· Results (program accomplishment,
Income, repayment)
Income, repayment)
· Reduced costs (must be real, not
transferred elsewhere)
transferred elsewhere)
Anticipated benefits are, of course, the
reasons any activity is undertaken in
the first place. It is easy, and often
dangerous, to become overly optimistic
on benefits. Like costs, benefits are
basic to economic analysis. They
provide the decision maker with the
economic facts available.
reasons any activity is undertaken in
the first place. It is easy, and often
dangerous, to become overly optimistic
on benefits. Like costs, benefits are
basic to economic analysis. They
provide the decision maker with the
economic facts available.
2.4. Compare costs and benefits.- It was
great to be able to send men to the moon,
but was it worth it? Such a difficult question
defies economic answers since many
noneconomic factors (such as political and
social) are involved. Economic answers too
many difficult questions can, however, be
obtained by comparing costs and benefits.
This can be done by using a discounting
table similar to that shown in
great to be able to send men to the moon,
but was it worth it? Such a difficult question
defies economic answers since many
noneconomic factors (such as political and
social) are involved. Economic answers too
many difficult questions can, however, be
obtained by comparing costs and benefits.
This can be done by using a discounting
table similar to that shown in
comparing the total present values (P) of
costs and benefits for each alternative con-
sidered. To select the best alternative, use
these rules:
costs and benefits for each alternative con-
sidered. To select the best alternative, use
these rules:
·
If benefits are equal, choose the least
costly alternative.
costly alternative.
·
If costs are equal, choose the most pro-
ductive alternative.
ductive alternative.
·
If costs are unequal and benefits are
unequal, use the alternative with the
highest benefit/cost ratio.
unequal, use the alternative with the
highest benefit/cost ratio.
3. THE TIME VALUE OF MONEY
3.1. Present value formula.- The following
basic economic formula, relating time to
money, defines the present value of money
that will be spent in the future. This formula
will be used in practically all of our economic
comparisons.
basic economic formula, relating time to
money, defines the present value of money
that will be spent in the future. This formula
will be used in practically all of our economic
comparisons.
P =
F
(1 1)
N
+
where:
P = Present value of F dollars to be
spent in a future year
spent in a future year
F = Future dollars to be spent in year N
N = Number of years, after start of the
study, that F dollars will be spent
N = Number of years, after start of the
study, that F dollars will be spent
I = Interest rate per year, expressed in
decimal form
decimal form
Table A shows present values calculated from
this formula for a wide range of years and Interest
rates. Using this formula, wherein the value of F
is assumed to be $1, it is a simple matter to use
a packet calculator to quickly develop your own
table of present values for any interest rate. This
present value formula provides the foundation for
the basic economic principle:
this formula for a wide range of years and Interest
rates. Using this formula, wherein the value of F
is assumed to be $1, it is a simple matter to use
a packet calculator to quickly develop your own
table of present values for any interest rate. This
present value formula provides the foundation for
the basic economic principle:
·
To enhance economic feasibility, at-
tempt to delay payment of costs and
accelerate accrual of benefits.
tempt to delay payment of costs and
accelerate accrual of benefits.
Using table A, solve the following "present
value" problem:
value" problem:
·
Problem.- You will need a supply of
make-up insulating oil for transformers
in about 8 years. You can buy insulat-
ing oil today for $50 a barrel. You
guess that in 8 years, the same oil will
cost $100 a barrel. If the annual
interest rate is 10 percent, should you
buy now or wait?.
make-up insulating oil for transformers
in about 8 years. You can buy insulat-
ing oil today for $50 a barrel. You
guess that in 8 years, the same oil will
cost $100 a barrel. If the annual
interest rate is 10 percent, should you
buy now or wait?.
P =
F
(1 1)
N
+
= 100/(1 + 0.10)
8
= $46.65 per barrel
· Solution.-
Since the present value of the cost to buy oil in
the future is lower than today's cost ($46.65 vs.
$50 per barrel), you should not buy the oil today.
In this example, we have assumed zero storage
costs, which, if included, would have reinforced
our decision not to buy today.
the future is lower than today's cost ($46.65 vs.
$50 per barrel), you should not buy the oil today.
In this example, we have assumed zero storage
costs, which, if included, would have reinforced
our decision not to buy today.
3 (FIST4-3)