The first step in the solution of this example problem is to determine the

amount of money saved per year for each design, from which the annual percent
return on the initial investment can be determined. The net annual savings
equals the value of heat saved minus the sum of the operating costs and fixed
charges; thus,
For design No. 1,
Annual savings = 4100 - (0.2)(10,000) - 100 = $2000
Annual percent return = (2000/10,000)(100) = 20%
For design No. 2,
Annual savings = 6000 - (0.2)(16,000) - 100 = $2700
Annual percent return = 16(100) = 16.9%
Because the indicated percent return for each of the four designs is above
the minimum of 10 percent required by the company, any one of the four
designs would be acceptable, and it now becomes necessary to choose one of the
four alternatives.
ALTERNATIVE ANALYSIS BY METHOD OF RETURN ON INCREMENTAL INVESTMENT.
Analysis by means of return on incremental investment is accomplished
by a logical step-by-step comparison of an acceptable investment to another
which might be better. If design No. 1 is taken as the starting basis, comparison
of design No. 2 to design No. 1 shows that the annual saving of $2700 - $2000 = $700
results by making an additional investment of $16,000 - $10,000 = $6,000.
Thus, the percent return on the incremental investment is (700/6000)(100) = 11.7
percent, and design No. 2 is acceptable by company policy in preference to
design No. 1. This logical procedure results in the following tabulation and the
choice of design No. 2 as the final recommendation:
Design No. 1 is acceptable.
Comparing design No. 1 to design No. 2, annual percent return
= (700/6000)(100) = 11.7 percent. Thus, design No. 2 is acceptable and is preferred
over design No. 1.
Comparing design No. 2 to design No. 3, annual percent return
= (100/4000)(100) = 2.5 percent. Thus, design No. 3 compared to design No. 2 shows
That the return is unacceptable and design No. 2 is preferred.
Comparing design No. 2 to design No. 4, annual percent return
= (850/10000)(100) = 8.5 percent. Thus, design No. 4 is not acceptable when compared
to design No. 2, and design No. 2 is the alternative that should be recommended.