The payback period analysis method is used as a

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itself. The payback period analysis method is used as a screening tool to determine whether proposed alternatives should receive a full engineering analysis or be screened from further consideration. To use the payback period analysis method, calculate the initial investment, or first cost. Next successively calculate the present worth of the net cash flows (NCF) for each year, beginning with year 1. Sum the NCF present worth values until the amount exceeds the first cost to determine the period when payback occurs. The present worth of the NCF values is most commonly calculated using 0% interest rate because it is a rough screening tool, not a thorough economic evaluation. Cash flows beyond the payback period are not considered in the analysis. One method to screen proposed alternatives is to use the payback period analysis coupled with a maximum payback period to qualify for further consideration. Another method is to screen alternatives out that have a payback period beyond the expected life of the alternative. Example: Small business PC assembly startup: First cost = $200,000; annual cost = $50,000. Expected revenue is $90,000. Determine the payback using i = 0% and i = 15%. 5 Ohlinger 0 $50,000 i = 0%, 15% 1 2 3 4 5 $200,000 $90,000
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Lecture 11 P = –$200,000 NCF = ($90,000 – $50,000) n P = –NCF –$200,000 = – ($90,000 – $50,000) n n = 5 years at i = 0% P = –$200,000 NCF = ($90,000 – $50,000) (P/A, 15%, n) P = –NCF –$200,000 = – ($90,000 – $50,000) (P/A, 15%, n) (P/A, 15%, n) = 5.000 By interpolation, n = 10 years at i = 15% Bonds – Bonds are a common method for financing public and private projects. A bond is a loan, at a guaranteed interest rate ( bond coupon rate ), for a defined period. Generally, a bond is purchased at face value and interest is paid to the bond holder throughout the bond life. At maturity, the face value of the bond is paid to the bond holder. The amount of interest is determined by: ( 29 ( 29 face value of bond bond coupon rate I = number of payment periods per year Vb I c = 6 Ohlinger
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Lecture 11 For example, a $10,000 face value bond with a 6% bond coupon rate and semi annual payments will pay: ( 29 ( 29 $10,000 0.06 $300 2 I = = every six months The purchase price of bonds is market driven and is a function of interest rates.
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