Rate Of Return Must We Bother?

Abstract

Rate of return (ROR) is a widely accepted criterion for determining the economic viability of an engineering project or other investment alternative. Similarly, incremental rate of return (IROR) is often used to choose the best alternative among several. Accordingly, most engineering economy textbooks provide appreciable instruction in ROR and IROR applications, often covering one or two chapters of text. As a result, computation of the ROR is certainly within the grasp of most engineering economy students. Even so, the underlying methodologies of ROR assessment and IROR selection are computationally more difficult than other economic methods, and results can be ambiguous, indeterminate and, unless used with care, misinterpreted. For example, students will often apply, without discernment, the oft-quoted decision rule, "If the ROR > MARR, accept the alternative …" and they are sometimes wrong. Since our engineering economic textbooks offer such a variety of topics, it begs the question "How much ROR (and IROR) instruction is necessary and truly beneficial for the undergraduate engineering student?" This paper explores possible answers to that question and its more pointed companion, "ROR-Must We Bother?" Advantages and potential disadvantages (and disbenefits) of "staying the course" with the current ROR/IROR emphasis are considered. Alternatively, a more innovative trail is suggested that seeks a better balance between engineering economy fundamentals and (applied) economic decision analysis.