Economic Analysis Technique - Copy (2)

8/13/2019 Economic Analysis Technique - Copy (2)

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Economic Analysis Techniques

KEY CONCEPTS

ime a ue of mone , inimum att acti e ate of e u n MA )etho s pa ack pe o et p ese t alue N V, net annual wo t N nte na ate

o etu ( )Ta an ep ecia ion consi e ations E aluatio pe o (p o ec li es

READINGS

ele ant sections in C apte s 6 7 8, 9, , a 2 (C apte s 3 a 4 asa itional ea n fo cla i icatio )

TOPIC OUTLINE

Inv stm nt paisal T chniq s

est ent app a sa techn ques can e e nto t ee oups

cono ic anal sis techniques ( ase solel on economic att i ute)Multi att u e anal sis ec n ques ( ase on se e a a t i utes, e econo ic e ia il tfle i il t etc)upp ementa a isk anal sis tec niques ha take isk an othe facto s i o

consi e atio

2 Ti Valu of Ca ital

Basic oncep

Asum of one to a is wo t mo e than the sa e a ount at so e time in the futu eecause of inte es o ate o e u n w ich can e ea e .o this eas n, a cas flow ust e i entifie i te of iming as well as a ountwo a ounts of one a e sai to e equi a ent if the a e equa at a en poi t in ti e o

a gi en nte est ateut w h compo n e the equi alent sum of o e at a poi t i the utu e fo oneecei e to aPr s t w rth he equi alent su of mone at to a s alue fo mone ecei e at a po ntin t e utu en o an w h unifo m annual se ies of mone o e a ce tai pe o o time w ich s

e ui alent n a ount to a pa ticula sche le of eceipts un e consi e at on

Determin g M n mum At rac ve Rate of Retu n

e futu e wo th o t e p esent wo th of a sum of one epen s on two facto s


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he time pe iod eg . umbe of ye s, de equi ed e of etu eg . 15% pe ye

e v lue of ept ble m imum te of etu depe ds o m y o s i lud g

Cu e t cos of pit l.

Cu e t oppo u ty ost.Cu e te of etu o i vestme sM geme t ttitude to ds i vestme ts d s s

As depe ds o m y o s i ud g m geme t tti ude to dsi vestme ts d is s t e v lue o i m y diffe f om omp y to omp y.

Fo B s c Equat o s

F P + n

A P* i 1+ i " ] / [ + 1 P ;3 A [ F * i ] [ 1 + i) 1]

P A1/ 1 i ] + [A2/ +i ] + +[A / 1+i "J

he fou equ io s bove be used to l u te the equiv le t o th of sum o mo ey

: utu e o t: p ese t o thA: u fo m u l o th: te of etu eg . 15% pe ye: ime pe iod eg . 4ye s

o ex mple equ tio 2 be used to l u te t e u ifo m u l o t A ove pe iod ofye s of sum of mo ey e eived t e p ese t t me p ese t o h P) give te of etu .Al e ive y he s me equ io be used to l u te t e p ese o t if the u ifo m

u o th A is o .

Equ t o 4 is used to u te the p ese t o t if he u sum of mo ey eceived ove pe iod of ye s v ies f om ye o ye , i e A 1 ... . A .

No ons

ul ti g equ v le o ths it s use u to use ot o s to ep ese t he v ous p mete svolved Belo e some ex mples:

X A P i% p . ye s W u ifo m u p yme t e h ye fo he ext ye s isequiv le t to p ese t lump sum of X , give te o e u of i% pe ye ? ote th i t eot tio A P he de omi to P i di tes X is the o p ese t lump sum, d theume o A i di tes t e u ifo m u p yme t t you t o c l ul te

X A i% p . . ye s): Wh t p ese t mou t of mo ey is equiv le t to u mou tso X g ve te of e u of i% pe ye ?


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$ X , i% a , n yea s) W at resent amount o money is equi ale to $ X t at w l beece ed a t e end o n years, gi en a ra e o re u n of i% er year

Exa s

$ , (P A 0% a yea s) $ 0 000

$ 0,000 A P, 0% .a 4 years) $ 3 5$ 4 (P 0% a years) $ 0 000

Economic Methods for Measuring Investment Worth

T r l gy

Inde e de alter a i es t e c o ce of ro ect does not eclude t e ot ersMu ually exc usi e a ter ati es: t e c oice of roject recludes t e ot ers .MARR mi im m a tracti e rate of return

c ic th dse economic wo t of an in estment can be measured n a number of ways Some of w c are

discussed below

ayback e od B ) met od: determines ow long t w ll take to reco er t e ni iain estment. qui alent wo t met ods :Net resent alue NPV) met od co er s a l cas f ows to a single et sum eq i alent attoday s alue using i M RRet a n al wo t ( AW) met od con e ts al cas flows to a eq i alent niform annual

ser es o cas lows o er t e life o t e in estment roject sing MARR.Inter al rate o re ur R) met od de erm nes e nteres rate t at yields a net resentwo of ero

C ts

Payback eriod met od does not take into acco nt interest and oject ife, i.e it ass mes aero interest rate PV and NAW met ods are equi alentPV assumes t at return on i es ment can be re-in es ed at e M RR w le assumes

t a et n o in estment ca be re n ested a t e I RInde endent rojects : ranking of nde endent ro ec s us ng N V and RR may d e bbot ead to t e same acce eject decis i on M t al y excl si e rojects : bo V and IRR do not necessa ly ead to t e sameacce t reject decision since t e anking de ends o t e me od used .

4 Payback Period Method

T e ayback e od of a ro ect is t e e iod w en t e total net re e es a e equal o e i itiali estment

Ift e net annua re enues are uniform t en t e ayback eriod is gi en by:

Payback eriod in years) ini ial n estment) (net annual re en e)


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a l , ons e t e two invest ent o t o s be ow .

nitial osti e

Sa va e va uen ua e ei tsn ua ex e itu e

Op ion$200005yea s

$4000$10000$4400

Mi mum att a tive ate o etu n 15% . a .

Op io B$300001 0 y e a rs

$ 0 $ 14 000 $8600

e PBP o o ion is ($20,000) $10000- $4 400 3. 7 yea s. ' . . . - : ,. ;

N ote th at t e P BP m e thod ta kes in to c on side ra tion ne it e r MAR R nor pr oje t l fe.

a l i is yi o se e between wo wei n s a es; tlas s ale a o s ale. Bot ave a yea e ssu e an 8%in e est ate. Given:

lt r at

tlas s aleom T um s a e

So utiontlas scal

Payback

Tom humb sca e:

Pa ba k

$3000co,l

1000

2

F g .

Cost

00000

U for ualB

4 000

s tPeri d -

Un form an u l bene i000- 4 4y450

CosPe d =b ne t

a)

n f nn60 0 5y s

00

3 4 I s4.

d of s fu L fSa va Va

10000

(h)

Pay b k per d plo r (a) Atlas cal and b om Thumb s le

e ef e , ni ise t e p yb k peri d e e A la al


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5 Net P esent Wo t Met od

Procedure

S 1:D a a ash o dia ra sho n all i o s a d x ndi r sS : W do n h N V by b in in a l r a u s o r s n al s usi h oa ionsd s b d aboS Ca la ons usin a ro ria q a onsS 4 Co l sion and o n s

s an xa l , o sid n s o io A d s rib d abo

WorksheetSte

This in s n has an ini ial os ( x ndiur ) o 20 000a y ar 0 i. a oday 's alu .h in s n has a n annual in o o 5600 10 000 4 400)or y ars In addi ion a nd o y ar 5 in s n i l b sold or 4000 (sal a alu )Dra h as lo dia a

Step

NPV 600 ( IA 1 % . a 5y a s +$ 4000 F 15%a , y a s $ 200005600 2) + 4000(0 49 20000

Ste 3

NPV 1 qn. 2 + 9 ( qn 1) 2 00060

No ha if

I h N V o a roj c is r a han ro, i ans ha h a o r urn o h roj ishi h r han h r q r d MARR

h NPV o a roj is qual o z ro, i ans ha h ra o r urn o h roj is q alo h r qu r d MARR

I h N V o a roj c is ss ha z ro, i ans ha h ra o r urn o ro is l sshan r q r d MARR

h NPV o o ion As 760 r or his oj is a ab as s ra o u is iha h q ir d MA Ro 15%

6 Net Annual Wort Met od

Pr ce re


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The roce ure for t e AW met o is similar to t at of PV met o exce t in ste 2 you co vertall cas flows toa equivalent un fo m a nua series of cash flows over t e fe of t e nvestmentojec usi g MARR

As a exam le, consi er i vestment o ion A escribe above.

W r s eetS e 1

This nvestme has an n t al cost ex e i u e of $20 000a yea 0 e at to ay s va ueT e investme t as a net annual come of $5600 ( $10 000 $4 400for 5years. a t o at e e of year 5 he i vestme t w l be sol for$4000salvage val e

Draw t e cas f ow iagram

S e 2

NAW $ 5600+ $ 4000A F 5% a , 5yea s -$ 20000A P, 5% . a 5years)$5600+ $4000(0 482)$20000(02983

Ste 3

NAW $5600+ $593eqn 3) $5 966eq 2$227

Ste

Note at f

If the NA W of a roject s greater t an ze o t means t at t e rate of retu of e roject isigher t an t e require ARR .

f t e AW of a roject s eq al to ze o it mea s t at the rate of ret rn o t e roject is equato t e require ARR.

If t e AW of a roject is less t an zero t means t at e rate of return of t e oject is lesst an t e require ARR .

The NAW of o t o A s$227 T erefore h s rojec s acce table as its rate of ret rn is ig ertha t e requi e ARR of 15%

C mmen s the eq ivale ce f NPV a d N W met s

As ev ously isc sse , the N V a NA W metho s are equ va e t T e AW of o tio A is$227er year for 5years. T e PV of $227er yea for 5years s $760 .e .

$ 227 A, 15% . a 5years =$ 760

7 nterna Rate of Ret r Met o

cedure

e roce u e fo he RR met o is s m lar to ha of N V et o exce t n ste 2 youbri g alf re values to rese values using the nota ions escribe above where t e va ue of e rate ofreturn s u nown


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T e value of the rate of return is t en etermine usua ly y trial an error metho y e uatingt e p esen values o a l net evenues o the p oject 's in tia cost.

As an e ample, consi er inves ment op ion A esc i e a ove.

St 1is nvestmen as an nit a cost expen iture of $20 000 at yea 0, i e a to ay s val ehe investment as a net ann al income of $5600 $10,000 - $4 400 o 5 yea sn a t on at the en of yea 5, the investmen wi l e so o $ 000 salvage va ueDraw t e cash ow iagram

St 2

$ 5600 P i % p a 5 years +$ 4000 % p . a . 5 years $ 20000

St 3

Solving t e equation in Step 2 for t e unknow varia le using tria an e or metho i 6.5 %

S

n t is case, the p opose project is accepta e eca se the IRR of 16 5 % is igher tha t eMARRof 15 %

Co e ts o NPV s IRRNPVass mes t at return on investment ca e re - investe at t e MARR while IRR assumest at re urn on nvestmen can e e investe at he RRor in epen ent projects rankings using PV an IRR may if e oth ea to the same

accept re ec ecisionFormutually e clusive projects : ot PV an IRR o not necessa y ea to he sameaccept reject ecision s nce t e ank ng epen s on the me ho se .

8 Tax and De eciatio

It s often necessa to ake into consi eration epreciation an income ta es in inves mentappra saleprec ation efe s to the ecrease i val e of a property with use a time .ep ec ation is sual y se for ta a ion pu poses here a e a num er of tech iques, which can e use to etermine the amou that can ee c e from t e value of a proper y e o eprecia ion, eg . Straight- ine metho ,ret rning alance metho

One of the mos com on tec niques s the stra gh -line metho where the va ue of theprope ty is ecrease li early to e o at t e en of the life of the property

he proce ure for taking nto accou t epreciatio an income taxes is as fo l ows

Esta lish net annual cash flow over project life, taki g into acco nt ep ecia ion antaxat on.Use appropr ate economic techniq e s c as V to evaluate the projec


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E a l

Consid t o low ng oj t:

nitial ostLi

a vagt i om

$100 , 000 y a s

$ 0 000$60 000 a

Min. at o tu n 1 %ax at 40%D iatio l n a ov y ars with no salvag valu st a ght l n m thod

Esta lish n t a nua ash ow ov oj t li , taki g to a ount d iatio a dtaxation.

Y a Cash in Cash out D iatio Tax. n om Tax N t ash low0

23455

100000 10000060000 20000 40000 16000 4400060000 20000 40000 16000 4400060000 20000 40000 16000 4400060000 20000 40000 6000 4400060000 20000 40000 16000 440000000 0000 4000 6000

O th a ov ta l has n om l t d o tly, any valuatio t hniq s s h asV t h q a s d to va uat th oj t using th t ash ow o a h y a

last ol mn

PV -$ 0000 + $44000 /A, 1 % y a s + $6000 / 1 %, 5 y a s

9. Com ar g Alternatives and Se ect g Studeriod

Asyst mati o d o om a i g i v st t alt nativ s (mutually x lusiv o ts an o tl d as ollows

D i t a t ativ sD t m n t study iodP ovid st mat s o th as low o a h alt nativ

y th t n rat MA R) l t th it ia o judging t su ss Eg . E onomi a d oth at i ut s m lti -

att i t w l ov d i t s ou sCom a th alt rnativ s

o m s sitivity analys s

l t th alt nativ sW n om a ng two o ts with di t l v s it V o AW t h iq an us d,assumingr ata i lity .

E a

Consid t o low ng o ts

O tion A O tio B


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Economic Analysis Technique - Copy (2)