Académique Documents
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Outline
Objectives /Introduction /Symbols
Equivalence & Conventions
Interest
Discount Factors
Equivalent Worth
Cash Flow Analysis
Multiple Alternatives
Incremental Analysis
Tax Consideration
Objectives
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
Introduction
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Alternative
2
Incremental
Analysis
Tax
Considerations
Alternative
1
Alternative
3
Maximization of benefit.
Minimization of cost.
or Maximization of the net profit.
20 March 2015
Economic Analysis
Symbols
Equivalence &
Conventions
Discount
Factors
Interest
Cash Flow
Analysis
Benefits or income
Cost or expenses
EOY
EUAC
EUAW
Future value
Incremental
Analysis
Tax
Considerations
Present value
ROR
Multiple
Alternatives
EUAB
MARR
20 March 2015
Equivalent
Worth
Rate of return
Sn
Economic Analysis
Equivalence
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
Conventions
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
10
Conventions
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Salvage Value
Residual value resulting in income at the end of the useful life of an alternative.
The resale or salvage value may be associated with the anticipated market value
of the asset at that point in time.
It is shown as an upward arrow on the cash flow diagram.
Any significant costs associated with disposal at the end of useful life also can be
shown on the diagram as a downward arrow.
20 March 2015
Economic Analysis
11
Conventions
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Example:
An investor bought an equipment and paid an advance payment of $ 20,000.
He is required to pay annual operation cost of $ 500 at the end of each year.
He is required to pay maintenance cost of $0, $100, $200, $300, and $400 at
the end year 1, 2, 3, 4 and 5 respectively.
He is expecting a revenue of $5,000 at the end of each year from renting the
equipment to outside users.
At the end of the fifth year he is planning to sell it for $10,000.
20 March 2015
Economic Analysis
12
Conventions
Equivalence &
Conventions
Discount
Factors
Interest
YEAR
20 March 2015
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
INCOME
Incremental
Analysis
EXPENSE
$20,000
$5,000
$500
$5,000
$600
$5,000
$700
$5,000
$800
$15,000
$900
Economic Analysis
Tax
Considerations
13
Conventions
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
$15,000
$5,000
Time Line
$5,000
2
$500
$5,000
3
$600
$5,000
$700
$800
Time Line
$900
$20,000
CASH OUT : COST / EXPENDITURE / DISBURESMENTS
20 March 2015
Economic Analysis
14
Conventions
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Time Line
$5,000
2
$500
$5,000
3
$500
$100
$5,000
4
$500
$200
$5,000
5
$500
$300
Time Line
$500
$400
$20,000
CASH OUT : COST / EXPENDITURE / DISBURESMENTS
20 March 2015
Economic Analysis
15
Conventions
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
S = $10,000
A = $5,000
Time Line
Time Line
A = $500
G = $100
$20,000
CASH OUT : COST / EXPENDITURE / DISBURESMENTS
20 March 2015
Economic Analysis
16
Interest
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Interest Types:
Simple Interest
Compound Interest
Nominal Interest Rate
Effective Interest Rate
Continuous Compounding
Minimum Attractive Rate of Return (MARR)
20 March 2015
Economic Analysis
18
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Simple Interest
The interest due is proportional to the length of time the principal is
outstanding and does not accrue or compound on previous interest. Each
subsequent interest payment is calculated based on the total principal, ignoring
accumulated interest to date.
SIMPLE INTEREST (i = 10%)
20 March 2015
Principal
$1,000
$100
$100
Total at EOY2
$1,200
Economic Analysis
19
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Compound Interest
The interest is considered an increased increment of principal earning
additional interest with time. Each subsequent interest payment is calculated
based on total principal plus accumulated interest to date.
COMPOUND INTEREST (i = 10%)
Principal
$1,000
$100
20 March 2015
$110
Total at EOY2
$1,210
Economic Analysis
20
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
21
Interest
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
k
= ( 1 + r/k)
i
20 March 2015
- 1
k
= ( 1 + ) -
(equation 27.1)
(equation 27.2)
Economic Analysis
22
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
More than 1%
Equal to1%
Less than 1%
None of the above is correct
A1: C, The monthly interest rate must be less than 1. Were it 1% per
month and not compounded at all, then the annual return would be 12 X
1% = 12%, which the stated effective rate. But the monthly rate is
compounded in this case, so the annual rate would exceed 12%, if the
monthly rate were 1%. Since the effective annual rate is 12%, not more,
then the compounded monthly rate must be less than 1%.
20 March 2015
Economic Analysis
23
Interest
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Q2: Given the interest rate of 12%, find the effective and annual rate for
yearly, semi annual, and monthly compounding.
A2:
i = (1 +
k
)
1 where = r/k
Economic Analysis
24
Interest
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Continuous Compounding
Discrete compounding occurs when interest payments are made at the end of
finite compounding periods such as annually, monthly, quarterly, or daily.
As the duration of the interest period becomes infinitely short, the number of
compounding periods per year becomes infinite and is referred to as
continuous compounding.
20 March 2015
r
= e
- 1
(equation 27.3)
Economic Analysis
25
Interest
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
26
Discount Factors
Discount Factors
Equivalence &
Conventions
Interest
FACTOR
Single Payment
Compound Amount
Single Payment
Present Worth
Uniform series
Sinking Fund
Uniform Series
Capital Recovery
Uniform Series
Compound Amount
Uniform Series
Present worth
Arithmetic Gradient
Uniform Series
Arithmetic Gradient
Present Worth
20 March 2015
Discount
Factors
CONVERT
S
P to F
F to P
F to A
P to A
A to F
A to P
G to A
G to P
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
NOTATION
(F/P, i, n)
(P/F, i, n)
(1 +
n
i)
(1 +
-n
i)
n
i)
i / ( (1 +
(A/P, i, n)
i (1 +
n
i)
/ ( (1 +
( (1 +
n
i)
1) / i
( (1 +
n
i)
(P/A, i, n)
Tax
Considerations
FORMULA
(A/F, i, n)
(F/A, i, n)
Incremental
Analysis
1)
n
i)
1)
1)/ ( i (1 +
(A/G, i, n)
( 1 / i) ( n / ((1
n
+i)
(P/G, i, n)
n
i)
2
i
( ( (1 +
Economic Analysis
n
i)
1)
1)/ ( (1 +
n
i)
) ) ( n / ( i (1 +
n
i)
28
Discount Factors
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.0500
0.9524
1.0000
1.0500
1.0000
0.9524
0.0000
0.0000
1.1025
0.9070
0.4878
0.5378
2.0500
1.8594
0.4878
0.9070
1.1576
0.8638
0.3172
0.3672
3.1525
2.7232
0.9675
2.6347
1.2155
0.8227
0.2320
0.2820
4.3101
3.5460
1.4391
5.1028
1.2763
0.7835
0.1810
0.2310
5.5256
4.3295
1.9025
8.2369
1.3401
0.7462
0.1470
0.1970
6.8019
5.0757
2.3579
11.9680
1.4071
0.7107
0.1228
0.1728
8.1420
5.7864
2.8052
16.2321
1.4775
0.6768
0.1047
0.1547
9.5491
6.4632
3.2445
20.9700
1.5513
0.6446
0.0907
0.1407
11.0266
7.1078
3.6758
26.1268
10
1.6289
0.6139
0.0795
0.1295
12.5779
7.7217
4.0991
31.6520
20 March 2015
Economic Analysis
29
Discount Factors
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.0600
0.9434
1.0000
1.0600
1.0000
0.9434
0.0000
0.0000
1.1236
0.8900
0.4854
0.5454
2.0600
1.8334
0.4854
0.8900
1.1910
0.8396
0.3141
0.3741
3.1836
2.6730
0.9612
2.5692
1.2625
0.7921
0.2286
0.2886
4.3746
3.4651
1.4272
4.9455
1.3382
0.7473
0.1774
0.2374
5.6371
4.2124
1.8836
7.9345
1.4185
0.7050
0.1434
0.2034
6.9753
4.9173
2.3304
11.4594
1.5036
0.6651
0.1191
0.1791
8.3938
5.5824
2.7676
15.4497
1.5938
0.6274
0.1010
0.1610
9.8975
6.2098
3.1952
19.8416
1.6895
0.5919
0.0870
0.1470
11.4913
6.8017
3.6133
24.5768
10
1.7908
0.5584
0.0759
0.1359
13.1808
7.3601
4.0220
29.6023
20 March 2015
Economic Analysis
30
Discount Factors
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
31
Discount Factors
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Time Line
Economic Analysis
32
Equivalent Worth
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
34
Equivalent Worth
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
YEAR
EXPENSE
INCOME
$38,000
$11,000
$1,000
$11,000
$2,000
$11,000
$3,000
$11,000
Economic Analysis
35
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
By computing the present value of the net cash flow for each year.
By using the cash flow diagram.
By computing the future value of the net cash flow for each year.
By using the cash flow diagram.
20 March 2015
Economic Analysis
36
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
YEAR
EXPENSE
INCOME
NET
$38,000
($38,000)
$11,000
$11,000
$1,000
$11,000
$10,000
$2,000
$11,000
$9,000
$3,000
$11,000
$8,000
TOTALS
$44,000
$44,000
Economic Analysis
37
Equivalent Worth
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
EOY
Time Line
G = $1,000
$38,000
20 March 2015
Economic Analysis
38
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
EXPENSE
INCOME
NET
$38,000
FACTOR
PW
($38,000)
1.0000
($38,000)
$11,000
$11,000
F (P/F, 6%, 1)
0.9434
$10,377
$1,000
$11,000
$10,000
F (P/F, 6%, 2)
0.8900
$8,900
$2,000
$11,000
$9,000
F (P/F, 6%, 3)
0.8396
$7,556
$3,000
$11,000
$8,000
F (P/F, 6%, 4)
0.7921
$6,337
TOTALS
$44,000
$44,000
20 March 2015
NOTATION
Economic Analysis
($4,829)
39
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
NET
NOTATION
FACTOR
PW
1.0000
($38,000)
4.9455
($4,946)
3.4651
$38,116
($38,000)
P = P0 + P1 + P2 =
Economic Analysis
($4,829)
40
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
EXPENSE
INCOME
$38,000
$11,000
$11,000
$1,000
$11,000
$2,000
4
TOTALS
20 March 2015
NET
NOTATION
FACTOR
1.2625
($47,975)
P (F/P, 6%, 3)
1.1910
$13,101
$10,000
P (F/P, 6%, 2)
1.1236
$11,236
$11,000
$9,000
P (F/P, 6%, 1)
1.0600
$9,540
$3,000
$11,000
$8,000
1.0000
$8,000
$44,000
$44,000
Economic Analysis
FW
($6,098)
41
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
NET
FACTOR
FW
($38,000)
1.2625
($47,975)
($1,000)
($6,244)
4.3746
$48,121
$11,000
NOTATION
TOTALS
20 March 2015
F = F0 + F1 + F2 =
Economic Analysis
($6,098)
42
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
NET
NOTATION
A0
($38,000)
P (A/P, 6%, 4)
0.2886
($10,967)
A1
($1,000)
G (A/G, 6%, 4)
1.4272
($1,427)
A2
$11,000
1.0000
$11,000
A = A0 + A1 + A2 =
($1,394)
TOTALS
20 March 2015
Economic Analysis
FACTOR
AW
43
Equivalent Worth
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
NOTATION
FW
NOTATION
20 March 2015
FACTOR
AW
0.2886
($1,394)
FACTOR
AW
0.2286
($1,394)
Economic Analysis
44
Equivalent Worth
Equivalence &
Conventions
Discount
Factors
Interest
EOY
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Time Line
A = $1,394
$4,829
20 March 2015
$6,098
Economic Analysis
45
Equivalent Worth
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Q1: The following chart shows ending of period cash flows for expenses.
The interest rate is 10%:
YEAR
EXPENSE
$100
$100
$100
$100
$100
A1:
NPW
$500
$269
$316.99
$379.08
= $100 (P/A,10%,5)
= $100 (3.7908)
= $379.08
20 March 2015
Economic Analysis
46
Equivalent Worth
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
SAVINGS
$2,667
$14,292
$19,181
$13,114
A2:NPW
$746
$5,223
$9,296
$12,397
20 March 2015
Economic Analysis
47
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
49
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
INCOME
0
1
EXPENSE
$10,000
$2,342
$2,342
$2,342
$2,342
$2,342
EOY
$10,000
20 March 2015
Economic Analysis
50
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
1. Set present worth (PW) of benefits equal to the present worth (PW)
of costs.
Benefits PW = Cost PW
Benefits PW = $2,342 (P/A, I, 5)
Cost PW = $10,000
$2,342 (P/A, i, 5) = $10,000
(P/A, i, 5) = $10,000 / $2,342
(P/A, i, 5) = 4.270
20 March 2015
Economic Analysis
51
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
2. Look at the compound interest factors tables and read the factor
value where the P/A column intersect with the row where n = 5 for
a factor equal to or around the value of 4.270.
I = 5%
n
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.2763
0.7835
0.1810
0.2310
5.5256
4.3295
1.9025
8.2369
I = 6%
n
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.3382
0.7473
0.1774
0.2374
5.6371
4.2124
1.8836
7.9345
20 March 2015
Economic Analysis
52
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
(P/A, i, 5)
i1 = 5.0%
F1 = 4.379
i = ?
Fi = 4.270
i2= 6.0%
F2 = 4.212
By interpolation i = 5.5%
20 March 2015
Economic Analysis
53
Multiple Alternatives
Multiple Alternatives
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Many projects will require a selection from among several mutuallyexclusive alternatives. The selection of one alternative will preclude
the selection of any other alternative. Two simple rules will help
identify the preferred alternative:
Compute the net present worth of each alternative at the required minimum
attractive rate of return (MARR).
Select the alternative having the highest net worth
20 March 2015
Economic Analysis
55
Multiple Alternatives
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
ALTERNATIVE B
ALTERNATIVE C
-$2,500
-$2,700
-$3,000
$650
$650
$350
$650
$700
$650
$1050
$3,100
$650
$1400
$600
$550
$500
TOTAL
20 March 2015
ALTERNATIVE A
Economic Analysis
56
Multiple Alternatives
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.2763
0.7835
0.1810
0.2310
5.5256
4.3295
1.9025
8.2369
ALTERNATIVE
NOTATION
FACTOR
NPW
0.7835
-$71
4.3295
$114
8.2369
-$117
20 March 2015
Economic Analysis
57
Multiple Alternatives
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Analysis Period
When comparing alternatives using present worth methods, it is necessary to
analyze over a common planning horizon.
In the event that alternatives do not have equal lives, consideration must be
given to the difference. A common technique is to select an analysis period
equal to the least common multiple of the alternative lives.
Another approach is to select an analysis period and determine the salvage
value for each alternative at that point in time.
When using annual worth methods there is no need to establish equal lives.
20 March 2015
Economic Analysis
58
Multiple Alternatives
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Capitalized Cost
Problems occasionally arise involving extremely long analysis periods. For
example, in governmental analysis of permanent structures such as roads, dams,
and pipelines, the required maintenance can be spread over an infinite period (n
= ). In these cases the analysis is called capitalized cost.
Simply stated, capitalized cost is the present sum of money that would have to
be set aside now, at a given interest rate, to provide a perpetual uniform cash
flow.
20 March 2015
Economic Analysis
59
Incremental Analysis
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Assume that you have the following two alternatives. Which one
would you select?
20 March 2015
ALTERNATIVE
ROR
100%
20%
Economic Analysis
61
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
INITIAL INVESTMENT
ROR
EOY PROFIT
$100
100%
$100
$10,000
20%
$2,000
20 March 2015
Economic Analysis
62
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
This illustrate the need for a procedure to evaluate the return on the
increment of initial investment if one alternative requires a higher
initial investment than the other.
This process should also apply to multiple alternatives. By examining
the differences between alternatives, we can determine whether or
not the differential costs are justified based on the differential
benefits.
20 March 2015
Economic Analysis
63
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Rate of Return
This technique is based on the paired comparison of alternatives. The following
steps should be followed in an incremental rate-of-return analysis:
1.
2.
Compute ROR for each alternative and discard any alternative with ROR < MARR.
3.
4.
Calculate the ROR on the difference between the first two (lowest initial cost) alternatives. If
this ROR MARR, retain the higher cost alternative, otherwise retain the lower cost
alternative.
5.
Take the retained alternative from the previous step and compare it to the next higher
alternative.
6.
20 March 2015
Economic Analysis
64
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
ALTERNATIVE A
ALTERNATIVE B
ALTERNATIVE C
-$2,500
-$2,738
-$3,000
$650
$650
$350
$650
$700
$650
$1,050
$3,190
$650
$1,400
Economic Analysis
65
Incremental Analysis
Equivalence &
Conventions
Discount
Factors
Interest
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
1.2763
P/F
0.7835
A/F
0.1810
A/P
0.2310
F/A
5.5256
P/A
4.3295
A/G
1.9025
P/G
8.2369
F/A
5.6371
P/A
4.2124
A/G
1.8836
P/G
7.9345
i = 6%
n
5
F/P
1.3382
ALTERNATIVE
P/F
0.7473
A/F
0.1774
A/P
0.2374
NOTATION
FACTOR
0.7835
5%
4.2124
6%
8.5714
ROR<MARR
20 March 2015
Economic Analysis
66
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
ALTERNATIVE A
ALTERNATIVE B
B - A
-$2,500
-$2,738
-$238
$650
$650
$650
$650
$650
$650
$650
$650
$3,190
$650
-$2,540
Economic Analysis
67
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
1.2155
1.2763
P/F
0.8227
0.7835
A/F
0.2320
0.1810
A/P
0.2820
0.2310
F/A
4.3101
5.5256
P/A
3.5460
4.3295
A/G
1.4391
1.9025
P/G
5.1028
8.2369
YEAR 0 COST
-$238
YEAR 5 COST
-2,540 X 0.7835
-$1,990
$650 X 3.5460
$2,305
Economic Analysis
$77
68
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
6. Since the benefits are greater than the costs, or in other words, the
net present worth of the increment is greater than 0, the rate-ofreturn on the increment must be something greater than 5 percent
and we therefore accept the increment and retain the higher cost
alternative, B.
20 March 2015
Economic Analysis
69
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Benefit-Cost Ratio
The incremental approach for the analysis of two or more alternatives will
follow the same procedure as that for rate-of-return analysis.
1.
2.
3.
4.
5.
6.
OR
Economic Analysis
70
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
ALTERNATIVE A
ALTERNATIVE B
ALTERNATIVE C
-$2,500
-$2,738
-$3,000
$650
$650
$350
$650
$700
$650
$1,050
$3,190
$650
$1,400
Economic Analysis
71
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
F/P
1.2763
ALTERNATIVE
P/F
0.7835
A/F
0.1810
A/P
0.2310
F/A
5.5256
BENEFIT/COST RATIO
P/A
4.3295
A/G
1.9025
P/G
8.2369
NOTES
Acceptable
Acceptable
Not
Acceptable
20 March 2015
Economic Analysis
72
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
ALTERNATIVE A
ALTERNATIVE B
B - A
-$2,500
-$2,738
-$238
$650
$650
$650
$650
$650
$650
$650
$650
$3,190
$650
-$2,540
Economic Analysis
73
Incremental Analysis
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
20 March 2015
Economic Analysis
74
Tax Consideration
Tax Consideration
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Because taxes have been ignored in our analysis, the results are
considered a before-tax cash flow.
20 March 2015
Economic Analysis
76
Tax Consideration
Equivalence &
Conventions
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Considerations
Interest
Discount
Factors
Tax laws are complex and changing. All of the principles and
techniques that have been developed can be applied to an after-tax
analysis.
20 March 2015
Economic Analysis
77
AACE International
Arabian Gulf Section
CCP Certification
Exam Preparation Workshop
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Consideration
Problem
Solving
i = 6%
n
F/P
P/F
A/F
A/P
F/A
P/A
A/G
P/G
1.0600
0.9434
1.0000
1.0600
1.0000
0.9434
0.0000
0.0000
1.1236
0.8900
0.4854
0.5454
2.0600
1.8334
0.4854
0.8900
1.1910
0.8396
0.3141
0.3741
3.1836
2.6730
0.9612
2.5692
1.2625
0.7921
0.2286
0.2886
4.3746
3.4651
1.4272
4.9455
1.3382
0.7473
0.1774
0.2374
5.6371
4.2124
1.8836
7.9345
1.4185
0.7050
0.1434
0.2034
6.9753
4.9173
2.3304
11.4594
1.5036
0.6651
0.1191
0.1791
8.3938
5.5824
2.7676
15.4497
1.5938
0.6274
0.1010
0.1610
9.8975
6.2098
3.1952
19.8416
1.6895
0.5919
0.0870
0.1470
11.4913
6.8017
3.6133
24.5768
10
1.7908
0.5584
0.0759
0.1359
13.1808
7.3601
4.0220
29.6023
20 March 2015
Economic Analysis
79
Uniform Gradient
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Consideration
Problem
Solving
Uniform Gradient
EOY
Time Line
$300
$400
$500
$600
$700
20 March 2015
Economic Analysis
80
Uniform Gradient
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Consideration
Problem
Solving
Uniform Gradient
EOY
1
$400
$400
$400
$400
Time Line
$300
P = $300
A = $400
G = $100
20 March 2015
$100
$200
$300
Economic Analysis
81
Uniform Gradient
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Consideration
Problem
Solving
Uniform Gradient
EOY
Time Line
G = $100
20 March 2015
Economic Analysis
82
Linear Interpolation
Equivalence &
Conventions
Interest
Discount
Factors
Equivalent
Worth
Cash Flow
Analysis
Multiple
Alternatives
Incremental
Analysis
Tax
Consideration
Problem
Solving
20 March 2015
Economic Analysis
83