Chapter 4 - Comparison Methods Part 1

Question 1

Define an investment:

Answer 1

It’s an exchange of something valuable now for expectation of something of greater value in the future.

Question 2

Name 3 widely used comparison methods for evaluating opportunities.

Answer 2

1. Present Worth (PW)
2. Annual Worth (AW)
3. Payback Period

Question 3

Name the 6 assumptions regarding Comparison Methods:

Answer 3

1. Costs/Benefits always measurable in terms of money
2. Future cash flows are known with certainty
3. Cash flows are unaffected by inflation or deflation
4. Sufficient funds available to implement all projects
5. Taxes are not applicable
6. All investments have a cash outflow at the start

•These outflows are called first costs/initial investment

Question 4

Name the 3 categories which we classify projects.

Answer 4

1. Independent
2. Mutually Exclusive
3. Related but not Mutually Exclusive

Question 5

What are independent projects?

Answer 5

The expected costs/benefits of each project is independent of whether the other is chosen. (buying laptop and/or dryer)

Question 6

What are mutually exclusive projects?

Answer 6

By virtue of choosing one, all other alternatives must be excluded (sky scraper or pyramid office)

Question 7

What are Related but not Mutually Exclusive projects?

Answer 7

For such, expected costs/benefits of one depends on the others being chosen. (gas station at point A, at point B, or both, or none)

2^N posibilities

Question 8

What is the MARR?

Answer 8

Minimum Acceptable Rate of Return

It’s the interest rate required for any project to be accepted.

Question 9

What are the two methods used for dealing with alternatives of different service lives?

Answer 9

Repeated Lives Approach (repeat service life over least common multiple)

or

Study Period Approach (adopt a specific study period, realizing need to add a salvage value)

Question 10

What is the Payback Period?

Answer 10

Number of years it takes for an investment to be recouped (interest assumed to be 0)

PP= First Cost/ Annual Savings

Question 11

What is the Discounted Payback Period?

Answer 11

The PW of each year’s savings is subtracted from the first cost until it is diminished to zero.