Applying Present Worth Techniques 147
Applying Present Worth Techniques
One of the easiest ways to compare mutually exclusive alternatives is to resolve their
consequences to the present time. The three criteria for economic efficiencyare restated in
terms of present worth analysis in Table 5-1.
TABLE5-1 Present Worth Analysis
Situation Criterion
Fixed input Amount of money or other input
resources are fixed
There is a fixed task, benefit, or
other output to be accomplished
Neither amount of money, or
other inputs, nor amount of
benefits, or other output, is fixed
Maximize present worth of benefits
or other outputs
Minimize present worth of costs
or other inputs
Maximize (present worth of benefits
minuspresent worth of costs), that is,
maximize net present worth
Fixed output
Neither input
nor output is
fixed
Present worth analysis is most frequently used to determine the present value of future
money receipts and disbursements. It would help us, for example, to determine a present
worth of income-producing property, like an oil well or an apartment house. If the future
income and costs are known, then we can use a suitable interest rate to calculate the present
worth of the property.This should provide a good estimate of the price at which the property
could be bought or sold. Another application might be determining the valuation of stocks
or bonds based on the anticipated future benefits from owning them.
In present worth analysis,careful considerationmust be givento the timeperiod covered
by the analysis. Usually the task to be accomplishedhas a time period associated with it. In
that case, the consequences of each alternative must be considered for this period of time
which is usually called the analysis period, or sometimes the planning horizon.
The analysis period for an economy study should be determined from the situation. In
some industries with rapidly changing technologies, a rather short analysis period or plan-
ning horizon might be in order. Industries with more stable technologies (like steelmaking)
might use a longer period (say, 10-20 years), while government agencies frequently use
analysis periods extending to 50 years or more.
Three different analysis-period situations are encountered in economic analysis
problems:
- The useful life of each alternative equals the analysis period.
- The alternatives have useful lives different from the analysis period.
- There is an infinite analysis period,n= 00.
- Useful Lives Equal the Analysis Period
Since different lives and an infinite analysis period present some complications, we will
begin with four examples in which the useful life of each alternative equals the analysis
period.
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