Economic Models Flashcards
Net Profit
Net Profit = Revenue - Cost of Investment
Return on Investment (ROI)
ROI = (Net Profit / Cost of Investment) x 100
When comparing the ROI of two projects - Bigger is Better
Internal Rate of Return
(IRR)
Interest rate at which the project inflows (revenues) and project outflows (costs) are equal.
Calculating Internal Rate of Return (IRR) is complex and requires a computer.
Bigger is better when comparing IRR.
Net Present Value
(NPV)
NPV = PV cash outflows – PV cash inflows
Net Present Value equals the Present Value of cash outflows minus (-) the Present Value of cash inflows.
Net Present Value (NPV) compares the value of a dollar today vs. the value of that same dollar in the future after taking inflation and return into account.
Example: Project A has a NPV of $150,000 and takes six months or Project B having a NPV of $295,000 and takes one year.
Which Project do you choose?
Select Project B because bigger is better AND the years are already factored into the dollar amount.
Present Value (PV)
Present Value (PV) - the current worth of a future sum of money or cash flows streams at a specified rate of return.
Based on concept of money today is worth more than money in the future.
The formula is PV = FV/(1+r)^n
FV = Future Value, r = Interest Rate,
n = Number of Periods
Note: Watch out! PV also stands for planned value (described in the Cost Management knowledge area).
Benefit Cost Ratio
(BCR)
Benefit Cost Ratio (BCR) compares the benefit to the cost of the initiative. The format is 4:1, which means the benefits of the project outweigh the costs 4 to 1.
Profit is not the same as (Benefits or Revenue) This is simply noise. Benefit and cost are the main factors.
A project can have a BCR of less than one (.75:1) Indicating there was an underlying factor.
Example: What is the benefit cost ratio if revenue=$200,000 and cost=$50,000?
BCR = (Benefits or Revenue)/Cost $200,000/$50,000 = 4 Then the BCR is 4:1
Bigger is better.
Opportunity Cost
Opportunity Cost is associated with taking another opportunity. It is what you give up or leave on the table to take the other opportunity.
Example: What is the opportunity cost if you take a $100,000 a year job over a $60,000 /yr. job and a $75,000/yr. job?
The opportunity cost is $75,000.
(It is the BIGGEST amount not chosen, NOT the difference or the addition of choices.)
Payback Period
Payback period is the amount of time needed to earn back the original investment on the project. PMI® suggests that you select the project with the shortest payback period.
Return on Investment (ROI)
Guidance
The BIGGEST number or the percentage
Internal Rate of Return (IRR)
Guidance
The BIGGEST percentage
Net Present Value (NPV)
Guidance
The BIGGEST number
(Years are already factored in)
Present Value, Future Value
(PV, FV) Guidance
The BIGGEST number
Benefit Cost Ratio (BCR)
Guidance
The BIGGEST ratio
Opportunity Cost
Guidance
The BIGGEST cost NOT selected
Payback Period
Guidance
The SHORTEST duration
