CHAPTER 5-Understanding the 3 Worths, Capitalized Cost and Capitalized Recovery - CHAPTER FIVE Understanding the 3 Worths Analysis of a project or an

CHAPTER 5-Understanding the 3 Worths, Capitalized Cost and Capitalized Recovery

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CHAPTER FIVE Understanding the 3 Worths’
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2 Analysis of a project or an investment Methods of analyzing a project or an investment Pay back period (Initial Project Screening Method) Present/future worth analysis Equivalent annual worth analysis Internal rate of return Cost benefit ratio
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3 Bank Loan vs. Investment Project Bank Customer Loan Repayment Company Project Investment Return Bank Loan Investment Project
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Exercise I A company purchases equipment to improve production at a cost of $ 650,000 and expects an annual benefit of $ 215,000. maintenance costs incurred are $ 53, 000 per year resulting in a net benefit of saving of $ 162,500 for 8 years. Draw the cash flow diagram
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5 Describing Project Cash Flows Year ( n ) Cash Inflows (Benefits) Cash Outflows (Costs) Net Cash Flows 0 0 $650,000 -$650,000 1 215,500 53,000 162,500 2 215,500 53,000 162,500 8 215,500 53,000 162,500
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Present worth analysis Until the 1950s, the payback method was widely used as a means of making investment decisions. As flaws in this method were recognized, however. Business people began to search for methods to improve project evaluations. The result was the development of discounted cash flow techniques (DCFs), which take into account the time value of money. One of the DCFs is the net-present- worth (or net- present value) (PW or PV) method.
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Present worth analysis A capital-investment problem is essentially a matter of determining whether the anticipated cash inflows from a proposed project are sufficiently attractive to invest funds in the project.
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Present Worth Comparison Cash flows are known. Cash flows do not include effect of inflation. The interest rate (discounting rate) is known. Comparisons are made with before tax cash flows. Comparisons do not include intangible considerations. Comparisons do not include consideration of the availability of funds to implement alternatives. ASSUMPTIONS
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Present worth analysis As we observed, the most convenient point at which to calculate the equivalent values is often at time zero. Under the PW criterion, the present worth of all cash inflows associated with an investment project is compared with the present worth of all cash outflows associated with that project. The difference between the present worth‘s of these cash flows Referred to as the net present worth (PW), determines whether the project is or is not an acceptable investment. When two or more projects are under consideration, PW analysis further allows us to select the best project by comparing their PW figures directly.
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Present worth analysis Evaluation of a Single Project Step 1: Determine the interest rate that the firm wishes to earn on its investments. The interest rate you determine represents the rate at which the firm can always invest the money in its investment pool. This interest rate is often referred to as either a required rate of return or a minimum attractive rate of return (MARR). Usually this selection is a policy decision made by top management.
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