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1
Project Evaluation Methods
In the analyses so far, the focus has been on earning interest from
investments, rather than generating revenue or new wealth.
In commercial projects, investments are made and expenses
incurred in order to generate revenue.
For a project to be considered, the total revenue over the life of
the project must outweigh the investment and any other
expenses.
The timing of the revenue is also important.
IOE 201 Lecture Notes 8
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Project Evaluation Methods
Example:
A project requires an initial investment of $100,000
and is expected to generate $40,000 per year for the
next 5 years (the life of the project).
0
1
2
3
4
5
years
$100,000
$40,000
$40,000
$40,000
$40,000
$40,000
3
Project Evaluation Methods
•
Payback Period
•
Present Worth
•
Future Worth
•
Capitalized Equivalent Worth
•
Annual Equivalent worth
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Years
4
Payback
period
2.5 years

$
100,000

$
50,000
$
50,000
$1
50,000
$
100,000
$
0
Cumulative
cash flow
Payback Period
A simple way to evaluate the project is to determine how long
it takes to recoup the initial investment (payback period):
In our example:
3 years for discrete cash flow
2.5 years for continuous cash flow
$40,000
$40,000
5
Project Evaluation Methods
The payback period method provides a quick and simple
evaluation of a project, using minimal information.
It is a convenient method for quickly rejecting proposed
projects with a payback period that is too long.
In practice, for comparing several different projects, the
time value of money needs also to be taken into account.
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0
1
2
3
4
5
years
$100,000
$40,000
$40,000
$40,000
$40,000
$40,000
For discounted payback, each year’s revenue is discounted by
the interest rate
i
Discounted revenues are:
Year 1
Year 2
Year 3
Year 4
Year 5
5
4
3
2
)
1
(
000
,
40
$
)
1
(
000
,
40
$
)
1
(
000
,
40
$
)
1
(
000
,
40
$
)
1
(
000
,
40
$
i
i
i
i
i
+
+
+
+
+
Results in longer payback period, depending on size of rate
i
Project Evaluation Methods
•
Evaluation of commercial projects requires analyzing a firm’s
cash flow for each project, based on the earning power of money.
•
In our previous cash flow analyses, the interest rate used would
be the earning power of money as specified by a bank.
•
For cash flow analyses of a commercial firm, this rate is called
the
Minimum Attractive Rate of Return
(MARR)
.
•
MARR is the interest rate at which a firm can always earn or
borrow money. It is generally specified by the firm’s
management, and is the rate used for a firm’s cash flow analyses.
Minimum Attractive Rate of Return (MARR)
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This note was uploaded on 03/17/2010 for the course IOE 201 taught by Professor Dennisblumenfield during the Fall '09 term at University of MichiganDearborn.
 Fall '09
 DennisBlumenfield

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