E421-4 - APPLICATIONS OF MONEY-TIME RELATIONSHIPS CHAPTER 4...

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Unformatted text preview: APPLICATIONS OF MONEY-TIME RELATIONSHIPS CHAPTER 4 MINIMUM ATTRACTIVE RATE OF RETURN ( MARR ) An interest rate used to convert cash flows into equivalent worth at some point(s) in time Usually a policy issue based on:- amount, source and cost of money available for investment- number and purpose of good projects available for investment- amount of perceived risk of investment opportunities and estimated cost of administering projects over short and long run- type of organization involved MARR is sometimes referred to as hurdle rate CAPITAL RATIONING MARR approach involving opportunity cost viewpoint Exists when management decides to restrict the total amount of capital invested, by desire or limit of available capital Select only those projects which provide annual rate of return in excess of MARR As amount of investment capital and opportunities available change over time, a firms MARR will also change PRESENT WORTH METHOD ( PW ) Based on concept of equivalent worth of all cash flows relative to the present as a base All cash inflows and outflows discounted to present at interest -- generally MARR PW is a measure of how much money can be afforded for investment in excess of cost PW is positive if dollar amount received for investment exceeds minimum required by investors FINDING PRESENT WORTH Discount future amounts to the present by using the interest rate over the appropriate study period FINDING PRESENT WORTH Discount future amounts to the present by using the interest rate over the appropriate study period PW = F k ( 1 + i ) - k i = effective interest rate, or MARR per compounding period k = index for each compounding period F k = future cash flow at the end of period k N = number of compounding periods in study period k = 0 k = 0 N FINDING PRESENT WORTH Discount future amounts to the present by using the interest rate over the appropriate study period PW = F k ( 1 + i ) - k i = effective interest rate, or MARR per compounding period k = index for each compounding period F k = future cash flow at the end of period k N = number of compounding periods in study period interest rate is assumed constant through project k = 0 k = 0 N FINDING PRESENT WORTH Discount future amounts to the present by using the interest rate over the appropriate study period PW = F k ( 1 + i ) - k i = effective interest rate, or MARR per compounding period k = index for each compounding period F k = future cash flow at the end of period k N = number of compounding periods in study period interest rate is assumed constant through project The higher the interest rate and further into future a cash flow occurs, the lower its PW k = 0 k = 0 N BOND AS EXAMPLE OF PRESENT WORTH The value of a bond, at any time, is the present worth of future cash receipts from the bond The bond owner receives two types of payments from the borrower:-- periodic interest payments until the bond is...
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This note was uploaded on 10/24/2009 for the course ENGM 400 taught by Professor Blank during the Spring '09 term at American University of Beirut.

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E421-4 - APPLICATIONS OF MONEY-TIME RELATIONSHIPS CHAPTER 4...

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