A proposed capital investment

and its associated expenditures

can be recovered by revenue(or Evaluating a
savings) over time in addition to CHAPTER 2 Single Project
a return on the capital that uses.
LEARNING to discuss and critique
OUTCOMES contemporary methods for
determining project profitability.

Topics to be covered in this chapter:-

 Present worth method - PW
 Annual worth method - AW
 Internal rate of return method - IIR
 Benefit-cost ratio – BC Ration
 Entrepreneurship in Economic Growth
 Factors Affecting Entrepreneurial Growth

Students will be able to:-

 Evaluate a single project by using: PW method, AW method,
IRR method and B/C ratio

2
 PRESENT WORTH METHOD
Based on the concept of equivalent worth of all cash
flows relative to the beginning point in time (present)
All cash inflows and outflows are discounted to the
beginning point in time at an interest rate that is
generally the MARR

PW (i%) = ∑ Fj (P/F, i%, j)

j=0

Rule
The project is economically attractive if
PW is greater or equal to zero;
other wise, it is not Justification
The results is either accept or reject
3
PRESENT WORTH METHOD
1. Example
A friend who is trying to finance a small restaurant venture
offers you payments of RM2,000, RM4,000 and RM7,000
at the each or each of 3 years in order to repay a loan
of RM10,000. You would otherwise make an interest rate
of 10% on fixed deposits. Should you lend him the money
on the repayment terms he offers?
(ans: PW= RM382.9)
Practice in class!
Solution

Draw cashflow diagram

4
 Solution: 2,000 4,000 7,000

1 2 3
N=3
10,000
i =10%

PW(10%) = -RM10,000 + RM2,000(P/F,10%,1) + RM4,000(P/F,10%,2)

+ RM7,000(P/F,10%,3)
= -RM10,000 + RM2,000(0.9091) + RM4,000( 0.8262 )
+ RM7,000(0.7513 )
= RM382.9
Evaluation:
PW(10%)  0
The project is
acceptable
5
PRESENT WORTH METHOD
2. Example
A cooling system is being considered for an office building. The
system can be purchased and installed for RM110,000 and it will
save an estimated 300,000 kilowatt-hour of electric power each
year over a 6 years period. A kilowatt-hour of electricity costs
RM0.10 and the company has a MARR of 15% per year. The market
value of the system will be RM8,000 at the end of 6 year. Use PW
method to determine whether this system should be installed.
Practice in class! (ans: PW= RM 6,993.4)

6
7
 Solution:
8,000
30,000

6
N=6
110,000 i =15%

PW(15%)= -RM110,000 + RM30,000(P/A,15%,6) + RM8,000(P/F,15%,6)

= =-RM110,000 + RM30,000( 3.7845 ) + RM8,000( 0.4323 )

= RM 6993.4

Evaluation:

PW(15%)  0
The project is
acceptable
8
 PRESENT WORTH METHOD
3. Example
A small company purchased now for RM23,000 will lose
RM1,200 each year the first four years. An additional RM8,000
invested in the company during the fourth year will result in a
profit of RM5,500 each year from the 5th year through the 15th
year. At the end of 15 years, the company can be sold for
RM33,000. Calculate the PW if MARR = 12%
(ans: PW= RM -RM4,945.91)
Practice in class!

9
10
 Solution:
RM33,000
RM5,500

1 4 5 15
RM1,200 N=15
RM23,000 RM8,000 i =12%

PW(12%)= -RM23,000 - RM1,200(P/A,12%,4) - RM8,000(P/F,12%,4) +

RM5,500(P/A,12%,11)(P/F,12%,4) + RM33,000(P/F,12%,15)

= RM23,000 - RM1,200( 3.0373 ) - RM8,000( 0.6355 )

+ RM5,500( 5.9377)( 0.6 355 ) +RM33,000( 0.1827)

= -RM23,000 - RM3,644.76 – RM5,084 + RM20,753.75 + RM6,029.1

= -RM4,945.91
Evaluation:
PW(15%)  0
The project is
not acceptable
11
4. Example
Find the present worth equivalent of a series of $100 payments
which starts at the end end-of-year 21 and terminate at the end
of year 35.The interest rate is 8% compounded annually.

Solution:
P = RM100(P/A,8%,15)(P/F,8%,20)
= RM100(8.5595)(0.2145) = RM183.60

12
ANNUAL WORTH METHOD
An equal annual series of dollar amounts for a stated
study period, that is equivalent to the cash inflows and
outflows at an interest rate

N
AW (i%) = ∑ Fj (A/F, i%, j)
j=0

The difference between the annual benefit (revenue)

and annual cost, commonly known as gain if it is a net
benefit and loss if it is a net loss Rule
The project is economically attractive if
AW is greater or equal to zero;
Justification
other wise, it is not
The results is either accept or reject
13
Example
Darren is considering an investment in a laundry business. The
washer will cost for RM5,000 and will last for 3 years with no
resale value at the end of time. Rent, labor and maintenance will
cost approximately RM10,000 annually. Total revenue is
estimated as RM12,000 per each year. If MARR is 20%, should
he invest in the laundry business?
(ans: AW = -RM373.5)
Practice in class!

14
15
 Solution:

RM12,000

RM10,000 N=3
RM5,000 i =20%

AW(20%)= -RM5,000(A/P,20%,3) + RM12,000 - RM10,000

= -RM5,000(0.4747) + RM12,000 - RM10,000

= -RM2,373.5 + RM12,000 - RM10,000

= - RM373.5

AW(20%)  0, the project

16
is not acceptable
ANNUAL WORTH METHOD
Example
XYZ company is considering the introduction of a new product
line. The initial investment required for this project is RM120,000.
It is anticipated that the new product will increase the company’s
revenue by RM10,000 annually, the operating cost are expected
to be RM4,000 per year and the resale value is RM14,000.One
off saving RM 13,000 will consider in year 4. The MARR of the
company is 12% and the project has a life of 8 years. Determine
whether the project is economically viable
(ans: AW= )

17
18
 Solution: RM13,000
RM14,000
RM10,000

4 8
RM4,000 N=8
RM120,000 i =12%

AW(12%)= -RM120,000(A/P,12%,8) + RM10,000 -

RM4,000 + RM13,000(P/F,12%,4)(A/P,12%,8) +
RM14,000(A/F,12%,8)

= -RM120,000(0.2013) + RM10,000 - RM4,000

+ RM13,000(0.6355)(0.2013) + RM14,000(0.0813)

= -RM24,156 + RM10,000 - RM4,000 + RM1,759.7 + RM1,138.2

= - RM15,258.1

AW(20%)  0, the project

19
is not acceptable
 INTERNAL RATE OF RETURN METHOD-IRR
Is the percentage rate that causes the discounted
present value of the benefits in a cash flow to be equal
to the discounted present value of the costs
Can also be defined as the discount rate that causes the
present worth value to equal zero.
Also call as investor’s method, the discounted cash-
flow method, profitability method.
𝑵 𝑷 ′ 𝑵 𝑷
σ𝑲=𝟎 𝑹𝒌( , 𝒊 %, 𝒌 = σ𝒌=𝟎 𝑬𝒌( ,i’%,k)
𝑭 𝑭
or

𝑵 𝑷 ′ 𝑵 𝑷
PW=0=σ𝑲=𝟎 𝑹𝒌( , 𝒊 %, 𝒌) − σ𝒌=𝟎 𝑬𝒌( ,i’%,k)
𝑭 𝑭
Where: Rk= net revenues or saving for the kth year.
Ek = net expenditure, including any investment costs for
Practice in class! the kth year.
N= project life(or study period 20
Example
An assets was purchased for $5,000. It was sold 2 years
later for RM5,926. What was the IRR on the investment?
(ans: i' = 8.88%)

Solution:
Draw cash flow diagram.
General equation, PW=0
-$5,000 + $5,926(P/F,i’,2)=0
(P/F,i’,2)=$5,000/$5,926 = 0.8437

Trial&error method
Let i’% = 10%, (P/F,i’%,2) =0.8264
i’% at factor x = 0.8437
Let i’% = 8%, (P/F,i’%,2) =0.8573

Using interpolation method

𝑖 ′ % − 8% 0.8437 − 0.8573
=
10% − 8% 0.8264 − 0.8573
i’≅ 8.8802%
i’ ≥ 0 𝑇ℎ𝑒 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝑖𝑠 𝑎𝑐𝑐𝑒𝑝𝑡𝑒𝑑
21
INTERNAL RATE OF RETURN METHOD
Example
Urban University has installed a computerized energy
management system with 3,500 points of audit across the
campus. The $1.25 million system has achieved a 30% reduction
in electricity use and a 50% savings in heating costs. This
translates to yearly savings of $95,000 and $150,000,
respectively. If such systems last 20 years, what rate of return to
the nearest whole percentage is the university making on its
investment before taxes and before considering inflation effects?
No salvage value need be considered.
(ans: tba)
Exercise!

22
 RM95K + RM15K
Solution

N= 20
RM1.25M MARR= none
Find i’
Solution:

General equation, PW=0

-RM125,000 + RM245,000(P/A,i’,20)=0
(P/A,i’,20)=RM125,000/RM245,000 = 5.102

Trial&error method
Let i’% = 18%, (P/A,i’%,20) =5.3527
i’% at factor x = 5.102
Let i’% = 20%, (P/F,i’%,20) =4.8696

Using interpolation method

𝑖 ′ % − 18% 5.102 − 0.3527
=
20% − 18% 4.8696 − 5.3527
i’≅ 19.04%
i’ ≥ 0 𝑇ℎ𝑒 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝑖𝑠 𝑎𝑐𝑐𝑒𝑝𝑡𝑒𝑑
23
INTERNAL RATE OF RETURN METHOD
Example
A piece of new equipment has been proposed to increase the productivity of a
certain manual welding operation. The investment cost is RM25,000 and the
equipment will have market value of RM5,000 at the end of a study period of 5
years. Increased productivity attributable to the equipment will amount to RM8,000
per year after extra operating cost have been subtracted from the revenue
generated by the addition production. If the firm MARR is 20% per year, is this
proposal a sound one.
(ans: i' ≈ 21.68%)

24
 RM5,000
Solution RM8,000

N= 5
RM25,000 MARR= 20%

Find i’
Solution:
Draw cash flow diagram
PW=0
-RM25,000 + RM8,000(P/A, i’%, 5) + RM5,000(P/F, i’%, 5) = 0
Trial & error
Let i’ = MARR =20%
-RM25,000 + RM8,000(P/A, 20%, 5) + RM5,000.00(P/F, 20%, 5) = 0
-RM25,000 + RM8,000(2.9906) + RM5,000.00(0.4019) = 0
RM934.3

25
Let i’ =25%
-RM25,000 + RM8,000(P/A, 25%, 5) + RM5,000.00(P/F, 25%, 5) = 0
-RM25,000 + RM8,000(2.6893) + RM5,000.00(0.3277) = 0
-RM1,847.1

Let i’ =18%
i’% =RM2203.1 Choose one
20%≤ 𝑖′% ≤ 25% positive value and
one negative value

Using interpolation method

𝑖 ′ % − 20% 0 − 𝑅𝑀934
=
25% − 20% −𝑅𝑀1,847.1 − 𝑅𝑀934.3

i’% ≅ 21.68%
i’≅21.68 ≥ MARR,
The project is acceptable. 26
BENEFIT-COST RATIO
As a measure of the worth of each individual
alternative in comparison to all other
alternatives
B-C ratio:

B PW (Benefits) or B = AW (Benefits)
C = PW (Cost) C AW (Cost)

The project is economically

attractive if
B
≥ 1
C
other wise, it is not
The results is either accept or
reject
27
Example
A sewage containment project is expected to required an initial investment of
RM4 million and annual maintenance expenses of RM68,000. The benefits to
the public are valued at RM680,000 per year. The MARR is 12% per year
and the expected life is 30 years, determine whether the project is
economically attractive using the B-C PW ratio measure of merit.
(ans: B-C
ration(PW) = 1.2
B-C ration(AW) = ? )
Practice in class!

28
Solution RM680,000

N= 30
MARR= 12%
RM4M RM68,000

Solution:
Draw cashflow diagram
𝑃
𝑅𝑀680,000(𝐴,12%,30)
B-C ratio PW( 12%) = 𝑃
𝑅𝑀4𝑀+𝑅𝑀68,000 ,12%,30
𝐴

𝑅𝑀680,000(8.0552)
=
𝑅𝑀4𝑀+𝑅𝑀68,000(8.0552)
𝑅𝑀5,477,536
=
𝑅𝑀4,547,753.6
= 1.2
B-C ratio 1.2 ≥ 1, The project is acceptable.

29
Example
A sewage containment project is expected to required an initial investment of
RM4 million and annual maintenance expenses of RM68,000. The benefits to
the public are valued at RM680,000 per year. The MARR is 12% per year
and the expected life is 30 years, determine whether the project is
economically attractive using the B-C AW ratio measure of merit.
(ans: B-C
ration(PW) = 1.2
B-C ration(AW) = ? )
Practice in class!

30
31
32
ENTREPRENEURSHIP IN ECONOMIC GROWTH,
FACTORS AFFECTING ENTREPRENEURIAL
GROWTH

33
ENTREPRENEURSHIP IN ECONOMIC

34
FACTORS AFFECTING ENTREPRENEURIAL
GROWTH

35
36