate of return of a project, then
there is a way to eliminate the chance of multiple i*

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values.
• One possibility is to assume that the money is

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reinvested at some stated rate, say MARR.
• The rate of earnings used for the released funds is
called the reinvestment rate or external rate of return
and is symbolized by c.
• This rate, established outside the cash flow estimates
being evaluated, depends upon the market rate
available for investment.
• If a company is making, say, 8% on its daily
investments, then c = 8%.
• It is a common practice to set c equal to MARR.

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 Composite rate of return

• The one rate that now satisfies the rate of return

equation is called the composite rate of return (CRR)

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and is symbolized by i’.
• By Definition
The composite rate of return i’ is the unique rate of

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return for a project that assumes that net positive
cash flows, which represent money not immediately
needed by the project, are reinvested at the
reinvestment rate c.
• The term composite is used here to describe this rate
of return because it is derived using another interest
rate, namely, the reinvestment rate c.

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 Reinvestment Rate

• If c happens to equal any one of the i*

values, then the composite rate of return i’

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will equal that i* value.
• The CRR is also known by the term return on

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invested capital (RIC).
• Once the unique i’ is determined, it is
compared to the MARR to decide on the
project’s financial viability.
• The correct procedure to determine i’ is
called the net-investment procedure.

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 Net-Investment Procedure

• The technique involves finding the future

worth of the net investment amount 1 year in

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the future.
• Find the project’s net-investment value Ft in

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year t from Ft-1 by using F/P factor for 1 year
at the reinvestment rate c if the previous net
investment Ft-1 is positive (extra money
generated by project), or at the CRR rate i’ if
Ft-1 is negative (project used all available
funds).

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 Mathematically

• To do this mathematically, for each year t

setup the relation

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Ft = Ft-1 (1 + i ) + Ct
Where t = 1,2,….n

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n = total years in project
Ct = net cash flow in year t
i = c if Ft -1 > 0
i = i’ if Ft-1 < 0

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 Example

Year Cash Flows, $

0 50

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1 -200
2 50

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3 100
The development of F1 through F3 for the cash
flow will be determined, for a reinvestment
rate of c = MARR = 15%.

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 Relation between c, i’, and i*

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 Remember

• This entire net-investment procedure is used

when multiple i* values are indicated.

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• Multiple i* values are present when a non-
conventional series does have one positive

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root, as determined by Norstrom’s criterion.
• Additionally, none of the steps in this
procedure are necessary if the present worth
or annual worth method is used to evaluate a
project at the MARR.

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 Example 7.6

• Compute the composite rate of return for the cash flow

diagram given below, if the reinvestment rate is (a) 7.47%
and (b) the corporate MARR of 20%. The multiple i* values

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are 7.47% and 41.35% (from example 7.4)

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