Economic Justification

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Economic Justification
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Economic Justification

• Used to evaluate project alternatives
• Compare projects
• Often a hurdle rate (eg. An IRR of gt 20)
• Variety of measurements
• Net Present Worth, NPV
• IRR
• etc.

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Single Payment COMPOUND Interest

• P (P)resent sum of money
• i (i)nterest per time period (usually years)
• n (n)umber of time periods (usually years)
• F (F)uture sum of money that is equivalent to P
  given an interest rate i for n periods
• FP(1i)n PF(1i)-n
• Can also use tables, financial calculator,
  spreadsheet

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Example

• You invest 10,000 in a tax deferred retirement
  plan 401(k) or 403(b) or IRA. What is the
  expected balance after a) 20 years b) 40 years
  with annual return of
• i) 5 fixed rate interest and
• ii) 12 return from stocks (equities)?
• Note can also calculate PW of future income or
  costs

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NPW
Net Present Worth, NPW, may be used to establish
the current market value of projected future
benefits and costs associated with an investment
opportunity at some i. (examples include real
property and bond valuations.) NPW PW of
Benefits - PW of Costs PWB - PWC For a project
to be (barely) acceptable, the NPW must be gt 0.
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Purchase of Manhattan
n373
24

• PWC24
• PWB12X109(1i)-n
• Calculate for given i
• NPW PWB - PWC

12,000,000,000
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Rate of Return Analysis

• Rate of return analysis is equivalent to other
  methods and is the most frequently used.
• Interest rate provides a common metric for
  comparison

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Internal Rate of Return

• Internal Rate of Return, IRR, is the interest
  rate at which the discounted present worth of
  benefits equals the discounted present worth of
  costs, i.e. the Net Present Worth, NPW, 0.

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Purchase of Manhattan
n373
24

• PWC24
• PWB12X109(1i)-n
• PWCPWB
• ln(1i) -ln(24/ 12X109)/n
• i5.55

12,000,000,000