VIRFIA_ IEC115_U2_CT_2.1.3.1_ VC_P3

Summary

The video demonstrates how to evaluate projects using the internal rate of return (IRR) and the annual-equivalent-cost method. When the IRR is not directly available in financial tables, it can be estimated by interpolation.

General Method

1. Set the annual-equivalent costs equal to the annual-equivalent revenues.
2. Use the project’s life and relevant cash flows to find the interest factor associated with the unknown IRR.
3. If the factor falls between table values, interpolate between the lower and higher rates.
4. Classify the project’s cash-flow pattern:
   • Conventional: An initial cost is followed by net benefits. The project is generally viable when the investor’s required rate is at or below the IRR.
   • Unconventional: Costs and benefits occur in the reverse order, such as receiving income before incurring a large future cost. The relationship between the required rate and viability may be the opposite, so assess the project’s cash flows rather than automatically applying the conventional rule.

Example 1: Industrial-Waste Shredding Machine

The project costs $20,000, lasts 15 years, earns $2,500 per year, and has annual operating costs of $650. Its net annual operating benefit is therefore $1,850.

Using the annual-equivalent method, set the annualized investment cost equal to the annual benefit of $1,850. The resulting factor falls between the table values for 4% and 4.5%. Interpolation gives an IRR of approximately 4.4%.

Because this is a conventional project, it is viable at the investor’s 4% rate, which is below the IRR. It is viable for rates up to approximately 4.4%, but not at higher rates.

Example 2: Port Facilities Rental Contract

The owner receives $7,500 annually for 25 years, then pays $300,000 at the end of year 25 to rebuild the equipment.

This is an unconventional cash-flow pattern: income comes first, followed by a large cost. The future rebuilding cost is converted to an annual equivalent and compared with the annual rental income. Interpolation gives an IRR of approximately 3.71%.

At rates below 3.71%, the annualized rebuilding cost exceeds the rent, resulting in a loss. At 3.71%, the project breaks even; above that rate, the annualized cost falls below the rental income. Thus, the viable range for this reverse-pattern project is at or above 3.71%. At the owner’s stated rate of 8%, the project is profitable.

Speakers and Sources

• Speaker: One unnamed instructional narrator or instructor; no other speakers are identifiable in the subtitles.
• Source: FIA Oficial YouTube channel.
• Other audio: Background music.