W7_ANG_MARR based on full equity fund for Student Pick-up Service


Problem Statement

For the follow up of CfH comment about my Week 5th Blog posting, in this posting I will discuss about the value of Minimum Attractive Rate of Return (MARR) as our basis to determine whether the projected rate of return of having student pick up service business is attractive enough to be proceeded or not.

In this posting the determination of MARR is based on an assumption that the investment is fully funded by equity of personal investor. For the next blog posting, I plan to put assumption that the fund will be mixed between equity and debt (borrowed fund) to discuss about the Weighted Average Cost of Capital (WACC).

Feasible Alternatives

As personal investor, we have some limited alternative investments, considered low risk is like state bonds, bank deposits, and gold deposits and for the one considered high risk is like paper equity stocks.

Investors commonly expect to have projected rate of return in line with risk of investment they face. The more risk they have, the more rate of return they expect. Considering that, the writer use Capital Asset Pricing Model (CAPM) as the basis here to determine MARR and take beta value from the listed company that has similar business/ risk with Student Pick-Up Service.

Outcomes/ Calculations

Based on equation on page 527 of Engineering Economy book


where     R is the CAPM return depends upon its risk relative to the market

    RF is the risk free rate

    βS is the level of market risk

    RM is the market return

Refer to Trading Economic, BI rate that associated as risk free rate in Indonesia is 7.25%.

Refer to Country Default Spreads and Risk Premium update January 2013 that published at website: www.stern.nyu.edu, the Risk Premium in Indonesia is 8.8%

Refer to similar type business (Cipaganti Travel) in Jakarta Stock Exchange, the Beta ratio of transportation sector is 0.6

So then the cost of equity reflected by the risk of the business is

= 7.25% + 0.6 * 8.8% = 12.53%

MARR Before Tax = MARR After Tax / (1 – Tax Rate)

Maximum Progressive Income Tax is 30%

So then MARR Before Tax
= 12.53% / (1 – 30%) = 17.9%

Setting Minimum/ Selection Criteria

Traditionally workers who has no side business just put their money in bank deposit which is the interest is very low, only max 5.25% (today rate).

That bank deposit rate of return, even cannot cover the inflation rate of Indonesia: 8.40%

Analysis/ Comparison of the Alternatives against the Criteria

In my week 5th blog posting, the value of MARR: 15% was only based on my assumption/ feeling.

Based on above calculation acceptable rate of return 15% is enough to compare with opportunity of bank deposit and able to cover the inflation rate. But it is NOT enough to cover the risk based on CAPM and income tax.

Selection of the Best/ Preferred Alternative Compared against the Criteria

The justified calculation for minimum acceptable rate of return value based on above is 17.9%

Performance Monitoring and Post Evaluation of Result/ Follow up Assessment

Based on my week 5th blog posting, the pessimistic rate of return for student pick-up service is 18.26%.

It is slightly higher than MARR: 17.9%. So this projected business is justified to be proceeded.

References :

  1. Sullivan, William G., Wick, Elin M., Koelling, C. Patric. (2012), Engineering Economy. 15th ed. Chapter 14: Decision Making Considering Mutiattributes, page 551-573, USA: Pearson Higher Education, Inc.
  2. Amos, Scott PE. (2012), Skill & Knowledge of Cost Engineering. 5th ed., USA: AACE International.
  3. Humphreys, Gary C. (2002), Project Management Using Earned Value. 2nd ed., USA: Humphreys & Associates, Inc.
  4. Taborda, Joana (2013). Bank Indonesia Keeps BI rate On Hold at 7.25% . [ONLINE] Available at: http://www.tradingeconomics.com/indonesia/interest-rate. [Last Accessed 24 October 2013].
  5. Damodaran, Aswath (2013). Country Default Spreads and Risk Premiums. [ONLINE] Available at: http://pages.stern.nyu.edu/~%20adamodar/New_Home_Page/datafile/ctryprem.html. [Last Accessed 24 October 2013].
  6. (2013). Cipaganti Citra Graha Tbk PT (CPGT.JK). [ONLINE] Available at: http://www.reuters.com/finance/stocks/financialHighlights?symbol=CPGT.JK. [Last Accessed 24 October 2013].
  7. (2013). Pajak Penghasilan Orang Pribadi Untuk Keadilan. [ONLINE] Available at: http://www.pajak.go.id/content/pajak-penghasilan-orang-pribadi-untuk-keadilan. [Last Accessed 24 October 2013].
  8. (2013). Suku Bunga PT. Bank Mandiri (Persero) Tbk. Berlaku Mulai Tanggal 19 September 2013 Deposito Rupiah. [ONLINE] Available at: http://www.bankmandiri.co.id/resource/bunga_02122011.asp. [Last Accessed 24 October 2014].
  9. (2013). Indonesia Inflation Rate. [ONLINE] Available at: http://www.tradingeconomics.com/indonesia/inflation-cpi. [Last Accessed 24 October 2013].
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2 Comments

Filed under Anggono M, Week 07

2 responses to “W7_ANG_MARR based on full equity fund for Student Pick-up Service

  1. MUCH BETTER, Pak Anggono!!! Nice work on your revisions!!!

    Given your position with SSK MIGAS, it is very important that you know and understand this because I am very concerned that the Indonesian government is OFFICIALLY using 10% and I can only urge you to review Ibu Lita’s paper to see what those numbers SHOULD be for offshore oil and gas. Using 10% is resulting in projects being undertaken which never should even be considered, given their inherent risk.

    Which leads me to note that while your calculations were adequate for this case study, (You did miss COUNTRY RISK in your calculations) I am concerned about your citations…(Which is why you only got 4 instead of 5 stars)

    Why didn’t you cite the work of Ibu LIta? Her paper is REALLY something special and it has been accepted for presentation by AACE in Bangkok and New Orleans next year. I believe that paper has been shared with you early on in the course? And you already have the link to her blog postings….? So given her world class effort, why didn’t you cite her?

    Also, I have no clue how or why you cited Chapter 14 in Engineering Economy but missed pages 179-180, (Chapter 5); pages 309-310; (Chapter 7); page 453 (Chapater 11); and pages 530-533 (Chapter 13)?

    IF you had cited your work appropriately you could have claimed CREDIT for at least one of the problems from each of these chapters.

    Suggest that for FUTURE postings, you pay closer attention to your REFERENCES and be sure they back up what you are saying in your blog. To not back up your opinions puts you at risk of having them challenged.

    Be sure to review Ibu Lita’s paper and include ALL the risk adjustments in any future blog postings on this topic…..

    BR,
    Dr. PDG, Jakarta

  2. Dear Doc,

    I’ve just read Lita’s blog posting week 6th that state “Currently Government of Indonesia (GoI) is using 10% as hurdle rate to evaluate all upstream projects. Prior to get approval from GoI, production sharing contractor evaluates the project based on their own hurdle rate.”

    I can say that actually what she stated above is INCORRECT.

    The way we evaluate the approval of POD (Plan of Development) is different, It may be because of the term of cost recovery in PSC contract (Sharing Risk between GOI and PSC). Based on PTK/Guidelines POD, the economic criteria of the approval is based on NET % GOI take from Gross revenue. We usually set the minimum net percentage of GOI is at least 35% of the gross revenue.
    For example: Oil Net Income share scheme is 60% for GOI and 40% for PSC. PSC must maintain all cost (CAPEX and OPEX) not more than 41.6% of Gross Revenue ( 35%GrossRevenue = [100%GrossRevenue – CostRecovery] * 60% )
    That’s why PSC need to have our approval for Work Program & Budget (WP&B) and Approval for Expenditure (AFE). Those are ones of our instruments to control the cost for cost recovery.

    Regards,
    Anggono

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