Chapter 5 Applications of M-T

Chapter 5 Applications of M-T - 1 Applications of...

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Unformatted text preview: 1 Applications of Money-Time Relationships Chapter 5 Methods for evaluating the economic profitability of alternatives: • Present Worth Method • Future Worth Method • Annual Worth Method • Internal Rate of Return Method • External Rate of Return Method • Payback Methods (Simple and Discounted) 2 Minimum Attractive Rate of Return (MARR) The interest rate that the company could earn if it simply invested its money in its general investment pool rather than in the particular project in question. Sometimes it is referred to as a “ required rate of return” or a “hurdle rate”. Should consider: Type and quantity of money available for investment; types of projects to be funded; risk; type of organization 3 Present Worth (PW) Method – equivalent worth of all cash flows relative to some base or beginning point in time called the present. It can be used as a measure of how much money an individual or a firm could afford to pay for the investment. To find PW - convert all cash inflows and outflows to the present using the MARR IF PW ≥ 0, the investment is considered “economically attractive” PW(i%) = Σ F k /(1+i) k or F k (P/F, i ,k) k = 0 to N Note that if annuities are included in the cash flows you can also use the P/A formulas to solve for PW Note that as i increases, PW decreases 4 Example Suppose you have an opportunity for an investment that requires $20,000 now. It is expected to return $3,500 per year for 10 years and have a salvage value of $2,000 at the end of the 10 years. Evaluate whether the investment is economically attractive at a MARR of 10%. 5 Bonds V N = C(P/F, i%, N) + rZ(P/A, i%, N) Z = face, or par, value C = redemption price (usually equal to Z ) r = bond nominal rate per interest period N = number of periods before redemption i = bond yield rate per interest period V N = value (price) of the bond N interest periods prior to redemption Examples 1) A bond with face value of $10,000 pays interest of 6% per year. This bond will be redeemed at par value at the end of 10 years. How much should be paid now for this bondredeemed at par value at the end of 10 years....
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Chapter 5 Applications of M-T - 1 Applications of...

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