ASTM E1057-06(2010)

Standard Practice for Measuring Internal Rate of Return and Adjusted Internal Rate of Return for Investments in Buildings and Building Systems

SIGNIFICANCE AND USE
The IRR method has been used traditionally in finance and economics to measure the percentage yield on investment.
The IRR method is appropriate in most cases for evaluating whether a given building or building system will be economically efficient, that is, whether its time-adjusted benefits will exceed its time-adjusted costs over the period of concern to the decision maker. However, it has deficiencies that limit its usefulness in choosing among projects competing for a limited budget.
The AIRR method is a measure of the overall rate of return that an investor can expect from an investment over a designated study period. It is appropriate both for evaluating whether a given building or building system will be economically efficient and for choosing among alternatives competing for a limited budget.
The AIRR method overcomes some, but not all, of the deficiencies of the IRR. The AIRR is particularly recommended over the IRR for allocating limited funding among competing projects.
SCOPE
1.1 This practice covers a procedure for calculating and interpreting the internal rate of return (IRR) and adjusted internal rate of return (AIRR) measures in the evaluation of building designs, systems, and equipment.

General Information

• Status: Historical
• Publication Date: 30-Sep-2010
• ICS: 91.010.20 - Contractual aspects
• Technical Committee: E06 - Performance of Buildings
• Drafting Committee: E06.81 - Building Economics

Relations

• Replaces: ASTM E1057-06e1 - Standard Practice for Measuring Internal Rate of Return and Adjusted Internal Rate of Return for Investments in Buildings and Building Systems
• Effective Date: 01-Oct-2010
• Replaced By: ASTM E1057-15 - Standard Practice for Measuring Internal Rate of Return and Adjusted Internal Rate of Return for Investments in Buildings and Building Systems
• Effective Date: 01-May-2015
• Referred By: ASTM E1557-09(2020)e1 - Standard Classification for Building Elements and Related Sitework—UNIFORMAT II
• Effective Date: 01-Oct-2010
• Referred By: ASTM E1074-15(2020)e1 - Standard Practice for Measuring Net Benefits and Net Savings for Investments in Buildings and Building Systems
• Effective Date: 01-Oct-2010
• Referred By: ASTM E1121-15(2020)e1 - Standard Practice for Measuring Payback for Investments in Buildings and Building Systems
• Effective Date: 01-Oct-2010
• Referred By: ASTM E1765-16(2023) - Standard Practice for Applying Analytical Hierarchy Process (AHP) to Multiattribute Decision Analysis of Investments Related to Projects, Products, and Processes
• Effective Date: 01-Oct-2010
• Referred By: ASTM E2204-15(2020)e1 - Standard Guide for Summarizing the Economic Impacts of Building-Related Projects
• Effective Date: 01-Oct-2010
• Referred By: ASTM E3130-21 - Standard Guide for Developing Cost-Effective Community Resilience Strategies
• Effective Date: 01-Oct-2010
• Referred By: ASTM E1369-15(2020)e1 - Standard Guide for Selecting Techniques for Treating Uncertainty and Risk in the Economic Evaluation of Buildings and Building Systems
• Effective Date: 01-Oct-2010
• Referred By: ASTM E3200-21 - Standard Guide for Investment Analysis in Environmentally Sustainable Manufacturing
• Effective Date: 01-Oct-2010
• Referred By: ASTM E2103/E2103M-19 - Standard Classification for Bridge Elements—UNIFORMAT II
• Effective Date: 01-Oct-2010
• Referred By: ASTM E2506-15(2020)e1 - Standard Guide for Developing a Cost-Effective Risk Mitigation Plan for New and Existing Constructed Facilities
• Effective Date: 01-Oct-2010
• Referred By: ASTM E964-15(2020)e1 - Standard Practice for Measuring Benefit-to-Cost and Savings-to-Investment Ratios for Buildings and Building Systems
• Effective Date: 01-Oct-2010
• Referred By: ASTM E3008/E3008M-16(2023) - Standard Classification for Transportation Surface Elements—UNIFORMAT II
• Effective Date: 01-Oct-2010
• Referred By: ASTM E917-17(2023) - Standard Practice for Measuring Life-Cycle Costs of Buildings and Building Systems
• Effective Date: 01-Oct-2010

Standards Content (Sample)

NOTICE: This standard has either been superseded and replaced by a new version or withdrawn.
Contact ASTM International (www.astm.org) for the latest information
Designation: E1057 − 06(Reapproved 2010)
Standard Practice for
Measuring Internal Rate of Return and Adjusted Internal
Rate of Return for Investments in Buildings and Building
Systems
This standard is issued under the fixed designation E1057; the number immediately following the designation indicates the year of
original adoption or, in the case of revision, the year of last revision.Anumber in parentheses indicates the year of last reapproval.A
superscript epsilon (´) indicates an editorial change since the last revision or reapproval.
INTRODUCTION
The internal rate-of-return (IRR) and adjusted internal rate-of-return (AIRR) methods are members
of a family of economic evaluation methods that provide measures of economic performance of an
investmentovertime.Othermethodsinthisfamilyofevaluationmethodsarelife-cyclecostanalysis,
net benefits and net savings analysis, benefit-to-cost and savings-to-investment ratio analysis, and
payback analysis.
The IRR andAIRR methods are the topic of a single standard practice because they both measure
economic performance as a compound yield on investment.The IRR is the compound rate of interest
that,whenappliedasadiscountratetoaproject’sstreamofdollarbenefitsandcosts,willequatethem.
The AIRR is the overall yield taking into account earnings on receipts reinvested to the end of the
study period.The IRR orAIRR is compared against the investor’s minimum acceptable rate of return
(MARR), and the investment is considered economically attractive if the calculated yield exceeds the
MARR. If an investment entails an initial outlay and a single receipt at the end of the study period,
there is no difference between the IRR and the AIRR. But if cash flows occur over multiple time
periods, the two will normally be different. This arises because theAIRR includes in its measure the
return on reinvestment of receipts, whereas the IRR does not.
The AIRR is recommended for most applications in which a measure of yield is desired. Caution
is recommended in applying either measure, however, because problems arise under certain
conditions.
1. Scope E917Practice for Measuring Life-Cycle Costs of Buildings
and Building Systems
1.1 This practice covers a procedure for calculating and
E964Practice for Measuring Benefit-to-Cost and Savings-
interpreting the internal rate of return (IRR) and adjusted
to-Investment Ratios for Buildings and Building Systems
internal rate of return (AIRR) measures in the evaluation of
E1074Practice for Measuring Net Benefits and Net Savings
building designs, systems, and equipment.
for Investments in Buildings and Building Systems
E1121Practice for Measuring Payback for Investments in
2. Referenced Documents
2 Buildings and Building Systems
2.1 ASTM Standards:
E1185Guide for Selecting Economic Methods for Evaluat-
E631Terminology of Building Constructions
ing Investments in Buildings and Building Systems
E833Terminology of Building Economics
E1369Guide for Selecting Techniques for Treating Uncer-
tainty and Risk in the Economic Evaluation of Buildings
and Building Systems
This practice is under the jurisdiction of ASTM Committee E06 on Perfor-
mance of Buildings and is the direct responsibility of Subcommittee E06.81 on
E1765Practice for Applying Analytical Hierarchy Process
Building Economics.
(AHP) to Multiattribute DecisionAnalysis of Investments
Current edition approved Oct. 1, 2010. Published November 2010. Originally
ε1
Related to Buildings and Building Systems
approved in 1985. Last previous edition approved in 2006 as E1057–06 . DOI:
10.1520/E1057-06R10.
E1946Practice for Measuring Cost Risk of Buildings and
For referenced ASTM standards, visit the ASTM website, www.astm.org, or
Building Systems and Other Constructed Projects
contact ASTM Customer Service at [e-mail]. For Annual Book of ASTM
E2204Guide for Summarizing the Economic Impacts of
Standards volume information, refer to the standard’s Document Summary page on
the ASTM website. Building-Related Projects
Copyright © ASTM International, 100 Barr Harbor Drive, PO Box C700, West Conshohocken, PA 19428-2959. United States
E1057 − 06 (2010)
2.2 ASTM Adjuncts: concerntothedecisionmaker.However,ithasdeficienciesthat
Discount Factor Tables, Adjunct to Practices E917, E964, limit its usefulness in choosing among projects competing for
E1057, E1074, and E1121 a limited budget.
5.2 The AIRR method is a measure of the overall rate of
3. Terminology
return that an investor can expect from an investment over a
3.1 Definitions—For definitions of terms used in this
designated study period. It is appropriate both for evaluating
practice, refer to Terminologies E631 and E833.
whether a given building or building system will be economi-
cally efficient and for choosing among alternatives competing
4. Summary of Practice
for a limited budget.
4.1 This practice is organized as follows:
5.2.1 TheAIRRmethodovercomessome,butnotall,ofthe
4.1.1 Section 1, Scope—Identifies coverage.
deficiencies of the IRR. The AIRR is particularly recom-
4.1.2 Section 2, Applicable Documents—Lists ASTM stan-
mended over the IRR for allocating limited funding among
dards that are referenced.
competing projects.
4.1.3 Section 3, Terminology—Addresses definitions of
terms.
6. Procedure
4.1.4 Section 4, Summary of Practice—Outlines the con-
6.1 The recommended steps for applying the IRR or the
tents.
AIRR method to an investment decision are summarized as
4.1.5 Section 5, Significance and Use—Explains the rel-
follows:
evance of the IRR and AIRR and indicates their appropriate
6.1.1 Identify objectives, constraints, and alternatives.
uses.
6.1.2 Compile data and establish assumptions.
4.1.6 Section 6, Procedure—Summarizes the steps in IRR
6.1.3 Compute IRR orAIRR based on a comparison of two
and AIRR analysis.
alternatives (one of which may be to do nothing).
4.1.7 Section 7, Objectives, Constraints, and Alternatives—
6.1.4 Compare the computed IRR or AIRR against the
Discusses the first step in an analysis, that is, the identification
MARR to determine the acceptability of the alternative with
of the objectives of the analysis, any constraints that must be
the higher investment cost.
taken into account in finding a solution, and technically
6.1.5 Ifalimitedbudgetistobeallocatedamongcompeting
feasible project alternatives.
alternatives, select alternatives in descending order of their
4.1.8 Section 8, Data and Assumptions—Discusses the sec-
IRR or AIRR measures until the budget is exhausted.
ondstepinananalysis;thatisthedataandassumptionsthatare
6.1.6 Report the results.
typically required for calculating the IRR and AIRR, and, in
particular, the requirement of the AIRR for specification of a
7. Objectives, Constraints, and Alternatives
reinvestment rate.
4.1.9 Section 9, IRR Calculation—Describes the third step, 7.1 Specify clearly the objective of the economic analysis.
performing calculations, as it applies to the IRR.
7.1.1 Suppose, for example, an individual or organization
4.1.10 Section 10, AIRR Calculation—Describes the third hasfundsonhandtoinvestinrealestateprojects.Theproblem
step, performing calculations, as it applies to the AIRR. is which projects to choose from potential candidates. The
4.1.11 Section 11, Choosing Between the IRR and AIRR— objectiveoftheeconomicanalysisinthiscaseistoidentifythe
Discusses how to choose between the IRR and the AIRR. project or set of projects within the budget that is expected to
4.1.12 Section 12, Limitations—Discusses limitations and maximize profits over the long run.
shortcomings of the IRR and AIRR.
7.2 Identify any constraints that narrow the field of candi-
4.1.13 Section 13, Analysis of IRR or AIRR Results and the
dates.
Decision—Discussesthedecisioncriterionandthetreatmentof
7.2.1 Constraints, for example, might include a budget of
uncertainty, risk, and unqualified effects.
$1000000; a geographical limitation to buildings located
4.1.14 Section 14, Applications—Describes the types of
within 100 km from downtown; and a strong preference for
decisions to which the IRR and AIRR are applicable.
nonresidential property.
4.1.15 Section 15, Report—Identifies information that shall
7.3 Identify feasible alternatives.
be included in a report of an IRR or AIRR application.
7.3.1 Feasible alternatives include an office building in the
5. Significance and Use suburbs costing $1000000; convenience shopping strips in
nearby towns costing a total of $900000; two medical/dental
5.1 The IRR method has been used traditionally in finance
offices costing $500000 each; and a $1000000 investment
and economics to measure the percentage yield on investment.
share in a downtown shopping complex.
5.1.1 The IRR method is appropriate in most cases for
evaluating whether a given building or building system will be
8. Data and Assumption
economically efficient, that is, whether its time-adjusted ben-
efits will exceed its time-adjusted costs over the period of 8.1 To calculate the IRR or AIRR, data are needed.
8.2 Benefit and cost data that are often relevant when
calculating the IRR or AIRR are revenues, resale or salvage
Available from ASTM International Headquarters. Order Adjunct No.
ADJE091703. value, subsidies (for example, grants), and costs of planning,
E1057 − 06 (2010)
design,engineering,construction,purchase,installation,opera- graphical approach, and an approach that uses simple payback
tion and maintenance, utilities, and repairs and replacement. and uniform present value (UPV) factor tables. (See Practice
E1121 for a description of payback and the Adjunct on
8.3 The time of occurrence of each benefit and cost is also
Discount Factor Tables for UPV factors.)
needed.
9.2.1 Trial and Error Solution:
8.4 Taxes such as tax credits, property taxes, and income
9.2.1.1 The trial-and-error approach to calculating the IRR
taxes are also often relevant because they affect benefits and
entails choosing a trial rate of interest that is expected
costs. If benefits and costs are adjusted for taxes, the IRR or
approximately to balance benefits and costs over the project
AIRR measure gives the after-taxrate of return.
studyperiod.Thenpresentvaluecalculationsaremadeforthat
8.5 If the terms of financing are unique to each alternative,
trial rate. (For an illustration of discounting calculations, see
financingcosts(andassociatedtaxeffects)shouldalsobetaken
Practice E917.) If the PVNB is zero, then the trial rate is the
into account.
solution value of the internal rate of return. If the PVNB is
negative,thetrialrateistoohigh,andasecond,lowertrialrate
8.6 Choose a minimum acceptable rate of return (MARR)
is then used. If the PVNB is positive for the original trial rate,
for comparison against the calculated IRR or AIRR.
8.6.1 The appropriate MARR indicates the investor’s op- then the IRR is higher than the trial rate, and a second, higher
trial rate is used. When two trial rates are found such that one
portunity cost of foregoing the return on the next best invest-
ment opportunity in order to invest in the project in question. yields a PVNB greater than zero and the other a PVNB less
than zero, the IRR lies between those rates and can be
8.7 If the AIRR is used, a reinvestment rate is needed.
approximated by interpolation, provided the investment has a
8.7.1 The reinvestment rate is usually set equal to the
unique IRR. Considerable time is saved in the trial-and-error
MARR; hence, it equals the discount rate. This is because the
approach if the first trial rate is close to the true rate. One
reinvestmentrateisanindicatoroffutureopportunitycost,and
approach is to start with the MARR as the trial rate. If the
that is also the purpose of the discount rate. Setting the
PVNB is negative with the MARR, then the project is not
reinvestment rate and the discount rate equal makes the
economically feasible, and no further calculations are neces-
reinvestment rate assumption in the AIRR method consistent
sary.IfthePVNBispositive,thenselecthighertrialratesinan
withthereinvestmentrateassumptionthatisimplicitinthenet
attempt to bound the true rate.
benefits (net savings) method (Practice E1074).
9.2.1.2 The UPV factor tables are useful in finding a trial
9. IRR Calculation
rate. The first step is to sum the undiscounted cash flows (not
including the initial cost) and divide the sum by the number of
9.1 The IRR is the compound rate of interest that, when
years in the study period (excluding any planning/design/
used to discount a project’s cash flows, will reduce the present
construction period) to obtain an average annual cash flow.
value of net benefits (PVNB) to zero. (See Practice E1074 for
Then divide the initial project cost by the average to obtain a
adiscussionofhowtocomputethePVNB.)Thesolutionvalue
rough estimate of simple payback (SPB).The second step is to
of i*in Eq 1 is the IRR. It is computed as a decimal, then
search the UPV discount factor tables in the row that corre-
expressed as a percent.
sponds to the study period for the UPVfactor that is closest to
9.1.1 Find the value of i* for which:
the estimated SPB. (Again exclude any years in the planning/
N
¯ t
design/construction period.) The rate that appears at the top of
PVNB 5 ~B 2 C !/~11i*! 50 (1)
( t t
t50
the column in which the UPV factor is found is a promising
trial rate. The more uniform the annual cash flow, the more
where:
likely that this trial rate will be close to the solution rate.
PVNB = present value of net benefits (or, if applied to a
9.2.1.3 Table 1 illustrates the trial-and-error approach for
cost-reducing investment, present value of net
savings (PVNS)), calculating the IRR for an initial investment that yields an
N = number of discounting periods in the study period, uneven yearly cash flow over four years. Columns 2 and 3 list
B = dollar value of benefits in period t for the building thedollarvaluesofbenefitsandcoststhataccrueineachofthe
t
or system evaluated less the counterpart benefits in
four years, and Column 4 shows the net cash flow for each of
period t for the mutually exclusive alternative those years, including the initial investment.
against which it is compared,
9.2.1.4 From inspecting Column 4 in Table 1, one might
¯
C = dollar costs, including investment costs, in period t
t
expect a relatively high return over four years. Using the
for the building or system evaluated less the
approach described in 9.2.1.2 to select a trial rate, the calcu-
counterpart costs in period t for the mutually
lated UPV value for four years corresponds in the Adjunct
exclusive alternative against which it is compared,
discount tables most closely to a rate of 25%. Multiplying
and
yearly net cash flows by single present value (SPV) factors for
i* = interest rate for which PVNB=0, that is, the IRR
each year based on a 2
...