W7_RW_How to Determine WACC and MARR


Problem Statement

When startup the business, the company has to know what is the MARR (minimum Attractive of return) as a baseline of expected return of investment.

How to determine the WACC and MARR ?

Project Evaluation Techniques used:

  1. Determine WACC (Weighted Average Cost of Capital) : It is important to know the cost of capital, that may come from debt and equity of whatever source of fund.
  2. Determine MARR (Minimum Attractive of Return): It is important to know what is his company’s MARR, i.e. what is the minimum expectation of % attractive of return that would be accepted for the project to be executed, from the meeting he decided to go if the MARR is 20%/year.

Determine WACC:  recognize the source of fund of capital, it may source from Equity partners, stockholders, bondholders, banks and venture capitalists, those sources are expect the returns on their investment. They expected returns are cost for the lender. Below is the example how to calculate the WACC which the capital sources came from the banks which loan interest is 10.3% per annum, if the company also issues the shares then the cost of equity also should be counted, beside that the tax rate is part of the cost of capital.

Determine MARR:  the top management of the organization decided the MARR  evaluate following but not limited to following:

  1. The amount of money available for investment, and the source and cost of these funds.
  2. The number of good projects available for investment.
  3. The amount of perceived risk associated with investment opportunities available to the company and estimated cost of administering project over short plan and long term planning.
  4. The type of organization involved.
  5. Market assessment.

The following calculation will help you to illustrate how to calculate MARR.

Finally top management decide to apply MARR = 19.7%

Reference:

  1. Sullivan William. Wicks M, Elin. Koelling C, Patrick. (2009) Engineering Economic, Fifteenth edition. Pearson International Edition, 2012. (chapter 5 p.180, chapter 13 p.529)
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3 thoughts on “W7_RW_How to Determine WACC and MARR

  1. Hmmmm….. Park Ridwan not one of your better postings……. Certainly not up to your usual standard….. :-(

    Excellent topic and nicely written…… BUT your citations in support of your numbers was weak on this one……. And what about Step 7 Monitoring and Controlling? How would you go about tracking to see if your assumptions were correct. Maybe a MARR of 19.7% is too high? Or too low? How will you know this unless you have a plan to follow up and measure it?

    Where did you come up with the 10.3% Average Corporate Loan Interest value? The source of that data of interest not only me but to others on your team as well. You need to cite that piece of information

    And while you referenced page 529 from Sullivan, what about pages 526 to 533? Didn’t you use the quote “WACC merely establishes the floor of the MARR” which comes from page 531? As you are well along in writing your paper and getting close to running VIPER, you need to be VERY careful that you cite anything you used which came from other sources. VIPER http://www.scanmyessay.com/ (free) and the program AACE uses, “Check for Plagiarism” http://www.checkforplagiarism.net/ ($20.00) are both VERY good at picking up plagiarism.

    Also, your numbers on project administration and project risk seem low to me. If you look at RS Means, project overhead runs on average 16%. And the oil and gas companies tend to be heavy on overheads. (Not only management but SHE especially adds significantly) It would really be great if you could find some references to back up your overhead and risk values, and I think you will find you are probably closer to 25% to 30% in total.

    Bottom line- while your approach was appropriate, (with the exception of Step 7) your citations and use of unsupported values dragged down what was otherwise an excellent posting.

    I am sure your next posting will be back up to your usual standard…….!!!! (And hope both you and your daughter are getting better!!)

    BR,
    Dr. PDG, Jakarta

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