Economics of Engineers HM-EE601
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subrata baruiEconomics of Engineers HM-EE601
Uploaded by
subrata baruiEconomics Of Engineers
TITLE :- PRESENT WORTH ANALYSIS
Abstract:- Present Worth Analysis, also known as Net
Present Value (NPV) analysis, is a widely used financial
tool for evaluating the profitability of projects or
investments. This analysis involves calculating the
present value of all expected cash inflows and outflows
associated with a project, using a discount rate to
account for the time value of money. The basic premise
is that a dollar received in the future is worth less than a
dollar received today, due to the opportunity cost of not
being able to invest that dollar immediately .
Table of contents:-
SL NO CONTENT NAME PAGE NO
1 Introduction 1
2 Importance in financial decision-making 2-3
3 formula for calculating the Present Worth 3-4
4 Resources 5
Introduction:- Present Worth Analysis, also known as Net
Present Value (NPV) analysis, is a financial method used to evaluate the
profitability of a project or investment by comparing the present value
of all expected cash inflows and outflows associated with the project.
The analysis takes into account the time value of money, which states
that a dollar today is worth more than a dollar in the future due to its
potential earning capacity.
The basic principle of Present Worth Analysis is that future cash flows
are discounted back to their present value using a discount rate. This
discount rate is typically the cost of capital or the desired rate of
return. By discounting future cash flows, Present Worth Analysis helps
in determining the current value of a series of cash flows over time,
allowing for better decision-making regarding investments or project
selection.
Why it is important in Present Worth Analysis :-
Discounting Future Cash Flows: Present Worth Analysis involves
calculating the present value of future cash flows. The concept of TVM
allows us to discount these future cash flows back to their present
value, taking into account the opportunity cost of not having the
money available for investment today.
Comparing Investments: TVM enables us to compare investments with
different cash flow patterns and time horizons. By discounting all cash
flows to their present value, we can determine which investment or
project offers the highest return for a given level of investment.
Incorporating Risk: TVM helps in incorporating risk into Present Worth
Analysis. Cash flows that are further in the future are considered riskier
due to uncertainties, and the concept of TVM allows us to adjust these
cash flows for risk by applying a higher discount rate.
Capital Budgeting: In capital budgeting decisions, where companies
decide on long-term investments, TVM is essential. It helps in
evaluating the profitability of potential projects by considering the time
value of money and selecting projects that maximize shareholder
value.
Financial Planning: TVM is critical in financial planning, helping
individuals and organizations make informed decisions about savings,
investments, and retirement planning. It allows for the calculation of
how much money needs to be saved or invested today to achieve a
future financial goal..
Understanding Present Value:-
Present value is the concept that states that an amount of money
today is worth more than that same amount in the future. In other
words, money received in the future is not worth as much as an equal
amount received today.
Receiving $1,000 today is worth more than $1,000 five years from
now. Why? Because an investor can invest that $1,000 today and
presumably earn a rate of return over the next five years. Present
value takes into account any interest rate an investment might earn.
For example, if an investor receives $1,000 today and can earn a rate
of return of 5% per year, the $1,000 today is certainly worth more
than receiving $1,000 five years from now. If an investor waited five
years for $1,000, there would be an opportunity cost or the investor
would lose out on the rate of return for the five years.
Simple example to demonstrate how to calculate PW Use of
discount rate
and cash flows :-
Suppose you are considering an investment that requires an initial
outlay of $1,000 and is expected to generate the following cash flows
over the next three years:
Year 1: $300
Year 2: $400
Year 3: $500
The discount rate for this investment is 5%.
To calculate the Present Worth (PW) of this investment, we use the
formula:
Resources:-
1.Engineering Economics Analysis, Donald Newnan, Ted Eschembach, Jerome
Lavelle , OUP.
2. Principle of Engineering Economic Analysis, John A. White, Kenneth
E.Case,David B.Pratt , Wiley
