Engineering Economy 7th Edition by Leland Blank ,Anthony Tarquin

Exercise 37

Tom, the owner of Burger Palace, determined that his weighted average cost of capital is 8%. He ex­pects a return of 4% per year on all of his invest­ments. A proposal presented by the owner of the Dairy Choice next door seems quite risky to Tom, but is an intriguing partnership opportunity. Tom has determined that the proposal's "risk factor" will require an additional 3% per year return for him to accept it.
a) Use the recommended approach to determine the MARR that Tom should use, and explain how the 3% risk factor is compensated for in this MARR.
b) Determine the effective MARR for his busi­ness if Tom turns down the proposal.