Chapter 27

Financial & Cash Flow Analysis

By . Mohammad Salama
 Time Value of Money TVM

 Which would you prefer

- $10,000 today or
- $10,000 in 5 years?

 Money received sooner rather than later allows one to use the funds for investment or consumption
purposes. This concept is referred to as the TIME VALUE OF MONEY!!

Discounting
Pv Time Fv
Compounding
 Types of Interest

1 - Interest

Simple Interest Compound Interest Continuous Compounding

Effective Interest Rate

Nominal Interest Rate
EIR
 Example 1

If you borrow $ 6000 from bank . Which will charge you simple interest rate at the rate of 10 % per year. As per your
agreement you should pay the total amount within 5 years , how much you will have to pay?

6000

Year 1 : 10% Year 2 : 10% Year 3 : 10% Year 4 : 10% Year 5 : 10%

 Total amount to be paid at the end of 5 years = 6000 + 5X(6000*10%) = $9,000

 Example 2

If $ 400 is earned in three months on an investment of $ 8,000, what is the annual rate of simple interest?

8000

3 months 400 3 months 400 3 months 400 3 months 400

Total per year = 400 X 4 = 1600

 Simple Interest rate = (1600 /8000) X100 = 20%

 Example 3

Jan borrowed $30,000 for office furniture. The loan was for 6 months at an annual interest rate of 8%. What are Jan’s
interest and maturity value?

30,000

r = 8% for one year = 4% for 6 months

 Simple Interest rate = (30,000) X 1.04 = 31,200

 ‫‪Effective Interest Rate EIR‬‬

‫‪ ‬مثال ‪ :‬إذا كانت الفائدة على السند ‪ %6‬سنويا ً وكان تراكم الفوائد نصف سنوي‪ ،‬يتلقى المستثمر الذي يستثمر ‪ 1000‬دوالر في هذا‬
‫السند فائدة ‪ 30‬دوالر بعد ستة أشهر (‪ )0،3 * 1000‬و ‪ 30،9‬دوالر في األشهر الستة التي تليها (‪.)0،03 * 1،030‬‬

‫‪ ‬وبالتالي يكون على المستثمر دفع ‪ 60.90‬دوالر خالل العام وليس ‪ ، 60‬أي ّ‬
‫أن المعدّل االسمي كان ‪ %6‬بينما المعدّل الفعلي‬
‫يساوي ‪%6.09‬‬

‫‪(Ø) = r /k‬‬

‫‪EIR = ( 1 + Ø)k -1‬‬

‫‪ OR‬‬

‫‪EIR = ( 1 + (r /k) )k -1‬‬

 EIR (Example 1)

: Given an interest rate of 12 percent, find the effective and annual rates for yearly, semi-annual, and monthly

compounding. For yearly compounding, the annual rate is the same as the effective rate of 12 percent.

k = 1 r =0.12 ‫تكون‬ Annual Compounding ‫في حالة الفائدة المركبة السنوية‬

EIR = ( 1 + (0.12 / 1))1 – 1 = 12%

k = 2 ‫تكون‬ Semi – Annual Compounding ‫في حالة الفائدة المركبة النصف سنوية‬

EIR = (1 + ( 0.12/2))2 – 1 = 12.36%

k = 12 ‫تكون‬ Monthly Compounding ‫في حالة الفائدة المركبة الشهرية‬

EIR = (1 + ( 0.12/12))12 – 1 = 12.68%

 EIR (Example 2)

: Which provides a lower debt at the end of the loan period, a nominal rate 18% compounded monthly or an

18.5 %compounded semiannually?

k = 12 r =0.18 ‫في حالة الفائدة المركبة الشهرية تكون‬

EIR = ( 1 + (0.18 / 12))12 – 1 = 0.1956

I = 0.185 & k = 2 ‫في حالة الفائدة المركبة النصف سنوية تكون‬

EIR = (1 + ( 0.185/2))2 – 1 = 0.1936

Choose 0.1936
 Continuous Compounding

i=er-1

e ……… factor = 2.71828

What is the effective annual rate of 7% compounded continuously?

I = (2.71828) 0.07 - 1 = 7.25%

 Minimum attractive rate of return (MARR)

• Cost of borrowed money from banks, insurance companies, etc.

• Cost of capital or the composite value for the capital structure of the firm

• Opportunity cost or the rate-of-return of the best project that is rejected

A firm is evaluating the feasibility of a design and construction project and needs to know what
interest rate should be used in the study. The following data has been compiled:
- Cost of borrowed money, loan A = 9 percent;
- Investment opportunity, project B = 16 percent; and
- Cost of capital = 20 percent?

The MARR should be equal to or greater than the highest of the three values.

Choose 20 percent
 Annual Compounding

Present Value (P) A single lump sum occurring at time zero, the first of n time periods.

Future Value (F) A single lump sum value occurring at the end of the last of n time periods

Annual Value (A) Annual amount or annuity. A uniform series of end-of-period payments or receipts

Gradient Value (G) Uniform or arithmetic gradient amount; a constant increase or decrease in funds
flow at the end of each period
 Annual Compounding

Equations Tables Calculator

‫حساب القيمة الحالية‬

Present Value (P) ‫للدفعة الواحدة‬ Future Value (F)

‫حساب القيمة المستقبية‬

‫حساب القيمة الحالية‬
‫للدفعات المتساوية‬

‫للتدرج المنتظم‬
Annual Value (A) Gradient Value (G)

n i
Annual Compounding
Annual Compounding
Annual Compounding
 1 – From Present Value Get Future Value

P = F / (1+i) n

Example 1 : If you want to know how large of a deposit to make so that the money will grow to
$10,000 in 5 years at a discount rate of 10%?

P= F/ (1+i) n =10000/ ( 1.1) 5 = $6,209.21

Example 2 : You need to know how large of a deposit to make today so that the money will grow to
$2,500 in 5 years. Assume today’s deposit will grow at a compound rate of 4% annually.

P= F/ (1+i) n =2500/ ( 1.04) 5 = $2054.8

 Example 3

P = F / (1+i) n

How much would a person have to invest today to have EGP 2500 available next year at
a nominal interest rate of, 12% compounded quarterly?

n = 4 Fv = 2500 r = 0.12

EIR = (1 + (0.12/4)) 4 – 1 = 0.1255

P = F / (1+r) n = 2500 / ( 1+0.1255) 1

PV = 2221.2 EGP
 Example 4

• In 1970, when a construction company went public, an investment of 100 shares cost $1,650. That
investment would have been worth $12,283,904 on January 31, 2002. What is the rate of return on
that investment?
F = 12,283,904

Given: P = $1,650
0 32
F = $12,283,904
n = 32
Find i: F = P ( 1+ i )n P = 1,650

$12,283,904 = $1,650 (1 + i )32

i = 32.13%
 Example 5

• You are evaluating an alternative that requires an initial investment of $50,000. The following chart shows
ending of period cash flows of annual savings. The interest rate is 10 percent , What is the net present
worth (value) of this investment alternative at end of year 4?

Year 1 2 3 4
2,667 14,292 19.181 13.114

Savings $2,667 $14,292 $19,181 $13,114

0 1 2 3 4

P=-$50,000+$2,667*(P/F, 10%, 1) + $14,292*(P/F, 10%, 2) n =4

P = 50,000
+$19,181*(P/F, 10%, 3) +$13,114*(P/F, 10%, 4) i =10%

= -$50,000+$2,6667*(.9091) +$14,292*(.8264) +$19,181*(.7513) +$13,114*(.6830)

= -$50,000+$2,424.57+$11,810.91+$14,410.69+$8,956.86 = -$12,396.97
 2 – From Future Value Get Present Value

F= P (1+i) n

Example 1 : If you had $ 2000 now , and invested it at 10% how much would it be worth in eight year ?

F= P (1+i) n =2000 ( 1.1) 8 = $ 4287.18

OR

P (F/P , 10% , 8 ) = 2000 X 2.1436 =$ 4287.18

Read it as : To find F, given P when the interest rate is 10 % and the number of time periods
equals 8
 ‫‪Example 2‬‬

‫‪F= P (1+i) n‬‬

‫اقترض أحد األشخاص مبلغ ‪ 5000‬جنيه بمعدل فائدة ‪ % 12‬سنو ًيا‪ ،‬وتم االتفاق مع البنك على سداد أصل‬
‫القرض والفوائد المستحقة بعد ‪ 5‬سنوات ‪ ،‬فما هو المبلغ الذي سيدفعه للبنك في النهاية‬

‫)‪F = P( F/P , 12% , 5‬‬

‫‪F = 5000 (1+0.12) 5‬‬

‫‪F = 8811.71 EGP‬‬

 ‫‪Example 3‬‬

‫‪F= P (1+i) n‬‬

‫اذا كان لديك مبلغ ‪ 400,000‬دوالر هل تشتري به ارض تتوقع ان يصبح ثمنها في العام القادم ‪ 480,000‬دوالر‬
‫‪ ،‬أم تضع المال بالبنك بفائدة ‪ %10‬؟‬

‫‪Fv bank choice = 400,000 ( 1+0.10) 1 = 440,000 USD‬‬

‫‪ ‬بالتالي فان البنك سيجعل قيمة المال لديك في العام القادم ‪ 440.000‬بينما االرض ‪480.000‬‬

‫فتختار القيمة االعلى وهي شراء االرض ‪.‬‬

 Example 4

The office supplies for an engineering firm for different years were as follow
Year 0 = $ 600 , Year 2 = $300 , Year 5 = $400
What is the equivalent value in year 10 , if the interest rate is 5% per year ?

FV?

0 2 5 10
F = P0 ( F/P , 5% , 10) + P2 (F/P , 5% ,8) + P5 (

P = 600

P = 400
P = 300
F/P , 5% , 5) n =10
i =5%

F = (600 X 1.629) + (300 X1.477) +( 400 X 1.276) = $ 1931

 Example 5

F= P (1+i) n

 A bank gave your friend a 1000$ for three years at a compound interest rate of 8 %per year. How
much money the bank should be receiving of these three years?

F = ??

F = P (F/P, i, n) 1 r=8% 2

= P (1+i) n
= $1,000 (1+ 0.08) 3

= $1,259.71
P = 1000
 Example 6

F= P (1+i) n

If you deposit $100 now (n = 0) and $200 two years from now (n = 2) in a savings account that pays
10% interest, how much would you have at the end of 10 year?

F = P 0(F/P, i, n) + P 2(F/P, i, n)
F = ??

= P0 (1+i) n + P2 (1+i) n r = 10 %
0 1 2 3 4 5 6 7 8 9 10
= $1, 00 (1+ 0.10) 10 + $2, 00 (1+ 0.10) 8

= $688

P = 100 P = 200
 3 – From Future Value to Annual Worth

F= A ( (1+i) n -1 ) / i

What is the equivalent future worth of $1000 of investment each year for 8 years , starting 1 year from
now with an interest rate of 14%?

F=?
F = A X ( F/A , 14% , 8 ) = 1000 X 13.232 = $ 13232.8
1 2 3 4 5 6 7 8

F = 1000 X ((1+0.14)8 – 1 ) /0.14

i = 14%
= 1000 X 13.232 = $ 13232.8 A = 1000
 Example 2

Suppose that a person deposits $500 in a savings account at the end of each year, starting now, for the
next 12 years. If the bank pays 8% per year, compounded annually, how much money will accumulate
by the end of the 12-year period?

F= A ( (1+i) n -1 ) / i

F = $500 x (F/A, 8%, 12) = $500(18.9771) = $9488.55

 Example 3

How much money must be deposited at the end of each year in a savings account that pays 9% per year,
compounded annually, in order to have a total of $10 000 at the end of 14 years?

F= A ( (1+i) n -1 ) / i

A = F x (A/F, 9%, 14) = $10 000(A/F, 9%, 14) = $384.33

A = $384.33
 4 – From Planned Value to Annual Worth

P= A ( (1+i) n -1 ) / i (1+i) n )

How much money should you will be willing to pay now for a guaranteed $600 per year for 9 years
starting next year , at rate of return 16% per year ?

P = A ( P/A , 16% , 9) = 600 X 4.6065 = $ 2,763.9

0 1 2 3 4 5 6 7 8 9
OR

P = A ( P/A , 16% , 9) = 600 X( (1+i) n -1 ) / I (1+i) n )

r = 16 %
P=?
A = 600
P = 600 X ( (1.169-1) / (1.169 X 0.16)) = 600 X
(2.80296 /0.608) = = 600 X 4.6065 = $ 2,763.9
 Example 2
P= A ( (1+i) n -1 ) / i (1+i) n )

A= P (i (1+i) n ) / i (1+i) n -1 )

If you deposit 10,000 EGP today, what equal amounts can you withdraw at the end of each year for the
next 4 years from now (the annual compound interest rate is 1O %)?

0 1 2 3 4
A= P (i (1+i) n ) / i (1+i) n -1 )

= 3154.7 EGP
r = 10%
P = 10000
A=?
 Example 3

A start-up company has borrowed $800,000 to expand its work. The contract required the company to repay
the investors through a series of uniform annual payments over fixed period of time. If the company paid
$250,000 per year for 5 years, what was the interest rate on the loan?

P= A ( (1+i) n -1 ) / i (1+i) n )

800,000 = 250,000 ((1+i) 5 -1 ) / i (1+i) 5 )

0 1 2 3 4 5

From calculator i = 17%

r = ??
P = 800,000 A = 250,000
 Example 4

The following chart shows ending of period cash flows for expenses. The interest rate is 10 percent, What is
the net present worth (value) of this cash flow?

Year Expense
P= A ( (1+i) n -1 ) / i (1+i) n)

1 $100

P = A x (P/A, i% , n) = $100(P/A, 10%, 5) 2 $100

= $100 (3.7908) = $379.08 3 $100

4 $100

5 $100
 Example 5

An engineer who is about to retire has accumulated $50 000 in a savings account that pays 6% per year,
compounded annually. Suppose that the engineer wishes to withdraw a fixed sum of money at the end of
each year for 10 years. What is the maximum amount that can be withdrawn?

A= P (i (1+i) n ) / i (1+i) n -1 )

A= P x (A/P, i%, n) = $50 000(A/P, 6%, 10) = $50,000X(0.1359) = $6,795

 Example 6

An engineer who is planning his retirement has decided that he will have to withdraw $10 000 from his
savings account at the end of each year. How much money must the engineer have in the bank at the start of
his retirement, if his money earns 6% per year, compounded annually, and he is planning a 12-year
retirement

P= A ( (1+i) n -1 ) / i (1+i) n )

P = A x (P/A, i% , n) = $10,000(P/A, 6%, 12) = $10,000 (8.3839) = $83,839

 5 – From Planned Value to Gradient Worth

 A gradient series is a series of annual payments in which each payment is greater than the previous
one by a constant amount, G. F

G3
G1 G2
A

P= G ( (1+i) n -in-1 ) / i2 (1+i) )

 Example 1

An engineer is planning for a 15-year retirement. In order to supplement his pension and offset the
anticipated effects of inflation, he intends to withdraw $5000 at the end of the first year, and to increase the
withdrawal by $1000 at the end of each successive year (as shown in figure). How much money must the
engineer have in his savings account at the start of his retirement, if money earns 6% per year, compounded
annually?
F

13000

14000

15000
12000
8000
7000
6000
5000

A= 5000

0 1 2 3 4 5 12 13 14 15

p
 Example 1

 First obtain a series of uniform withdrawals A' equivalent to the series of gradients

A = G x (A/G, i%, n) = $1000(A/G, 6%, 15) = $1000 (5.9260) = $5926

A' = Ao + A = $5000 + $5926 = $10,926

 We can now calculate P as follows

P = A'x (P/A', i%, n) = $10,926(P/A, 6%, 15) = $10,926(9.7123) = $106,116.59

 Another way for solution

P = A0 X (P/A, 6%, 15) + G X (A/G, 6%, 15) X (P/A, 6%,15)

= $5000 (9.7123) + $1000 (5.9260) X (9.7123) = $106,116.59

 Example 2

How much money must initially be deposited in a savings account paying 5% per year, compounded annually,
to provide for ten annual withdrawals that start at $6000 and decrease by $500 each year?

A0 = $6000 and G = -$500.

A = G x (A/G, i%, n) = -$500(A/G, 5%, 10) = -$500(4.0991) = $-2049.55

A' = Ao + A = $6000-2049.55= $3950.45

P = A'x (P/A', i%, n) = $3950.45 (P/A, 5%, 10) = $3950.45(7.722) = $ 30,504.19

 Another way for solution

P = $6000(P/A, 5%, 10) - $500(A/G, 5%, 10)X (P/A, 5%, 10)

= $6000(7.7217) - $500(4.0991)X (7.7217) = $30 504.19

 Example 3

Mr. Jones is planning a 20-year retirement; he wants to withdraw $6000 at the end of the first year, and then
to increase the withdrawals by $800 each year to offset inflation. How much money should he has in his
savings account at the start of his retirement, if the bank pays 9% per year, compounded annually, on his
savings?

P = A o (P/A, 9%, 20) + G (A/G, 9%, 20) (P/A, 9%, 20)

= Ao (A/P, 9%, 20)-1 + G (A/G, 9%, 20) (A/P, 9%, 20) -1

= $6000(0.10955) -1 + $800(6.7674) (0.10955) -1 = $104,189.14

 Example 4

What is the Net Present Value for the given cash flow?
A = 10,000 G = 5000 i = 12% n=3 Cost = 20,000

1 – Present worth for ( Uniform Serious)

P =A(P/A,12%,3) = = 10,000(2.402) = $24,020

2 – Present worth for (Gradient Series)

P =G(P/G,12%,3) = =5,000(2.221)= $11,105

3 – Total Present worth

PW= $ 24,020 + $11,105 = $ 35,125

4 – Net Present Worth = Present Worth ( Benefit) – Present Worth (Cost)

PW= $ 35,125 - $20,000 = $ 15,125

6 – From Future Value to Gradient Worth

F= G ( (1+i) n -in-1 ) / i2

G3
G1 G2
A

p
7 – From uniform Series A to Arithmetic Gradient G

A= G ( (1+i) –(n/( (1+i)n-1)

 8 - Capitalized Cost Method (CC)

• The present worth of a constant annual cost over an infinite analysis period

A=P*i so P capitalized = A/i

A : Uniform Series cash flow which extends for an infinite time i : Interest rate
P : Capitalized Cost (Present Value)
 Example 1

A=P*i so P capitalized = A/i

 A bridge is built for $5,000,000 and will have maintenance costs of $100,000 per year. At 6 percent
interest, what is the capitalized cost of perpetual service ‫ماهي التكلفة المستغلة لتلك الخدمة الدائمة‬

1 – Fist Cost of the bridge is = $5,000,000

2 – The $100,000 which occurs per year can be converted into an infinite value using the pervious
equation
P = A/ i = 100.000 /0.06 = 1,666,667
3 – Capitalized Cost = $5,000,000 + 1,666,667 = 6,666,667
 Example 2

A=P*i so P capitalized = A/i

 What is the capitalized cost of a public works project that will cost $15,000,000 now and will
require $1,000,000 in annual maintenance?
 The effective annual interest rate is ten percent.

The capitalized cost will be equal to the initial cost of $15,000,000 plus the capitalized annual cost as
determined from

P = $15,000,000 + $1,000,000/0.10 = $25,000,000

 7 - Rate of Return Analysis ( ROR )or(IRR)

• The fundamental concept behind rate-of-return (ROR) analysis is that the ROR is the interest rate at
which benefits are equivalent to costs

For IRR Cash in = Cash out

A : Uniform Series cash flow which extends for an infinite time i : Interest rate
P : Capitalized Cost (Present Value)

For IRR questions make cash in – cash out = 0 ( get i)

 ‫‪Example 1‬‬
‫مطلوب امثلة على ‪IRR‬‬

‫افترض أنك تدرس مشروع يحتاج استثمارات قيمتها ‪ 1000‬جنيه اآلن ويعطيك عوائد ‪ 500‬جنيه‪ 400 ،‬جنيه‪ 300 ،‬جنيه في‬
‫األعوام من األول إلى الثالث ثم ينتهي المشروع‬

‫‪ ‬لحل هذا المثال باستخدام اآللة الحاسبة سنضطر لعمل عدة محاوالت حتى نصل إلى قيمة معدل العائد الداخلي عن طريق حل‬
‫المعادلة‬

‫‪0 = -1000 + 500/(1+IRR) + 400 / (1+IRR)2 + 300 / (1+IRR)3‬‬

‫‪ ‬ويمكن حل ذلك مباشرة باستخدام برنامج االكسل وذلك بكتابة االرقام في صفوف متتالية (‪ )300، 400 ، 500 ، 1000-‬ثم‬
‫الضغط على ‪ formula – insert function – IRR‬فيظهر مباشرة معدل العائد الداخلي ( في المثال يكون ‪)% 10.65‬‬
 Example 2
• An investment of $20,000 in new equipment will generate income of $7000 per year for 3
years , at which time the machine can be sold for an estimated $8000 . If the company
MARR is 15% per year , should it buy the machine ?

ROR equation based on PW relation is

0 = -20,000 + 7000 (P/A , I,3) + 8000 (P/F,I,3)

By try and error I = 18.2% per year

So I > MARR , the company should buy the machine

 Example 2
• A $10,000 investment returned $2,342 per year over a 5- year period. What was the rate of return
on this investment?

Set the present worth of benefits equal to the present worth of costs, then algebraically isolate the
discount factor and treat it as an unknown

$2,342 (P/A, i, 5) = $10,000

(P/A, i, 5) = $10,000 /$2,342 = .2342
Now look at the compound interest factors in the tables for the value of I , where (P/A, i, 5) = 4.270;
I (P/A, i, 5)
5.0 % 4.379
? 4.270
6.0 % 4.212
The rate of return for the investment was found to be 5.5 percent
 8 - Benefit-Cost Ratio Analysis ( B/C ratio )

• Analysis technique is based the ratio of benefits to costs

B / C = PW of benefits / PW of costs > 1

 Example 1
• Given the following mutually-exclusive alternatives and a MARR of 5 percent, which one should be
chosen? Use the benefit-cost method and assume the “do nothing” alternative is not available

Year A B C
For alternative A:
0 ($2,500) ($2,738) ($3,000)
B/C = $3,191 (P/F, 5%, 5) / $2,500 = 1 0 650 0
$3,191 (.7835) / $2,500 = 1 2 0 650 350
3 0 650 700
For alternative B: 4 0 650 1,050

B /C= $650 (P/A, 5%, 5)/ $2,738 = $650 5 $3.191 650 1,400

(4.329) / $2,738 = 1.03

For alternative C:
B/c = $350 (P/G, 5%, 5) / $3,000 = $350 (8.237) / $3,000 = 0.96
 ‫‪9 - MULTIPLE ALTERNATIVES‬‬
‫‪• Suppose you have $5000 and there are 2 mutually-exclusive alternatives, each with a one year‬‬
‫‪service life‬‬
‫)‪• One requires an investment of $1,000 with a return of $2,000 (Plan 1‬‬
‫)‪• The other requires $5,000 with a return of $7,000 (Plan 2‬‬
‫‪• MARR equals 10%‬‬
‫?‪• Which alternative would you prefer‬‬
‫• بالنسبة للبديل االول سيتم استثمار مبلغ ‪ 1000‬دوالر ليصبح بنهاية السنة ‪ 2000‬دوالر ‪ ،‬ويتبقى لديك ‪ 4000‬دوالر سيصبحون‬
‫بنهاية السنة ‪ 4400‬حيث ان المبلغ عليه نسبة فائدة ‪ %10‬كما هو معطى وبالتالي ففي نهاية السنة سيكون لديك مبلغ ‪4400+2000‬‬
‫= ‪ . 6400‬بينما يصبح لديك مبلغ ‪ 7000‬دوالر في حالة االختيار الثاني‪Plan 2. .‬‬

‫ومع ذلك فانه يمكننا القول ان المشروع االول اعطى نسبة عائد مقدارها ‪ %100‬على رأس المال المستثمر ( ‪ 1000‬تم‬ ‫•‬
‫استثمارها اصبحت ‪ ، ) 2000‬بينما اعطي االختيار الثاني نسبة ‪ %40‬فقط وبالتالي فان االختيار االول افضل من حيث نسبة‬
‫العائد على رأس المال ‪IRR‬‬

‫‪Compute Net Present / Annual / Future worth for each alternative at MARR‬‬
 Example 2
• Given the mutually-exclusive alternatives A, B, C, and a minimum attractive rate of return (MARR)
of five percent, which one would be chosen?

Year A B C
PVa = - $2,500 + $3,100 (P/F, 5%, 5) 0 ($2,500) ($2,700) ($3,000)
1 0 650 0
= -$2,500 + $3,100 (.7835) = -$71
2 0 650 350
3 0 650 700
PVb = - $2,700 + $650 (P/A, 5%, 5) = 4 0 650 1,050
5 $3.100 650 1,400
-$2,700 + $650 (4.329) = $114 TOTAL 600 550 500

PVc = - $3,000 + $350 (P/G, 5%, 5) =

-$3,000 + $350 (8.237) = -$117

 10 - Incremental Analysis

• A decision-making technique used in business to determine the true cost difference between
alternatives

• Only relevant costs are incorporated into analysis models, and these costs are typically broken into
variable costs and fixed costs. Incremental analysis considers opportunity costs to make sure the
most favorable option is pursued. Non-relevant sunk costs are charges that have already been
incurred

Ratio of Return Method Benefit Cost Ratio

 Incremental Analysis (Ratio of Return Method )
• Given the mutually-exclusive alternatives A, B, C and a minimum attractive rate of
return (MARR) of five percent, which one should be chosen? Use the incremental rate-of-
return method and assume the “do-nothing” alternative is not available

• 1 – Get ROR for each Alternative

Year A B C
• For Alternative A 0 ($2,500) ($2,738) ($3,000)
• 2,500 = 3,191 (P/F , i , 5) 1 0 650 0
i = 5% 2 0 650 350
• For Alternative B 3 0 650 700
4 0 650 1,050
• 2.738 = 650 (P/A , i , 5)
5 $3.191 650 1,400
i = 6%

• For Alternative c
• 3000= 350(P/G , i , 5) < 5 less than minimum required MARR so it should be neglected
 Incremental Analysis (Ratio of Return Method )

• 2 – Deduct the higher initial cost alternative – Lower initial cost alternative = B-A

Year A B B-A
• 3 – Calculate ROR for the choice B-A 0 ($2,500) ($2,738) ($238)
1 0 650 650
• Cash in = cash out 2 0 650 650

• 650(P/A , i , 4) = 238 + 2541(P/F,I,5) 3 0 650 650

4 0 650 650
i = 5%
5 $3.191 650 ($ 2,541)

• ‫تستكمل‬
 ‫‪Example 5‬‬
‫) ‪P= A ( (1+i) n -1 ) / i (1+i) n‬‬

‫‪ ‬بفرض ان لدينا وحدتين ‪ ،A , B‬وحدة ‪A‬سعر شرائها ‪ 10.000‬دوالر والعمر االفتراضي لها ‪ 4‬سنوات في خالل االربع‬
‫‪annual maintenance costs‬بقيمة ‪ 500‬دوالر ‪ ،‬علما بان سعر بيع الوحدة خردة‬ ‫سنوات ستحتاج الى صيانة سنوية‬
‫‪salvage value‬هو صفر‬

‫‪ ‬اما بالوحدة ‪ B‬سعر شرائها هو ‪ 20.000‬دوالر ‪ ،‬والعمر االفتراضي لها ‪ 12‬سنة وقيمتها عند البيع خردة ‪ 5.000‬دوالر‬

‫‪ ‬نسبة لمصاريف الصيانة فستكون صفر في العام االول ثم ‪ 100‬دوالر في العام الثاني ثم تزداد بقيمة ‪ 100‬دوالر كل عام‬
‫‪ ،‬اي انها ستكون ‪ 200‬دوالر في العام الثالث ثم ‪ 300‬في العام الرابع وهكذا‪.‬‬

‫‪ ‬مع العلم ان ‪The firm’s cost of capital is 8 percent‬‬

 ‫‪Example 5‬‬
‫‪ ‬هنا كال االختيارين ال يتشابهان سواء في فترة حياة المنتج ‪ ،‬كذلك مصاريف الصيانة فانها واحدة للوحدة االولى لكنها متدرجة للوحدة الثانية‬

‫‪ ‬اوال ‪ :‬عند مقارنة وحدتين غير متساويتين في دورة الحياة نختار دورة الحياة االطول ( ‪ 12‬عام في هذا المثال)‬

‫‪ ‬بالنسبة للوحدة ‪A‬‬

‫‪P =1000 , n=4 years , A=500‬‬

‫)‪NPW = $10,000+$10,000(P/F,8%,4)+$10,000(P/F,8%,8)+$500(P/A,8%,12‬‬
‫‪)7.536(500$ + )0.5403(10,000$ + )0.7350(10,000$ + = 10,000$ = 26,521$‬‬

‫‪ ‬بالنسبة للوحدة ‪B‬‬

‫‪NPW = $20,000 + $100(P/G,8%,12) - $5000(P/F,8%,12)-$100 ‬‬

‫‪= 100$-)0.3971(5000$ - )34.634(100$ + 20,000$ = 21.347‬‬