Appraisal of Income Acceleration Projects
Authors: Henry Arthur J. 
Published: December 2007

Here is a review of several unique rate-of-return procedures showing the differences and similarities of each, emphasizing the method that seems the most applicable. A solution is presented that utilizes discrete compounding. Also discussed are various yardsticks for evaluating income acceleration projects.

Introduction

Although rate of return (ROR) has been used for many years in the field of banking and finance, it is still fairly new to industry, having come into rather widespread use in the petroleum industry in the middle and late 1950's. The discounted cash flow (DCF) method was widely adopted as the means of computing ROR, and a definition was adopted to fit the method: "rate of return is that interest rate which causes the present value of cash inflows to equal the present value of investments." While this definition does little to explain the concept of ROR, the method and the definition are applicable to simple cash flow streams consisting of an initial outflow (investment) followed by a series of cash inflows, This should be expected, since the concept originated in the field of finance where a preestablished payback series was keyed to a single investment, or loan.

In industry, however, we are confronted with project cash flow streams that include multiple-period investments, and incremental streams of alternate methods of development or operation. income acceleration projects, particularly, fit into the latter category. particularly, fit into the latter category. Such cash flow streams may contain numerous periods of cash outflows, as well as inflows. Application of the standard DCF method to streams of this type may yield two or more rates of return according to the definition given. This fact has been widely discussed, and has been pointed up by some authors as a significant shortcoming of ROR as an investment yardstick.

An acceleration project is a project undertaken primarily to speed up the rate of income recovery primarily to speed up the rate of income recovery from an existing plant or property. There are, of course, different degrees of acceleration. A project that only accelerates income may be defined as a "pure acceleration" project. In practice, the changes that bring about acceleration usually also result in some additional income through operating-cost savings or increased product recovery, or both. These projects may be termed "partial acceleration" or "acceleration-type" projects. The principles of appraisal for partial acceleration and pure acceleration projects are the same. It should be understood also that the appraisal of an acceleration project is simply the appraisal of two mutually, project is simply the appraisal of two mutually, exclusive alternatives, and the economic considerations involved are identical whether one alternative is an existing project or both alternatives are only in the planning stage. planning stage. A number of authors have presented methods for obtaining a unique ROR, or other related index, for cash flow streams that yield two or more rates by the DCF method. These methods all have in common the use of a preestablished nominal interest rate, generally taken to be the average opportunity reinvestment rate for the investor.

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