Lecture6

# Principle for comparison focus on the difference we

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Unformatted text preview: Principle for comparison: focus on the difference. We ask this question: can the additional investment for B be justiﬁed by the additional beneﬁts (incremental analysis)? To answer this question, we can use the measures we learned for evaluation of a single project. If the answer is “yes”, then B should be selected. SEEM5740/ECLT5930 7 Example 6.1: investment alternatives Consider projects A and B, both last for 4 years. MARR = 10%. A Capital investment Annual revenues minus expenses PW(10%) B ∆(B − A) -60,000 22,000 9,738 -73,000 26,225 10,131 -13,000 4,225 393 PWA (10%) > 0, PWB (10%) > 0 suggest that both A and B are better than do-nothing. PW∆(B−A) (10%) > 0 implies additional investment in B is justiﬁed, and B is better than A. SEEM5740/ECLT5930 8 Example 6.1 We note that PWB = PWA + PW∆(B−A) . In general, PW (FW and AW) have the following additivity property (X , Y represent two projects): PWX +Y (i) = PWX (i) + PWY (i). This is because N k =0 X Y Ck + Ck = (1 + i)k N k =0 X Ck + ( 1 + i) k N k=0 Y Ck . (1 + i)k Due to the additivity property of PW, the result of incremental analysis agrees with the result from maximizing PW. So no need to do incremental analysis using PW. Rule: For investment alternatives, choose the one with the largest positive PW (equivalently, FW, AW). If all alternatives have negative PW (FW, AW), then choose do-nothing. SEEM5740/ECLT5930 9 Example 6.2: cost alternatives MV stands for market value. MARR = 10%. -380000-(-38100/1+1.1)-39100/(1+1.1)^2 time C D 0 1 2 3 MV at 3 PW(10%) -380,000 -38,100 -39,100 -40,100 0 -477,077 -415,000 -27,400 -27,400 -27,400 26,000 -463,607 ∆(D − C) -35,000 10,700 11,700 12,700 26,000 13,470 计算D-C的PW PW∆(D−C) (10%) > 0 implies additional investment in D is justiﬁed, and D is better than C. Rule: For cost alternatives, choose the one with the least negative PW (FW, AW). SEEM5740/ECLT5930 10 Incremental analysis by IRR: Example 6.1 -600000+(22000/1+i)+....(22000/(1+i)^4) = 0 A Capital investment Annual revenues minus expenses IRR B ∆(B − A) -60...
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## This note was uploaded on 03/23/2013 for the course SEEM 5740 taught by Professor Zhou,xiang during the Fall '12 term at CUHK.

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