Other Analysis Techniques Chapter 9: Newnan, Eschenbach, and Lavelle Dr. Hurley’s AGB 555 Course

Future Worth Analysis Future worth analysis focuses on examining what will be the value of an investment or costs at some point in the future Knowing the future worth of a project may be useful when you are shooting for a particular goal

Benefit Cost Ratio Analysis This ratio is calculated by taking the present worth of the benefits and dividing it by the present worth of the costs If the benefit cost ratio is greater than or equal to 1, then you would accept the project If you are looking at multiple alternatives, you want to calculate the incremental present worth of the benefits divided by the incremental present worth of the costs If the ratio is greater than or equal to one, you would choose the higher cost alternative

Payback Period The payback period examines the length of time it takes the investment to recoup the costs While this measure is used quite a bit, it does not take into account the time value of money Hence, it is not a very good measure of how good the investment is All economic consequences after the payback period has been met are ignored in this analysis

Sensitivity and Breakeven Analysis This analysis makes the assumption that there are aspects about the investment that are not known with certainty This is a very realistic assumption A sensitivity analysis looks at how sensitive your decision regarding an investment is when attributes about the decision might change E.g., initial costs are not predicted correctly, your timeline on the investment or returns is not correct Breakeven analysis looks at the conditions for alternatives being equivalent

Dealing With Multiple Alternatives for Investment When multiple alternatives exist for investment, it is useful to graph that investment in terms of interest rate and present worth (PW), equivalent uniform annual cost (EUAC), or equivalent uniform annual worth (EUAW) From this you can develop a choice table that tells you which alternative to choose at a particular rate When you dealing with PW and EUAW you choose the highest value, while EUAC would require you to choose the lowest value

Elements in Comparing Mutually Exclusive Alternatives Identify all alternatives Make sure to include the status quo or do nothing option in the analysis Graph PW, EUAC, or EUAW for each alternative on the same axis Examine the envelope (best line) for particular ranges of interest rates where the ranges are found by looking at where alternatives cross each other Calculate the changeover points for when one alternative begins to exceed another alternative You can do this visually or more accurately by calculating the incremental internal rate of return for the two crossing alternatives Create a choice table

Incremental Challenger- Defender Comparisons Alternatives are ranked from lowest cost to highest cost The lowest cost alternative starts out as the first defender Make sure the initial alternative has an IRR greater than MARR Next calculate the incremental internal rate of return between the two lowest cost alternatives that have not been excluded Choose the best alternative based on the rules given in the previous chapter The one that is considered the best becomes the defender for the next pairwise comparison Continue the comparison until no more can be made

Spreadsheet Tools for Examining Multiple Alternatives There are two useful tools in Excel to help you graphically examine multiple alternatives Goal Seek allows you to solve for interest rates that cannot be easily solved for by hand/formula Data Table allows you to run many different alternative interest rates at a single time which will allow you to develop your graphs more quickly especially when your returns are not constant over the life of the investment