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:
- 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.
- 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:
- The amount of money available for investment, and the source and cost of these funds.
- The number of good projects available for investment.
- 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.
- The type of organization involved.
- Market assessment.
The following calculation will help you to illustrate how to calculate MARR.
Finally top management decide to apply MARR = 19.7%
- 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)