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**Basic Methods for Making Economy Studies
**

Prepared by: Click to edit Master subtitle style Engr. Rolly C. Ramos

8/17/12

The Rate of Return (ROR) Method The rate of return on the capital invested is given by the formula Rate of Return = Net annual profit Capital invested Rate of return is a measure of the effectiveness of an investment of capital. isPrepared by: Rolly C. Ramos a financial efficiency 8/17/12 It .

Conditions: • a single investment of capital at the beginning of the first year of the project life and identical revenue and cost data for each year the capital invested is the total amount of capital investment required to finance the project Prepared by: Rolly C. Ramos 8/17/12 • • .

000 per year. Is this a desirable investment? a single investment of capital at the beginning of the first year of the project life identical revenue and cost data for each year ? √ ? √ Php270.000 can be made in a project that will produce a uniform annual revenue of Php85.400 Costs of operation = Php81.Example: An investment of Php270.400 for 5 years and then have a salvage value of 10% of the investment. Taxes and insurance will be 4% of the first cost per year.000/yr Solution Prepared by: Rolly C. Costs for operation and maintenance will be Php81.000 Uniform Annual Revenue = Php85. Ramos 8/17/12 . The company expects capital to earn not less than 25% before income taxes.

then the proposed investment is justified/valid. interest on the original investment (minimum required profit) is included as a cost. Prepared by: Rolly C. If the excess of annual cash inflows over annual cash outflows is not less than zero. Ramos 8/17/12 .The Annual Worth Method In this method.

400 Costs of operation = Php81. Is this a desirable investment? a single investment of capital at the beginning of the first year of the project life identical revenue and cost data for each year ? √ ? √ Php270.400 for 5 years and then have a salvage value of 10% of the investment.000/yr Solution Prepared by: Rolly C. Costs for operation and maintenance will be Php81.000 per year. Ramos 8/17/12 . The company expects capital to earn not less than 25% before income taxes.000 Uniform Annual Revenue = Php85.000 can be made in a project that will produce a uniform annual revenue of Php85.Example: An investment of Php270. Taxes and insurance will be 4% of the first cost per year.

zero. the project is justified economically. or greater than. If the present worth of the net cash flows is equal to.The Present Worth Method This pattern for economy studies is based on the concept of present worth. Advantage: It Prepared by: Rolly C. Ramos can8/17/12 used for is flexible and be .

Ramos 8/17/12 . Is this a desirable investment? No conditions to satisfy. Costs for operation and maintenance will be Php81. The company expects capital to earn not less than 25% before income taxes. Taxes and insurance will be 4% of the first cost per year. Solution Prepared by: Rolly C.400 for 5 years and then have a salvage value of 10% of the investment.Example: An investment of Php270.000 per year.000 can be made in a project that will produce a uniform annual revenue of Php85.

the project is justified economically. or greater than. If the future worth of the net cash flows is equal to.The Future Worth Method It is comparable to the present worth method except that all cash inflows and outflows are compounded forward to a future time. Ramos 8/17/12 . Advantage: Prepared by: Rolly C. zero.

000 can be made in a project that will produce a uniform annual revenue of Php85. Is this a desirable investment? No conditions to satisfy.400 for 5 years and then have a salvage value of 10% of the investment.000 per year.Example: An investment of Php270. Taxes and insurance will be 4% of the first cost per year. Ramos 8/17/12 . Solution Prepared by: Rolly C. The company expects capital to earn not less than 25% before income taxes. Costs for operation and maintenance will be Php81.

The Payback (Payout) Period Method The payback period is the length of time required to recover the first cost of an investment from the net cash flow produced by that investment for an interest rate of zero. Ramos 8/17/12 . Payout Period = investment – salvage value net annual cash flow Prepared by: Rolly C.

400 for 5 years and then have a salvage value of 10% of the investment.Example: An investment of Php270.000 per year. Costs for operation and maintenance will be Php81. Solution Prepared by: Rolly C. Taxes and insurance will be 4% of the first cost per year. Is this a desirable investment? No conditions to satisfy. Ramos 8/17/12 . The company expects capital to earn not less than 25% before income taxes.000 can be made in a project that will produce a uniform annual revenue of Php85.

End of Lecture Prepared by: Rolly C. Ramos 8/17/12 .

000 93.800 Net annual cash flows = 185.400 – 91.04) = 91.000 – 27.000 + 270.600 Payout Period = 2.000 (0.Payback Period: Total annual costs (excluding depreciation) = 81. Ramos .600 Payout Period = investment – salvage value net annual cash flow Payout Period = 270.6 years 8/17/12 Prepared by: Rolly C.800 = 93.

800 270.800 91. 5) = Php1.800 91.000 (F/P.400 185.000 185. the Prepared by: Rolly C.000 + 185.400 185.400 (8.04) 3 = 91.000 + 270.800 91.000 2(0.2070) = Php1.000 + 185.400 27.By the Future Worth Method: 185.400 185.390) = -Php28.580 Annual costs (excluding depreciation) 0 1 = 81.390 Since the FW of the net cash flows is less than zero (1.548. 5) + 91. .800 FW of cash outflows = 270.548. 25%.400 0 1 2 3 4 5 Cash flow diagram of cash inflows FW of cash inflows = 27. 25%.400 (F/A.577. 5) + = 27.810.800 (F/A.800 4 5 91.580 – 1. 25%. Ramos 8/17/12 investment is not justified.000 91.577.

5) = 185.800 PW of cash outflows = = 270.800 270. 5) Php516.000 + 270.370 – 516.400 185.000 (0.880 Since the PW of the net cash flows is less than zero (506. 25%.400 0 1 2 3 4 5 Cash flow diagram of cash inflows PW of cash inflows = 185.3277) = Php506.000 2(0.000 (P/F.400 185. 5) + 27. 25%.800 91.6893) + 27.800 91.000 + 91.400 185.800 4 5 91. the investment is Prepared 8/17/12 not justified.800 (P/A.370 Annual costs (excluding depreciation) 0 1 = 81. 25%.510.880) = -Php10.400 (2.400 27.000 91.400 (P/A.By the Present Worth Method: 185. Ramos .04) 3 = 91. by: Rolly C.000 185.800 91.

By the Annual Worth Method: Annual Revenue Annual 270.9 09 Php3.500 Php188.509).000 = 10. 5 Operation and Maintenance Taxes and Insurance (270.000 F/A.609 = 81.50 9 Since the excess of annual cash inflows over annual cash outflows is less than zero (-3.000 – Costs: Php185.000 * 25%) Total Annual Cost Excess .400 = 29. 25%. Prepared by: Rolly C. the investment is not justified.000 * 4%) Interest on capital (270.800 = 67. Ramos 8/17/12 Depreciation = 27.

609 Operation and Maintenance Taxes and Insurance (270. Prepared by: Rolly C.70% Since the rate of return is less than 25%. Ramos 8/17/12 . the investment is not justified.800 Php121. 25%.000 = 10.00 0 Depreciation = 27.400 = 29.99 1 x 100 = 23.000 – Costs: Php185. 5 = 81.000 * 4%) Total Annual CostAnnual Net Profit Php63.991 Rate of Return = Php270.By the Rate of Return Method: Annual Revenue Annual 270.000 F/A.4 09 Php63.

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