PROBLEM DEFINITION
Considering traffic Jam in Jakarta, many of the worker who live at suburb of Jakarta using motorcycle as mean of transportation to office. This situation gives opportunities to develop a business motorcycle rental. I want to see whether this motorcycle rental is economically justified.
DEVELOPMENT OF FEASIBLE ALTERNATIVES
There are several methodologies used to justify whether the investment is justifiable or not. One of them is by measuring the Internal Rate of Return (IRR) and Minimum Acceptance Rate of Return (MACC).
DEVELOPMENT OF OUTCOMES FOR EACH ALTERNATIVE
The rule is if IRR ≥ MARR, the investment is economically justified. In this case, MARR is determined 5 % per month. The duration of the investment is 1 year.
SELECTION OF CRITERIA
MARR (Minimum Acceptance Rate of Return).
Considering that “ I can invest the total cost for Investment below to Bank” as an options. So The MARR will be based on this assumption.
Investment Expected Return can be calculated based on below equation.
RS-RF = β (RM-RF),
where
RS = Expected Return
RF = Risk Free Rate of Investment
RM = Return of Marker as a whole
RM – RF = Market Premium
Β = Beta of Stock
Equation 1. Expected Return
This exercise considering below assumption:
Risk Free (RF) = fixed interest deposits rate (Bank Mandiri) = 5.13 % / year
Market Premium (RM-RF) = 8.5% ()
Beta of Stock = 1.5
RS = RF+ β (RM-RF)
RS = 5.13% +1.5 (8.5%) = 17.88%
MARR = RS = 17.88%
IRR (Internal Rate of Return).
Figure 1. Cost of Investment for an a year
Figure 2. Revenue of One year + Salvage Value
Figure 3. Cashflow for one year considering the IRR
ANALYSIS FOR THE ALTERNATIVES
IRR is reached when Total NPV = 0.
Figure 4. IRR = NPV=zero
| NPV = PV1 + PV2 + PV3 + PVn…Equation 1. Net Present Value | PV = C / (1 + i)^nEquation 2. Present Value |
| IRR = NPV = 0,Equation 3. Interest Rate of Retun | WherePV = Present ValueNPV = Net Present ValueIRR = Interest Rate of Return
I = interest rate N = number of time |
Folllowing the equation above, it’s clear that NPV is function of interest rate (i) and number (n) inversely. This also represented in the graphic when interest rate increase, NPV is decrease. In one point where NPV = 0, it’s interest rate is the IRR.
According to IRR 30,01% > MARR 17.88%, this investment is economically justified.
SELECTION ON THE PREFERRED ALTERNATIVES
The investement is economically justified for investment according to IRR 30.01 % > MARR 17.88%. The margin of IRR – MARR = IDR 4,324K.
PERFORMANCE MONITORING AND POST EVALUATION RESULT
IRR determination is based on cash flow. Higher income, lower cost would result higger IRR.
REFERENCES
Investovedia.(2013).Internal Rate of Return.Access September 27, 2013 from
http://www.investopedia.com/terms/i/irr.asp
Princeton University.(2013).Internal Rate of Return.Access September 27, 2013 from
http://www.princeton.edu/~achaney/tmve/wiki100k/docs/Internal_rate_of_return.html
Investodia.(2013).How to calculate Required Rate of Return.Access October 1, 2013 from
http://www.investopedia.com/articles/fundamental-analysis/11/calculating-required-rate-of-return.asp
Kontan.(2013).Suku Bunga Keuangan.Access.October1,2013 from.
http://pusatdata.kontan.co.id/bungadeposito/
REALLY SORRY Pak Sutoyo for having to reject this posting because your CASE STUDY is an excellent one and the analysis you did was good.
The ONLY reason I am rejecting your posting this week is because you didn’t explain or justify WHERE you came up with the 5% MARR?
BEFORE you fix this report (which should only take you 15 minutes) turn to pages 179-180,309-310,453 and 526-533. Once you can justify or explain how or why you chose the MARR you did, I will be happy to give you 5 stars for what was an otherwise very well done blog posting!!
BR,
Dr. PDG, Jakarta
Pak Paul,
Thank you very much for the guidance. I already update the blog posting following your guidance. The way I made the MARR is based on the Page 528 where expected Return is a function of Free Risk Market investment rate, beta stock rate, and Market premium Rate.
BR,
Sutoyo Saragih