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Some Basic Truths

Some Basic Truths. You can’t add or subtract cash flows occurring at different points in time You can’t compare two equivalent values at different points in time You can’t compare cash flow series spanning different lengths of time The interest rate must match the payment frequency.

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Some Basic Truths

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  1. Some Basic Truths • You can’t add or subtract cash flows occurring at different points in time • You can’t compare two equivalent values at different points in time • You can’t compare cash flow series spanning different lengths of time • The interest rate must match the payment frequency

  2. Decoding Interest Statements • Assume that all interest rates are nominal rates unless you’re told otherwise. • Assume the compounding frequency is m = 1 unless you’re told otherwise. • Assume that the time period of interest is a year unless you’re told otherwise.

  3. PW, FW, AW • If the equivalent worth is positive, the project earns more than the MARR • If the equivalent worth is negative, the project earns less than the MARR • If the equivalent worth is zero, the project earns exactly the MARR

  4. Cost vs. Revenue • Do nothing is usually not an option with cost projects; it usually is an option with revenue projects • For cost projects, select the one with the least negative equivalent worth • For revenue projects, select the one with the most positive equivalent worth or do nothing

  5. Cost vs. Revenue • For cost projects with unequal lives, assume repeatability (if possible) and use AW to make a fair comparison • For revenue projects with unequal lives, assume reinvestment at the MARR (if possible) and use PW to make a fair comparison • Otherwise, select a common study period and use additional info to make a fair comparison

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