ISEN 302 - Exam 2 - Rodgers - TAMU

Amortization Schedule

a record of your loan payments that shows the principle amounts and the interest included in each (equal) payment until the end of the loan term

Capital Recovery

recovering initial funds put into an investment through returns from that investment, making it a break-even measure

Caveat Emptor (Buyer Beware)

the principle that the buyer alone is responsible for checking the quality and suitability of goods before a purchase is made

In Present Worth Analysis, we resolved alternatives into: (3)

Net Present Worth

Present Worth Cost

Present Worth Benefit

In Annual Cash Flow Analysis, we compare alternatives based on (3)

Equivalent Uniform Annual Benefit (EUAB)

Equivalent Uniform Annual Cost (EUAC)

Equivalent Uniform Annual Worth (EUAW)

what is the relationship between EUAW, EUAC, and EUAB?

EUAW = EUAB - EUAC

What does "A" represent

end of period costs/ benefits

Definition of sunk cost and how they affect decision making

= expenditures that have occurred in the past

they do not affect decision making for the future since they can not be changed

What are the two borrowed money viewpoints and their definitions?

1. Financing = obtaining money at an interest rate, borrowed from a bank or firm

2. Investment = spending money considering lifecycle costs and benefits

Standard assumption is that the money needed will be ____ with ____

borrowed (from a bank or firm) with interest rate "i"

What does "S" represent?

salvage value

EUAC = (3)

P(A/P, i, n) - S(A/F, i, n)

(P-S)(A/F, i, n) + P(i)

(P-S)(A/P, i, n) + S(i)

if Situation is: neither input or output fixed (typical situation),

then Criterion is: _____

Maximize EUAW using EUAW = EUAB - EUAC

if Situation is: fixed input,

then Criterion is: _____

Maximize EUAB

if Situation is: fixed output,

then Criterion is: _____

Minimize EUAC

Types of Annual Cash Flow and Analysis Periods (5)

1. Analysis period equal to alternative lives

2. Analysis period is a common multiple of alternative lives

3. Analysis period for a continuing requirement

4. Infinite analysis period

5. Some other analysis period

Analysis period equal to alternative lives meaning

Economic study is based on the analysis period

Analysis period is a common multiple of alternative lives meaning

under assumption of identical replacement, economic study is based on the alternatives' own lives

you can assume that all costs and benefits will remain unchanged throughout the life of the porject

Analysis period for a continuing requirement meaning

Under the assumption of identical replacement, economic study is based on the alternatives' own lives

Infinite analysis period meaning

under the assumption of identical replacement, economic study is based on the alternatives' own lives

Some other analysis period meaning

need to estimate the terminal values for all alternatives at the end of the analysis period

Excel function to find the loan balance given i, n, and A

PV(i, n, -A)

Excel function to find payment per period (A) given i, n, P

PMT(i, n, -P)

Excel function to find the interest portion in the xth payment

IPMT(i, x, n, -P)

Excel function to find the principal portion in the xth payment

PPMT (i, x, n, -P)

Excel function to find remaining periods to payoff the loan

NPER (i, -A, P)

What is the most frequently used measure in the industry?

Rate of Return

Calculating the Rate of Return is (dependent/independent) from the MARR

independent

Internal Rate of Return (3)

interest rate where PW = EUAW = 0

on a loan, it is the interest rate on unpaid balance so balance = 0 after final payment

on an investment, it is the interest rate earned on the un-recovered investment so un-recovered investment = 0 after last cash-flow

Two perspectives of IRR and their definitions

1. Borrowing = interest rate paid on the unpaid balance of a loan, such that the payment schedule makes the unpaid loan balance equal to 0 after the final payment is made

2. Investment = the interest rate earned on the unrecovered investment, such that the payment schedule makes the unrecovered investment equal to 0 at the end of the investment life

When graphing NPW vs i, where on the graph is the IRR?

The x intercept

a NPW vs i graph from the borrowing perspective will trend (up/down)

up

a NPW vs i graph from the investment/lending perspective will trend (up/down)

down

Two forms of interest rates and their definitions

1. Nominal = does not take into account the compounding period

2. Effective = does take into account the compounding period and thus is a more accurate measure of interest charges

Discount Rate definition

the interest rate used to calculate the present value of future cash flow from a project/investment

What rate do many companies use when budgeting for a new project?

Discount Rate

Incremental Analysis looks at ___

the ΔIRR, the difference between two courses of action

Incremental Cash Flow =

(higher initial - cost alternative) - (lower initial - cost alternative)

how to calculate ΔRoR (B-A)

(Net income for Alternative B - Net income for Alternative A)/ (Initial cost for B - Initial cost for A)

If ΔIRR ≥ MARR, choose the (higher/lower)-cost alternative

If ΔIRR < MARR, choose the (higher/lower)-cost alternative

higher

lower

Why do businesses use Incremental Analysis?

To decide whether to accept additional business, make or buy products, sell or process products further, eliminate a product or service, and decide how to allocate resources

Mutually Exclusive Alternatives definition (2)

only one alternative may be implemented

all alternatives serve the same purpose

Definition of Monotonically Increasing/Decreasing

if its graph is only increasing

Process to compare multiple alternatives

1. Compute i for each alternative individually and discard those with i , MARR

2. rearrange the alternatives in order of increasing cost

3. Calculate the IRR of the least expensive alternative to see if it's better than the "do nothing" alternative of the given MARR

4. Calculate the ΔIRR (challenger - defender) of the next alternative vs whichever was best in 3

5. Keep doing this until you are left with which one is the best

ROR analysis (does/does not) require a MARR

Present Worth or Annual Cash Flow Analysis (does/does not) require a MARR

does not

does

When comparing mutually exclusive alternatives and calculating the EUAC, which is the best option?

The one with the lowest EUAC

When comparing mutually exclusive alternatives and calculating the EUAW, which is the best option?

The one with the highest EUAW