Appendix A 223Figure A-6 An investment opportunityA.7 PROJECT MEASURES OF WORTH
A.7.1 Introduction
In this section measures of worth for investment projects are intro-
duced. The measures are used to evaluate the attractiveness of a single
investment opportunity. The measures to be presented are (1) present
worth, (2) annual worth, (3) internal rate of return, (4) savings investment
ratio, and (5) payback period. All but one of these measures of worth re-
quire an interest rate to calculate the worth of an investment. This inter-
est rate is commonly referred to as the minimum attractive rate of return
(MARR). There are many ways to determine a value of MARR for invest-
ment analysis, and no one way is proper for all applications. One prin-
ciple is, however, generally accepted. MARR should always exceed the
cost of capital as described in Section A.4, Sources of Funds, presented
earlier in this appendix.
In all of the measures of worth below, the following conventions are
used for defining cash flows. At any given point in time (t = 0, 1, 2,..., n),
there may exist both revenue (positive) cash flows, Rt, and cost (negative)
cash flows, Ct. The net cash flow at t, At, is defined as Rt – Ct.
A.7.2 Present Worth
Consider again the cash flow series illustrated in Figure A-5. If you
were given the opportunity to “buy” that cash flow series for $5,747.49,
would you be interested in purchasing it? If you expected to earn a 12%/
yr return on your money (MARR = 12%), based on the analysis in the pre-
vious section, your conclusion should be that you are indifferent between
(1) retaining your $5,747.49 and (2) giving up your $5,747.49 in favor of
the cash flow series. Figure A-6 illustrates the net cash flows of this second
investment opportunity.