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Econ 2 > Module 4: Comparison Methods 1 > Flashcards

Module 4: Comparison Methods 1 Flashcards

(49 cards)

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1
Q

A project, program, and policy action are a means to…

A

Achieve a goal

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2
Q

What are the 3 types of projects in EE?

A
  1. Independent Projects
  2. Mutually Exclusive Projects
  3. Related but NOT Mutually Exclusive Projects
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3
Q

What are “independent projects”? Give examples.

A

projects that can be undertaken separately and simultaneously, since the costs/benefits do not depend on what other projects are being done.

EX: building a new factory while also purchasing electrical trucks

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4
Q

What is the best alternative for investing money in an independent engineering project?

A

the best alt is to invest in other EE projects that generate a return =/> than the MARR

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5
Q

What are mutually exclusive projects? Give example.

A

projects where you CANNOT undertake multiple others simultaneously. Only one at a time

EX: a company deciding between using solar panels or wind turbine.

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6
Q

What are “Related but NOT mutually exclusive” projects? Give example.

A

projects when costs and benefits of one project depend on whether/what other projects are undertaken

EX: a company investing in evs and charging stations

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7
Q

What can you do with the third type of projects? (related but not mutually exclusive projects)

A

you can reframe them as a set of mutually exclusive options, by viewing the as separate scenarios where only one alternative can be chosen. Add the “do nothing” option

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8
Q

What does MARR stand for?

A

Minimum Acceptable Rate of Return

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9
Q

Why do we need the MARR?

A

we need it as a base to compare different alternatives

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10
Q

What is MARR? What does it reflect?

A

it is an interest rate that must be earned by a project to be accepted. It reflects opportunity cost

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11
Q

From an economic viewpoint, what is the best way to justify the choice of MARR? Why?

A

the cost of capital is the best way to justify the choice of MARR. This is because it directly reflects the true cost of funding a project

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12
Q

What are some ways that you can choose an appropriate MARR? (three ways)

A
  1. Use the current interest rate for large scale/public projects
  2. Look at past investment returns in the same industry
  3. Calculate the cost of capital (which includes the cost of borrowing money/using company funds)
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13
Q

What 2 comparison methods are based on absolute monetary criteria?

A

PW method and AW method

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14
Q

What comparison method is based on absolute NON-monetary criterion?

A

Payback Period Method

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15
Q

What is the PW method?

A

Present Worth method compares projects by calculating their present worth at MARR

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16
Q

What is the AW Method?

A

Annual Worth Method compares projects by calculating their annual worth at MARR

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17
Q

What is an independent project usually compared with?

A

usually compared with the “do nothing” alternative

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18
Q

The present worth of the “do nothing” alternative at the MARR is equal to…

A

zero

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19
Q

if an independent project earns + PW at the MARR, is it accepted or no?

A

Yes, it is accepted

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20
Q

if an independent project earns - PW at the MARR, is it accepted or no?

Study These Flashcards
A

No. It will be rejected

21
Q

If an independent project “breaks even”, or in other words, PW = 0, is the project accepted or no?

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A

if PW = 0, the project is marginally accepted

22
Q

What does “PW = 0 at the MARR” mean?

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A

this means the project earns exactly the Minimum acceptable rate of return, thus marginally accepted.

  • “If we calculate the PW using the MARR as the interest rate, we get zero”
23
Q

what are some basic assumptions for PW Comparison Methods (for mutually exclusive projects)? two

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A
  1. Service life for all projects/alternatives is the same
  2. If the above does not hold, the AW method should be applied
24
Q

For mutually exclusive projects, when should the AW comparison method be applied?

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A

when the service life for all projects/alternatives is NOT the same

25
What is the framework for PW Comparison method (for mutually exclusive projects)?
- if multiple projects exist, the one with the highest PW is selected - If benefits are the same across all projects, choose the one with the lowest PW of costs at MARR - Sometimes it is more logical to evaluate alternatives in terms of future worth at MARR
26
What's the only difference between AW method and PW method?
instead of calculating total value at one point in time, AW method converts all costs and benefits into uniform series at MARR
27
Since in AW method, final values are expressed in terms of annual values, projects with ____ ____ can be compared
unequal lives
28
For mutually exclusive projects with the same lifespans, PW and AW will give the ____ decision
same
29
For projects with different lifespans, ___ is the most useful because it expresses everything in ____ terms, making comparison easier to interpret.
AW; annual
30
Which method is the easiest way to compare two or more projects/alternatives with unequal service lives?
AW method
31
What are the two approaches you can apply to the PW comparison method to modify it (when looking at projects with unequal service lives)?
1. Repeated Lives Approach 2. Study Period Approach
32
What is the "Repeated Lives Approach"? Give simple example.
when you extend the project lives to the least common multiple EX: Project A lasts 6 years and Project B lasts 3. TO compare the two, you can use repeated lives and evaluate project B twice to match the lifespan of project A
33
What are the 2 ways you can compare two projects with different lifespans?
1. Use AW method 2. Modify PW method
34
What is the "Study Period Approach"? Give simple example.
when you evaluate all projects over a common time frame called the "Study period" EX: Project A lasts 4 years and Project B lasts 6 years. You decide on a 4-year study period, since Project A only lasts 4 years anyway
35
What are the 2 interpretations of the Payback Period (PP)?
1. Simple PP 2. Adjusted PP
36
What does the interpretation "Simple PP" include/not include?
Simple PP does NOT include time value of money- it ignores TVM
37
What does the interpretation "Adjusted PP" include/not include?
Adjusted PP includes time value of money
38
What is "Simple payback period" defined as?
defined as the period of time for the initial investment to be recovered (under zero interest rate). The project with the shortest PP is chosen.
39
What's the formula for simple payback periods (in years)?
PP = Initial Investment / Annual Net Savings
40
What does Simple PP method discriminate? How so? How is it addressed?
it discriminates against long-term projects because it ignores time value of money. It is addressed by the adjusted PP comparison method
41
In adjusted PP method, how is the TVM used?
it's used to calculate the PW of the net annual savings before deducting them from the initial investment
42
by using the simple payback period method, a decision maker...
ignores the benefits accumulated by a project after the end of the payback period.
43
the annual worth of a project is measured in terms of...
$/period of time
44
what method cannot be used for comparison of alternative projects?
sensitivity analysis
45
If project A has the present worth of (-$27,000) and project B has the present worth of (-$26,000) and both are independent projects then...
both projects should be rejected (- PW's)
46
Strictly speaking, two projects are mutually exclusive if...
by choosing one project the other project is excluded
47
the annual worth method may not require _____ ____ compare to the present worth method
complicated calculations
48
If the first project cannot be done by itself, the second project can be done alone, and both of them can be done together, then the first project is said to be _______ __ ___ _____ _____
contingent on the second project
49
Which assumption is wrong for doing the comparison between alternative projects? A) Taxes are not applicable B) Future cash flows are known with certainty C) Costs and benefits can be expressed in monetary terms D) Funds for implementing projects are limited E) Cash flows are unaffected by inflation
D)

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