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(Future Worth Analysis, Benefit-Cost Ratio

Analysis and Payback Period)

Date:20/11/2017

1

Future Worth Analysis

Benefit-Cost (B/C) Ratio Analysis

Payback Period/Time

Cost Ratio and Payback Period Analysis

2

Part I

3

Future Worth Analysis

analysis, dealing with then (future worth) rather than with

now (present worth) situations.

4

Example 1

carton of cigarettes a week. He wonders how much money he

could accumulate by age 65 if he quit smoking now and put his

cigarette money into a savings account. Cigarettes cost $35

per carton. Ron expects that a savings account would earn 5%

interest, compounded semi annually. Compute Ron's future

worth at age 65.

Solution:

Future worth (FW) = A(F/A, 2.5%, 90) = 910 (329.2) = $299,572

5

Example 2

6

Example 2

7

Benefit-Cost Ratio Analysis

8

Benefit-Cost Ratio Analysis

consider an alternative acceptable, provided:

PW of benefits- PW of costs ≥ 0, or EUAB - EUAC ≥ 0

o or

9

Example 3

reduce costs in a particular situation. Both devices cost

$1000 and have useful lives of 5 years and no salvage value.

Device B will provide cost savings of $400 the first year, but

savings will decline by $50 annually, making the second

year savings $350, the third-year savings $300, and so forth.

With interest at 7%, which device should the firm purchase?

10

Recall: Example 1 in PW Analysis

Example 3

12

Example 4

13

Example 4: Solution

14

Example 4: Solution cont.

15

Example 4: Solution cont.

16

Example 5

Consider six mutually exclusive alternatives A-F. They have

20 year useful lives and no salvage value. If the minimum

attractive rate if return is 6%, which alternatives should be

selected?

17

Example 5: Solution

18

Example 5: Solution cont.

19

Part II

20

Payback Period

profit or other benefits of an investment to equal the cost

of the investment.

period.

21

Example 6

22

Example 6: Solution

23

Example 7

24

Example 7: Solution cont.

(a)Atlas Scale; (b) Tom Thumb Scale.

To25 minimize Payback Period, select the Atlas Scale

(However, see next…….)

Note: Disadvantage of Payback Period

Payback period may select the wrong alternative.

When payback period is used, the Atlas scale appears to be

the more attractive alternative. Using present worth

method (Example 5-4 in Newmann's book), the Tom

Thumb scale was the chosen alternative. A review of the

problem reveals the reason for the different conclusions.

The $700 salvage value at the end of 6 years for the Tom

Thumb scale is a significant benefit. The salvage value

occurs after the payback period, so it was ignored in the

payback calculation. It was considered in the present worth

analysis, with the result that the Tom Thumb scale was in

fact more desirable.

Exercise

b) Benefit-Cost Ratio

c) The Payback Period

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