Present Worth Method of
Comparison
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Present Worth Method of Comparison, Schemes and Mind Maps of Industrial economy
The importance of present worth comparisons in selecting the best alternative among assets or investment projects. It provides an example of how to use the present worth method of comparison to suggest the best technology to be implemented based on initial outlay, annual revenues, interest rate, and life of the technology. It also includes another example of comparing the present worth of two investment proposals at a given interest rate.
Typology: Schemes and Mind Maps
2022/2023
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Present Worth Method of
Comparison
Why present worth comparisons?
- (^) Comparisons of assets or investment projects
are necessary in order to select the best
among the alternatives.
- (^) Two deciding factors govern in choosing
alternatives.
- (^) Minimisation of cost (use of least present
worth).
- (^) Maximisation of profit (maximum present
value).
REVENUE-DOMINATED CASH FLOW DIAGRAM
- (^) A generalized revenue-dominated cash flow diagram to demonstrate the present worth method of comparison is shown in the below Figure. - P represents an initial investment - Rj the net revenue at the end of the jth year. - (^) i The interest rate is i, compounded annually. - (^) S is the salvage value at the end of the nth year. Formula to find the present worth of the above cash flow diagram for a given interest rate is
EXAMPLE-1: Alpha Industry is planning to expand its production operation. It has identified three different technologies for meeting the goal. The initial outlay and annual revenues with respect to each of the technologies are summarized in the below table. Suggest the best technology which is to be implemented based on the present worth method of comparison assuming 20% interest rate, compounded annually.
Since the present worth of technology 2 is the highest among the other two Technology 2 is suggested for implementation to expand the production.
The total present worth cost of bid 1 is less than that of
bid 2. Hence, bid 1 Alpha Elevator Inc. is to be purchased
and installed in the new building
The present worth of Investment Proposal B at i = 18% is computed as