Lecture5_35090 - Wealth Maximizing Rate (WMR) It measures...

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Wealth Maximizing Rate (WMR) It measures the growth of the original investment during the lifespan of the project. Consider a project that lasts n years. The future value of the benefits of a project FV B equals the present value of the costs (PV C ) times (1+WMR) to the power of n. : FV B = PV C (1+WRR) n 1
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The stream of benefits of the project can be invested at an interest rate, r. The future value of the benefits of the project are: 2 Wealth Maximizing Rate (WMR) ( 29 t n n t t B r B FV - = + = 0 1
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Wealth Maximizing Rate (WMR) 3 ( 29 t n n t t n C r B WMR PV - = + = + 0 1 ) 1 ( Therefore, A project is attractive if the WMR exceeds the interest rate (assuming that the loan rate is equal to the rate paid on investments)
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Example WMR An investor is offered a business that yields $2000 per year for your years, at a cost of $6000. The best alternative investment yields a rate of 11%. If he can borrow money at 11%, (so r=11%), is investing a good business? Estimate the WMR. 4
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WMR for comparing projects It can be used for comparing projects Better than the IRR However, projects need to be of the same scale (like the B/C ratio) 5
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6 Comparing projects of different lifespan One of the most common uses of NPV calculations is to compare alternative projects. Sometimes, Projects are often undertaken to fulfill a certain purpose, and the lifespan of the projects are irrelevant as long as the purpose is achieved. However, other cases, lifespan is relevant: A firm might have to choose between two machines to produce a certain item. One last two years and the other one four. How compare?
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7 Comparing projects of different lifespan Replication: Compare two 2-year cycles of the first machine with one 4-year cycle of the second machine
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Example: Replication Machine A costs $10000 and lasts four years. Machine B costs $4000 but lasts only two years. Machine A requires no maintenance, but B requires $2000 worth of maintenance one year after purchase. The discount rate is 8%. Which is a better buy? (use NPV) 8
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Comparing projects of different lifespan Compare equivalent annuities Choose the one with highest A. 1
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This note was uploaded on 05/27/2010 for the course ECON ECON 3509 taught by Professor Pablo during the Winter '09 term at Carleton CA.

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Lecture5_35090 - Wealth Maximizing Rate (WMR) It measures...

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