Minimum acceptable rate of return

From Wikipedia, the free encyclopedia

This article does not cite any references or sources. (December 2007)
Please help improve this article by adding citations to reliable sources. Unverifiable material may be challenged and removed.

This article or section needs to be wikified to meet Wikipedia's quality standards.
Please help improve this article with relevant internal links. (December 2007)

In business and engineering, the Minimum Acceptable Rate of Return, often abbreviated MARR, is the minimum return on a project a manager is willing to accept before starting a project, given its risk and the opportunity cost of foregoing other projects^[1]. (A synonym seen in many contexts is Minimum Attractive Rate of Return.)

For example, suppose a manager knew that investing in a conservative project, such as a bond investment or another project with no risk, yields a known rate of return. When analyzing a new project, the manager may use the conservative project's rate of return as the MARR. The manager will only implement the new project if its anticipated return exceeds the MARR by at least the risk premium of the new project.

1 Project Analysis
2 Typical Values
3 Notes
4 See also

[edit] Project Analysis

When a project has been proposed, it must first go through a preliminary analysis in order to determine whether or not it has a positive Net present value using the MARR as the discount rate^[2]. The MARR is the target rate for evaluation of the project investment. This is accomplished by creating a cash flow diagram for the project, and moving all of the transactions on that diagram to the same point, using the MARR as the interest rate. If the resulting value at that point is zero or higher, then the project will move on to the next stage of analysis. Otherwise, it is discarded. The MARR generally increases with increased risk.

[edit] Typical Values

The MARR is often decomposed into the sum of following components (range of typical values shown)^[3]:

Traditional inflation-free rate of interest for risk-free loans: 3-5%
Expected rate of inflation: 5%
The anticipated change in the rate of inflation, if any, over the life of the investment: Usually taken at 0%
The risk of defaulting on a loan: 0-5%
The risk profile of a particular venture: 0-50% and higher

[edit] Notes

^ Park, Chan S. (2007). Contemporary Engineering Economics (4th Edition). Prentice Hall, 216. ISBN 0-13-187628-7.
^ Park, Chan S. (2007). Contemporary Engineering Economics (4th Edition). Prentice Hall, 216. ISBN 0-13-187628-7.
^ Lang, Hans J.; Merino, Donald N. (1993). The selection process for capital projects. New York: J. Wiley & Sons. ISBN 978-0-471-63425-6.