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Comparative Analysis of Investment Alternatives

Learn how to compare feasible investment proposals, develop cash flow profiles, and select the most favorable alternative based on Mutually Exclusive, Independent, and Contingent proposals. Understand the significance of defining planning horizons and standardizing cash flows.

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Comparative Analysis of Investment Alternatives

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  1. CTC 475 Review • Bonds • Not straightforward because bonds can be bought and/or sold between the date of issuance and the date of maturity • P=Vr(P/Ai,n)+F(P/Fi,n) • Find P • Find F • Find I • Cash flow frequency, i and n must match

  2. CTC 475 Comparing Alternatives

  3. Objectives • Know the steps for comparing alternatives • Know how to determine the possible set of alternatives • Know how to develop cash flows using the same planning horizon

  4. Steps for Comparing Alternatives • Determine the feasible alternatives • Define the planning horizon • Develop the cash flow profiles • Specify the MARR • Compare the alternatives • Perform supplementary analyses • Select the preferred alternative

  5. Determine Feasible Alternatives • Alternatives can consist of various investment proposals • Proposals can be: • Mutually exclusive • Independent • Contingent upon another proposal

  6. Mutual Exclusive • At most one project out of the group can be chosen: If I have proposals A, B, and C------- only A or B or C can be chosen (not a combination)

  7. Independent • All, none or any combination may be selected • Total number of alternatives = 2m where m is the number of proposals • If there are 4 proposals, the total number of options is 24 = 16 alternatives

  8. Contingent • The choice of a project is conditional on the choice of another project If A is contingent on B then A can’t be implemented unless B is also implemented

  9. Example of Defining Alternatives and Developing Cash Flow Profiles Steps 1 and 3 (planning horizon is the same)

  10. Three Proposals-A,B,C

  11. Number of Alternatives 23 = 8 alternatives

  12. Alternatives

  13. Restrictions • Budget for initial investment is $50K • Proposal B is contingent on proposal A (can’t do B unless A is implemented) • Proposals A and C are mutually exclusive (A & C can’t be implemented together)

  14. Alternatives

  15. Remaining Alternatives • Null or “Do Nothing” • C only • A only • A and B

  16. Cash Flow Profiles

  17. Planning Horizon (PH) • Period of time over which service is required • Period of time over which receipts continue to occur • Period of time over which reasonably accurate cash flow estimates can be provided

  18. Planning horizon, working life of equipment and depreciable life are not necessarily the same

  19. When comparing Alternatives----- The Planning Horizon must be the same

  20. Methods: • Least common multiple (LCM) • Shortest life • Longest life • Some determined life

  21. Example • Alternatives A, B & C have 3, 6, and 5-year lives • Least common multiple = 30 years • Shortest life = 3 years • Longest life = 6 years • Standard planning horizon could be 5 years (or 4 years or some other number)

  22. Problems in standardizing the PH • LCM-usually assume cash flow patterns repeat • Shortest Life-Must estimate the unused portions of the alternatives (salvage value) • Longest Life-Must estimate cash flow patterns between the shortest and longest life

  23. Example of Standardizing the PH and Developing Cash Flow ProfilesSteps 2/3 • Alternative 1 (use existing equipment) PH=3 years • Alternative 2 (buy new $50K) PH=6 years • Alternative 3 (buy new $75K) PH=5 years

  24. Standardizing PH-Example

  25. Example-LCM

  26. Example-Shortest Life

  27. Example-Longest Life

  28. Next lecture • Methods for Comparing Alternatives: • Ranking (PW, AW, FW) • Incremental (all) • Supplementary Analyses • Selling the Alternative

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