Comparison Methods Part 1 Flashcards
Three ways of evaluating opportunities
- Present Worth: compare the present worth of the options
- Annual Worth: turns all the values into a uniform series e.g.: Annuity
- Payback Value: Compare all the “payback” periods of all options
Assumptions when using Comparison methods
- Cost and Benefits measured in terms of money
- Future cashflows are known with certainty
- Taxes are not applicable
- Cash flows are unaffected by inflation and deflation
- Sufficient funds to implement all projects
- All investments had a cash outflow at the start call the INITIAL INVESTMENT or FIRST COSTS
Independent Project
The benefits or cost of choosing a project is independent of whether or not another project is chosen
Mutually-Exclusive
By choosing a project no other project can be chosen. Impossible to do more than one project.
Related but not Mutually Inclusive
The benefits or costs of choosing a project is dependent on whatever project you also choose. This type is CONTINGENT. If you want to build a third story of a building the first and second floors must be present already. Therefore when choosing your option you have to consider its relationship between or among all the options
MARR
Minimum Acceptable Rate of Return: The minimum interest rate that must be earned for a project to be approved. The MARR determines whether or not to invest in a project
If the alternatives were are comparing have different lives or periods…
We use the
1. Repeated Live approach or
2. Study Period Approach
Why is annual worth better for Mutually Inclusive Projects with different periods???
Because we don’t need to do the Repeated Live Method or the Study Period Approach.
The simplest method for judging economic viability of projects is…
The Payback Period Method
*Because the payback period is very easy to grasp and use it should not be the sole criterium for accessing projects.
Payback Period formula
First Cost/Annual Savings
