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Chapter 6 - Annual Worth Analysis Click here for Streaming Audio To Accompany Presentation (optional). EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz Industrial & Manufacturing Engineering Department Cal Poly Pomona. EGR 403 - The Big Picture.

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Chapter 6 annual worth analysis click here for streaming audio to accompany presentation optional

Chapter 6 - Annual Worth AnalysisClick here for Streaming Audio To Accompany Presentation (optional)

EGR 403 Capital Allocation Theory

Dr. Phillip R. Rosenkrantz

Industrial & Manufacturing Engineering Department

Cal Poly Pomona


Egr 403 the big picture

EGR 403 - The Big Picture

  • Framework:Accounting& Breakeven Analysis

  • “Time-value of money” concepts - Ch. 3, 4

  • Analysis methods

    • Ch. 5 - Present Worth

    • Ch. 6 - Annual Worth

    • Ch. 7, 8 - Rate of Return (incremental analysis)

    • Ch. 9 - Benefit Cost Ratio & other techniques

  • Refining the analysis

    • Ch. 10, 11 - Depreciation & Taxes

    • Ch. 12 - Replacement Analysis

EGR 403 - Cal Poly Pomona - SA8


Annual cash flow calculations resolving a present cost to an annual cost

Annual Cash Flow CalculationsResolving a Present Cost to an Annual Cost

  • A is -PMT in EXCEL.

  • To duplicate the A/P factor, put the value for P in place of PV in the PMT fields:

  • PMT(rate, nper, pv, fv, type)

  • (fv and type are 0)

  • To duplicate the A/F factor, put the value for F in place of FV in:

  • PMT(rate, nper, pv, fv, type)

  • (pv and type are 0)

  • Simplest case is to convert the PV to an A-series (annual worth):

    • A = P(A/P, i, n)

  • Where there is salvage value:

    • A = F(A/F, i, n)

See Examples 6 -1 & 2

EGR 403 - Cal Poly Pomona - SA8


Annual cash flow four essential points

Annual Cash FlowFour Essential Points

  • EUAC = PWC(A/P, i, n)

  • EUAB = PWB(A/P, i, n)

  • EUAW = EUAB - EUAC

  • EUAW is

    • Decreased by a cost.

    • Increased by a benefit.

  • In MS Excel use “-PMT” to calculate EUAW

    (remember the minus sign)

  • For an irregular cash flow over the analysis period first determine the PW then convert to EUAW.

EGR 403 - Cal Poly Pomona - SA8


Annual cash flow analysis

Situation

Criterion

Fixed input

Amount of capital available fixed

Maximize EUAB

Fixed output

$ amount of benefit is fixed

Minimize EUAC

Neither fixed

Neither capital nor $ benefits are fixed

Maximize EUAW

Annual Cash Flow Analysis

EGR 403 - Cal Poly Pomona - SA8


Two more examples of resolving a pw to an euaw

Two More Examples of Resolving a PW to an EUAW

These two examples further illustrate:

  • The equivalency of PW and EUAW.

  • Example 6-5 (Example 5-1)

  • Example 6-6 EUAW

EGR 403 - Cal Poly Pomona - SA8


Analysis period considerations

Analysis Period Considerations

  • Analysis period equal to alternative lives.

  • Analysis period a common multiple of alternative lives.

  • Analysis period for a continuing requirement.

  • Some other period such as project life.

EGR 403 - Cal Poly Pomona - SA8


Analysis period equal to alternative lives

Analysis Period Equal to Alternative Lives.

  • Base the comparison on the life of the alternatives.

  • This is the case we have most often considered in our examples.

  • This is rarely the case in ‘real’ life organizations.

EGR 403 - Cal Poly Pomona - SA8


Analysis period a common multiple of alternative lives

Analysis Period a Common Multiple of Alternative Lives.

  • When the lives of the equipment in the two alternatives varies, use a common multiple of the two lives.

  • Example 6-7

  • However, calculations are simplified. You only need to use one useful life to get the EUAW.

EGR 403 - Cal Poly Pomona - SA8


Analysis period for a continuing requirement

Analysis Period for a Continuing Requirement.

  • Where the project will last forever (nothing does) use an infinite time period.

  • In most analyses organizations often use a representatively long time period to get a reasonable estimate.

  • Example 6-9: Alt A has infinite analysis period. Use A = P i

EGR 403 - Cal Poly Pomona - SA8


Some other period such as project life

Some Other Period Such AsProject Life.

  • Most often physical equipment has a useful life that varies from the project life.

  • In this case use the project life as the analysis period.

  • This is the most common case in ‘real’ organizations.

EGR 403 - Cal Poly Pomona - SA8


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