p_eval04_l7_disc

p_eval04_l7_disc - 1.011 Project Evaluation Choosing a...

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1.011 Project Evaluation Choosing a Discount Rate Carl D. Martland Rate of Return on an Investment Minimally Acceptable Rate of Return Capital Markets - Risk vs. Return Weighted Average Cost of Capital Leveraging
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A Basic Question For any arbitrary sequence of cash flows and for any interest rate i, we can find an equivalent cash flow that is much easier to work with when evaluating projects: Present worth Future worth, at any time t An annuity for N periods begining at time 0 An annuity for N periods beginning at any future time But - how do we choose i?
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Opportunity Cost of Capital What else could we do with our money? Give it away Spend it on food, Red Sox games, movies, or clothes Put it in the bank Buy government bonds or corporate Buy blue chip stocks Buy growth stocks Buy emerging markets mutual funds The opportunity cost depends upon what other options are available to us given our own situation and current market conditions
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Return on Investment = A/I (where A is the annual income from the investment over a long time horizon) Time 0 200 400 600 800 1000 1200 Investment Time 0 200 400 600 800 1000 1200 Equivalent Annual Income From Investment I = Investment A = Equivalent Annual Return
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Minimum Attractive Rate of Return The MARR is the lowest return that you would be willing to accept given: The risks associated with this project The other opportunities for investment In general, we can look at the capital markets to find out what kinds of return are available for different kinds of investment Interest rates for bonds
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p_eval04_l7_disc - 1.011 Project Evaluation Choosing a...

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