Lecture 5 - Different Measures of Money Value

Question 1

What is Net Present Value?

Answer 1

Net Present Value (NPV) is a metric that is suitable for valuing projects because it can deal with the
- Timing aspect of cash flows
- Risk aspect of cash flows
by discounting or penalizing future cash flows.

Question 2

How do we calculate NPV?

Answer 2

Procedure:
 write down uninflated cash flows for the project.
 convert future cash flows to a present value (select appropriate date) using the discount rate (r).
 SUM the present values of the cash flows to determine the net present value (NPV) of the investment or project.
REFER TO SLIDES FOR FORMULA

Question 3

What is payback?

Answer 3

• Investments can be evaluated in terms of how long it will take the system to pay for itself from benefits, revenue, savings.
• Systems that pay for themselves quickly are often desirable because there is less uncertainty with estimates of short duration.
• Payback period is the amount of time required for the difference in the present value of savings to equal the present value of the costs.
• Payback period may be calculated by interpolating from graphs or tables.

Question 4

What is Rate of Return?

Answer 4

• Rate of return r* is a widely accepted index of profitability.
• ROR can be thought of as the discount rate that causes the cash flow in to be equal to the cash flow out.
  REFER TO SLIDES FOR FORMULA

Question 5

What is Equivalent Annual Cost (EAC)

Answer 5

• To evaluate asset investments with different service lives use an Equivalent Annual Cost (EAC) calculation
• This determines the cost per year of owning and operating an asset over its entire lifespan
  REFER TO SLIDES FOR FORMULA

Question 6

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