Evaluation Methods Flashcards
Independent
investments evaluated without reference to any other projects
Mutually Exclusive
choosing one investment automatically results in rejecting the other project
Payback Period
the length of time it takes to recover the cost of the initial investment
Disadvantages of the payback rule
- ignores the time value of money
- ignores project specific risk
- cutoff point is arbitrary
- ignores cash flow after the payback period
- biased towards short term projects
Advantages of the payback rule
- easy to use and understand
- biased towards liquidity
- adjust for uncertainty of later cash flow
Net Present Value
the sum of the initial investment and the discounted future cash flows
MARR
minimum acceptable rate of return chosen by the spender; used to calculate NPV
What is MARR determined by?
Risk and possible return
CE Method
capitalized equivalent; used when the project is >40 years (infinite)
Capitalization of the project
the PV of long projects (infinite)
Capitalization Cost
the amount of money today that would yield a certain return at the end of every period forever
Revenue Projects
the investment will generate revenue in the future which are dependent on the alternative chosen (use NPV)
Service Projects
each project alternative produces the same output (use the lowest present value production cost)
Annual Equivalent Worth Analysis
measures the worth of an investment; determine equal annual earnings
Comparing Mutually Exclusive Alternatives
- must be compared in equal time spans
2. analysis period must be taken into consideration
