1 / 13

Evaluating the Profitability of an Investment

Evaluating the Profitability of an Investment. Jim Dunn Ag Economist Penn State University 203 Armsby Building University Park, PA 16802 jwd6@psu.edu 814-863-8625. Introduction. Money now is more valuable than money later Some method of comparing the two is necessary Three choices

Download Presentation

Evaluating the Profitability of an Investment

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Evaluating the Profitability of an Investment Jim Dunn Ag Economist Penn State University 203 Armsby Building University Park, PA 16802 jwd6@psu.edu 814-863-8625

  2. Introduction • Money now is more valuable than money later • Some method of comparing the two is necessary • Three choices • Net present value • Benefit cost ratio • Internal rate of return • All imply a discount rate

  3. Discount Rate • Amount by which you deflate future amounts to compare them to current amounts • Borrowing rate • Return on alternative investment • Rate which reflects the risk of unpleasant surprise – Union Pacific 25% (high interest rate period)

  4. Net Present Value • Take all current cash flows and discount them to now • Deflate them by discount rate • (1+r)n • r is discount rate • n is years in future

  5. Simple ExampleNet Present Value

  6. Benefit Cost Ratio • Use net present value numbers but put discounted benefits in numerator and discounted benefits in denominator

  7. Simple ExampleNet Present Value

  8. Benefit Cost Ratio • Ratio = Discounted net benefits over net costs • =($1,109/$1,000) = 1.109 • At this discount rate the numbers say it is worth doing

  9. Internal Rate of Return • Discount rate where net present value equals zero • For our example, the rate is 15%

  10. Simple ExampleNet Present Value

  11. Benefits of these tools • Compare investments that are not similar • Compare investments of different life • Objective evaluation of the numbers

  12. Important factors • Include all the costs – operator labor • Include all the benefits (money you don’t have to spend)

  13. Challenges • Benefits or costs borne by others • Estimating numbers • Anticipating surprises • Bob Graves will address some of these issues next

More Related