Page 308 - Analysis, Synthesis and Design of Chemical Processes, Third Edition
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When comparing mutually exclusive investment alternatives, choose the alternative with the
greatest positive net present value.
When carrying out an incremental investment analysis on projects that are mutually exclusive, the
following four-step algorithm is recommended:
Step 1: Establish the minimum acceptable rate of return on investment for such projects.
Step 2: Calculate the NPV for each project using the interest rate from Step 1.
Step 3: Eliminate all projects with negative NPV values.
Step 4: Of the remaining projects, select the project with the highest NPV.
10.4 Establishing Acceptable Returns from Investments: The Concept of Risk
Most comparisons of profitability will involve the rate of return of an investment. Company management
usually provides several benchmarks or hurdle rates for acceptable rates of return that must be used in
comparing alternatives.
A company vice president (VP) has been asked to recommend which of the following two alternatives to
pursue.
Option 1: A new product is to be produced that has never been made before on a large scale. Pilot plant
runs have been made, and the products sent to potential customers. Many of these customers have
expressed an interest in the product but need more material to evaluate it fully. The calculated return on
the investment for this new plant is 33%.
Option 2: A second plant is to be built in another region of the country to meet increasing demand in the
region. The company has a dominant market position for this product. The new facility would be similar
to other plants. It would involve more computer control, and attention will be paid to meeting pending
changes in environmental regulations. The rate of return is calculated to be 12%.
The recommendation of the VP and the justifications are given below.
Items that favor Option 1 if pursued:
• High return on the investment
• Opens new product possibilities
Items that favor Option 2:
• The market position for Option 2 is well established. The market for the new product has not been
fully established.
• The manufacturing costs are well known for Option 2 but are uncertain for the new process
because only estimates are available.
• Transportation costs will be less than current values due to the proximity of plant.
• The technology used in Option 2 is mature and well known to us. For the new process there is no
guarantee that it will work.
The closing statement from the VP included the following summary:
