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CHAPTER 4: Present Worth Analysis - Coggle Diagram
CHAPTER 4: Present Worth Analysis
FORMULATING ALTERNATIVES
Two types of economic proposals
Mutually Exclusive (ME) Alternatives: Only one can be selected; Compete against each other
Independent Projects: More than one
can be selected; Compete only against DN
Two types of cash flow estimates
Cost: Alternatives include only costs; revenues and savings assumed equal for all alternatives; also called service alternatives
Revenue: Alternatives include estimates of costs (cash outflows) and revenues (cash inflows)
PW EVALUATION USING A STUDY PERIOD
Once a study period is specified, all cash flows after this time are ignored
Salvage value is the estimated market value at the end of study period
Capitalized Cost (CC) ANALYSIS
DEFINATION
PW of project with
infinite life
BASIC EQUATION
CC = P = A/i
PRESENT WORTH ANALYSIS OF EQUAL LIFE ALTERNATIVES
For one project, if PW > 0, it is justified
For mutually exclusive alternatives, select
one with numerically largest PW
Precede costs by minus sign; receipts by p lus sign
For independent projects, select all with
PW > 0
Convert all cash flows to PW using
MARR
SELECTION OF ALTERNATIVES BY PW
MUTUALLY EXCLUSIVE
Select numerically largest PW; alternative A
INDEPENDENT
Select all with PW > 0; projects A, B & D
FUTURE WORTH ANALYSIS
FW
Analysis of alternatives using FW values is especially applicable to large capital investment decisions when a prime goal is to maximize the future wealth of a corporation’s stockholders.
FW exactly like PW analysis, except calculate FW
PRESENT WORTH ANALYSIS OF
DIFFERENT LIFE ALTERNATIVES
Two ways to compare equal service:
LCM (least common multiple) : Compare the PW of alternatives over a period of time equal to the (LCM) of their estimated lives.
Study period: Compare the PW of alternatives using a specified study period of n years.
Assumptions of LCM approach
Selected alternative can be repeated over each life cycle of LCM in exactly the same manner
Cash flow estimates are the same for each life cycle
(i.e., change in exact accord with the inflation or deflation rate)
Service provided is needed over the LCM or more years