Economics

What do you need to determine to compare and rank multiple projects

• Mutually exclusive

• Independent

• Divisible (part of a project)

• Indivisible (all or nothing)

If capital is unlimited accept any project with NPV > 0, IRR>=MAR, or B / C >= 1

______ Projects are those not affected by the cash flows of other projects

Independent

____ _____ Projects means there are two options for accomplishing the same result

Mutually exclusive.

What does a negative NPV mean for both projects

Reject both projects

Unequal size

Normalizing for size: add smaller projects until they match the capital requirements of the larger pop

Required if the NVP >0 and IRR>MAR

Always required for an IRR or B/C comparison

Profitability Index (PI) method

Helps us compare projects of varying sizes by calculating the ratio of NVP to initial investment

NVP / Cost

Choose the project with the highest PI for the most efficient use of capital and potentially the highest return on investment

A PI greater than 1 indicates the project creates value, while a PI less than 1 suggests it destroys value

Unequal Time

Long duration vs short duration

Maximize long run cash flows in

If it can not be repeated than timeline can not be equalized apply Equivalent Annual Annuity

Replacement Chain Approach

as many short life projects as necessary are strung together to equal the life of the long project

This method can be tedious when the length of the longer project is not a multiple of the shorter project

Equivalent Annual Annuity (EAA)

Helps compare projects with different lifespans by converting their NPVs into a single, annual cash flow

Divide each projects NPV by the corresponding present value of an annuity factor (based on the discount rate and lifespan) to find the EAA.

Choose the project with the highest EAA for the highest average annual cash flow potential.

Terminal Value Approach

Select a common lifespan

Determine Net Present Value

Lifespans may or may not be common (@)

How to use VPS for Forest Value

Forest Value = Land value + timber value

what is forest value

is the present value of the projected costs and revenues from an existing forest tract, plus the present value of an infinite series of identical future forest rotations that starts after the current tract is harvested.

LEV vs Forest Value

•Land Expectation Value: present value of costs and revenues from an infinite series of identical even-aged forest rotations starting from bare land; LEV=PVSales - (PvPlant+PvSpray+PVThin+PVHarvest)

•Forest Value (a generalization of LEV): the present value of a property with an existing stand of trees + the present value of a LEV for all future rotations of timber that will be grown on the property after harvesting the current stand. Very simple (PV of Standing Timber)+LEV

Forest Value Allows us to

•To determine when a given stand should be cut;

•To separate the management of the current stand from that of future stands;

•To account for price changes that might occur during the life of the current stand;

Biological vs Economic Rotation

Biological Rotation = Rotation age that maximizes the meal annual increment (MAI) Seeks to maximize long term sustained yield from a forest

Does not consider financial costs and benefits of harvesting and do not maximize economic returns on the investmet