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Investment Worth

Investment Worth. Investment Worth. MARR Suppose a company can earn 12% / annum in U. S. Treasury bills No way would they ever invest in a project earning < 12% Def: The Investment Worth of all projects are measured at the Minimum Attractive Rate of Return (MARR) of a company. MARR.

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Investment Worth

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  1. InvestmentWorth

  2. Investment Worth MARR Suppose a company can earn 12% / annum in U. S. Treasury bills No way would they ever invest in a project earning < 12% Def:The Investment Worth of all projects are measured at the Minimum Attractive Rate of Return (MARR) of a company.

  3. MARR MARRis company specific • utilities - MARR = 10 - 15% • mutuals - MARR = 12 - 18% • new venture - MARR = 20 - 30% MARR based on • firms cost of capital • Price Index • Treasury bills

  4. Investment Worth Alternatives • NPW(MARR) > 0 Good Investment

  5. Investment Worth Alternatives • NPW(MARR) > 0 Good Investment • EUAW(MARR) > 0 Good Investment

  6. Investment Worth Alternatives • NPW(MARR) > 0 Good Investment • EUAW(MARR) > 0 Good Investment • IRR > MARR Good Investment

  7. Present Worth Example: Suppose you buy and sell a piece of equipment. Purchase Price $16,000 Sell Price (5 years) $ 4,000 Annual Maintenance $ 3,000 Net Profit Contribution $ 6,000 MARR 12% Is it worth it to the company to buy the machine?

  8. 4,000 4,000 6,000 3,000 0 0 5 5 3,000 16,000 Present Worth NPW = -16 + 3(P/A,12,5) + 4(P/F,12,5) 16,000

  9. 4,000 4,000 6,000 3,000 0 0 5 5 3,000 16,000 Present Worth NPW = -16 + 3(P/A,12,5) + 4(P/F,12,5) = -16 +3(3.6048) + 4(.5674) 16,000

  10. 4,000 4,000 6,000 3,000 0 0 5 5 3,000 16,000 Present Worth NPW = -16 + 3(P/A,12,5) + 4(P/F,12,5) = -16 +3(3.6048) + 4(.5674) = -2.916 = -$2,916 16,000

  11. Annual Worth Annual Worth (AW or EUAW) AW(i) = PW(i) (A/P, i%, n) = [ At (P/F, i%, t)](A/P, i%, n) AW(i) = Annual Worth of Investment AW(i) > 0 **OK Investment** 

  12. 4,000 3,000 0 5 16,000 Annual Worth; Example Repeating our PW example, we have AW(12) = -16(A/P,12,5) + 3 + 4(A/F,12,5)

  13. 4,000 3,000 0 5 16,000 Annual Worth; Example Repeating our PW example, we have AW(12) = -16(A/P,12,5) + 3 + 4(A/F,12,5) = -16(.2774) + 3 + 4(.1574)

  14. 4,000 3,000 0 5 16,000 Annual Worth; Example Repeating our PW example, we have AW(12) = -16(A/P,12,5) + 3 + 4(A/F,12,5) = -16(.2774) + 3 + 4(.1574) = -.808 = -$808

  15. 4,000 3,000 0 5 16,000 Alternately AW(12) = PW(12) (A/P, 12%, 5) = -2.92 (.2774) = - $810 < 0 NO GOOD

  16. Internal Rate of Return Internal Rate-of-Return IRR- internal rate of return is that return for which NPW(i*) = 0 i* = IRR i* > MARR **OK Investment**

  17. Internal Rate of Return Internal Rate-of-Return IRR- internal rate of return is that return for which NPW(i*) = 0 i* = IRR i* > MARR **OK Investment** Alt: PWrevenue(i*) = PWcosts(i*)

  18. 4,000 3,000 0 5 16,000 Internal Rate of Return Example PW(i) = -16 + 3(P/A, i, 5) + 4(P/F, i, 5)

  19. 4,000 3,000 0 5 16,000 Internal Rate of Return Example PW(i) = -16 + 3(P/A, i, 5) + 4(P/F, i, 5)

  20. 4,000 3,000 0 5 16,000 Internal Rate of Return Example PW(i) = -16 + 3(P/A, i, 5) + 4(P/F, i, 5) i* = 5 1/4 % i* < MARR

  21. Summary • NPW > 0 Good Investment

  22. Summary • NPW > 0 Good Investment • EUAW > 0 Good Investment

  23. Summary • NPW > 0 Good Investment • EUAW > 0 Good Investment • IRR > MARR Good Investment

  24. Summary • NPW > 0 Good Investment • EUAW > 0 Good Investment • IRR > MARR Good Investment Note: If NPW > 0 EUAW > 0 IRR > MARR

  25. Internal Rate of Return Internal Rate-of-Return IRR- internal rate of return is that return for which NPW(i*) = 0 i* = IRR i* > MARR **OK Investment** Alt: FW(i*) = 0 = At(1 + i*)n - t PWrevenue(i*) = PWcosts(i*) 

  26. 4,000 3,000 0 5 16,000 Internal Rate of Return Example PW(i) = -16 + 3(P/A, i, 5) + 4(P/F, i, 5)

  27. 4,000 3,000 0 5 16,000 Internal Rate of Return Example PW(i) = -16 + 3(P/A, i, 5) + 4(P/F, i, 5) i* = 5 1/4 % i* < MARR

  28. Spreadsheet Example

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