CHAPTER 4

APPLICATIONS OF
MONEY-TIME
RELATIONSHIPS

MINIMUM ATTRACTIVE RATE OF

RETURN ( MARR )

An interest rate used to convert cash flows into

equivalent worth at some point(s) in time
Usually a policy issue based on:
-- amount,
amount, source
source and
and cost
cost of
of money
money available
available for
for
investment
investment
-- number
number and
and purpose
purpose of
of good
good projects
projects available
available for
for
investment
investment
-- amount
amount of
of perceived
perceived risk
risk of
of investment
investment
opportunities
opportunities and
and estimated
estimated cost
cost of
of administering
administering
projects
projects over
over short
short and
and long
long run
run
-- type
type of
of organization
organization involved
involved

MARR is sometimes referred to as hurdle rate

CAPITAL RATIONING
MARR approach involving opportunity cost
viewpoint
Exists when management decides to restrict
the total amount of capital invested, by desire
or limit of available capital
Select only those projects which provide
annual rate of return in excess of MARR
As amount of investment capital and
opportunities available change over time, a
firms MARR will also change

PRESENT WORTH METHOD ( PW )

Based on concept of equivalent worth of all
cash flows relative to the present as a base
All cash inflows and outflows discounted to
present at interest -- generally MARR
PW is a measure of how much money can be
afforded for investment in excess of cost
PW is positive if dollar amount received for
investment exceeds minimum required by
investors

FINDING PRESENT WORTH

Discount future amounts to the present by using the

Discount future amounts to the present by using the

interest
interest rate
rate over
over the
the appropriate
appropriate study
study period
period

FINDING PRESENT WORTH

Discount future amounts to the present by using the

Discount future amounts to the present by using the

interest
interest rate
rate over
over the
the appropriate
appropriate study
study period
period
N

PW = Fkk ( 1 + i ) -- kk
k=0

ii == effective
effective interest
interest rate,
rate, or
or MARR
MARR per
per
compounding
compounding period
period
kk == index
index for
for each
each compounding
compounding period
period
F
Fkk == future
future cash
cash flow
flow at
at the
the end
end of
of period
period kk
N
N == number
number of
of compounding
compounding periods
periods in
in study
study
period
period

FINDING PRESENT WORTH

Discount future amounts to the present by using the

Discount future amounts to the present by using the

interest
interest rate
rate over
over the
the appropriate
appropriate study
study period
period
N

PW = Fkk ( 1 + i ) -- kk
k=0

ii == effective
effective interest
interest rate,
rate, or
or MARR
MARR per
per
compounding
compounding period
period
kk == index
index for
for each
each compounding
compounding period
period
F
Fkk == future
future cash
cash flow
flow at
at the
the end
end of
of period
period kk
N
N == number
number of
of compounding
compounding periods
periods in
in study
study
period
period
interest
interest rate
rate is
is assumed
assumed constant
constant through
through project
project

FINDING PRESENT WORTH

Discount future amounts to the present by using the

Discount future amounts to the present by using the

interest
interest rate
rate over
over the
the appropriate
appropriate study
study period
period
N

PW = Fkk ( 1 + i ) -- kk
k=0

ii == effective
effective interest
interest rate,
rate, or
or MARR
MARR per
per
compounding
compounding period
period
kk == index
index for
for each
each compounding
compounding period
period
F
Fkk == future
future cash
cash flow
flow at
at the
the end
end of
of period
period kk
N
N == number
number of
of compounding
compounding periods
periods in
in study
study
period
period
interest
interest rate
rate is
is assumed
assumed constant
constant through
through project
project
The
The higher
higher the
the interest
interest rate
rate and
and further
further into
into future
future aa
cash
cash flow
flow occurs,
occurs, the
the lower
lower its
its PW
PW

BOND AS EXAMPLE OF
PRESENT
WORTH
The value of a bond, at any time, is the present

The value of a bond, at any time, is the present

worth of future cash receipts from the bond
The bond owner receives two types of
payments from the borrower:
--- periodic
periodic interest
interest payments
payments until
until the
the bond
bond is
is
retired
retired (( based
based on
on rr );
);
--- redemption
redemption or
or disposal
disposal payment
payment when
when the
the bond
bond
is
is retired
retired (( based
based on
on ii );
);

The present worth of the bond is the sum of the

present values of these two payments at the
bonds yield rate

PRESENT WORTH OF A BOND

For
For aa bond,
bond, let
let
ZZ == face,
face, or
or par
par value
value
C
C == redemption
redemption or
or disposal
disposal price
price (usually
(usually Z
Z ))
rr == bond
bond rate
rate (nominal
(nominal interest)
interest) per
per interest
interest period
period
N
N == number
number of
of periods
periods before
before redemption
redemption
ii == bond
bond yield
yield (redemption
(redemption )) rate
rate per
per period
period
V
VNN == value
value (price)
(price) of
of the
the bond
bond N
N interest
interest periods
periods
prior
prior to
to redemption
redemption --- PW
PW measure
measure of
of merit
merit
VN
VN == C
C (( P
P // F,
F, i%,
i%, N
N )) ++ rZ
rZ (( P
P // A,
A, i%,
i%, N
N ))
Periodic
Periodic interest
interest payments
payments to
to owner
owner == rZ
rZ for
for N
N periods
periods
--- an
an annuity
annuity of
of N
N payments
payments
When
When bond
bond is
is sold,
sold, receive
receive single
single payment
payment (C),
(C), based
based
on
on the
the price
price and
and the
the bond
bond yield
yield rate
rate (( ii ))

FUTURE WORTH METHOD (FW )

FW
FW is
is based
based on
on the
the equivalent
equivalent worth
worth of
of all
all cash
cash
inflows
inflows and
and outflows
outflows at
at the
the end
end of
of the
the planning
planning
horizon
horizon at
at an
an interest
interest rate
rate that
that is
is generally
generally MARR
MARR

FUTURE WORTH METHOD (FW )

FW
FW is
is based
based on
on the
the equivalent
equivalent worth
worth of
of all
all cash
cash
inflows
inflows and
and outflows
outflows at
at the
the end
end of
of the
the planning
planning
horizon
horizon at
at an
an interest
interest rate
rate that
that is
is generally
generally MARR
MARR
The
The FW
FW of
of aa project
project is
is equivalent
equivalent to
to PW
PW
FW
FW == PW
PW (( FF // P,
P, i%,
i%, N
N ))

FUTURE WORTH METHOD (FW )

FW
FW is
is based
based on
on the
the equivalent
equivalent worth
worth of
of all
all cash
cash
inflows
inflows and
and outflows
outflows at
at the
the end
end of
of the
the planning
planning
horizon
horizon at
at an
an interest
interest rate
rate that
that is
is generally
generally MARR
MARR
The
The FW
FW of
of aa project
project is
is equivalent
equivalent to
to PW
PW
FW
FW == PW
PW (( FF // P,
P, i%,
i%, N
N ))
IfIf FW
FW >> 0,
0, itit is
is economically
economically justified
justified

FUTURE WORTH METHOD (FW )

FW
FW is
is based
based on
on the
the equivalent
equivalent worth
worth of
of all
all cash
cash
inflows
inflows and
and outflows
outflows at
at the
the end
end of
of the
the planning
planning
horizon
horizon at
at an
an interest
interest rate
rate that
that is
is generally
generally MARR
MARR
The
The FW
FW of
of aa project
project is
is equivalent
equivalent to
to PW
PW
FW
FW == PW
PW (( FF // P,
P, i%,
i%, N
N ))
IfIf FW
FW >> 0,
0, itit is
is economically
economically justified
justified
N

FW ( i % ) = Fkk ( 1 + i ) NN -- kk
k=0

FUTURE WORTH METHOD (FW )

FW
FW is
is based
based on
on the
the equivalent
equivalent worth
worth of
of all
all cash
cash
inflows
inflows and
and outflows
outflows at
at the
the end
end of
of the
the planning
planning
horizon
horizon at
at an
an interest
interest rate
rate that
that is
is generally
generally MARR
MARR
The
The FW
FW of
of aa project
project is
is equivalent
equivalent to
to PW
PW
FW
FW == PW
PW (( FF // P,
P, i%,
i%, N
N ))
IfIf FW
FW >> 0,
0, itit is
is economically
economically justified
justified
N

FW ( i % ) = Fkk ( 1 + i ) NN -- kk
k=0
i = effective interest rate
k = index for each compounding period
Fk = future cash flow at the end of period k
N = number of compounding periods in study period

ANNUAL WORTH METHOD ( AW )

AW
AW is
is an
an equal
equal annual
annual series
series of
of dollar
dollar amounts,
amounts, over
over
aa stated
stated period
period (( N
N ),
), equivalent
equivalent to
to the
the cash
cash inflows
inflows
and
and outflows
outflows at
at interest
interest rate
rate that
that is
is generally
generally MARR
MARR
AW
AW is
is annual
annual equivalent
equivalent revenues
revenues (( R
R )) minus
minus annual
annual
equivalent
equivalent expenses
expenses (( E
E ),
), less
less the
the annual
annual equivalent
equivalent
capital
capital recovery
recovery (CR)
(CR)
AW
AW (( ii %
% )) == R
R -- E
E -- CR
CR (( ii %
% ))
AW
AW == PW
PW (( A
A // P,
P, ii %,
%, N
N ))
AW
AW == FW
FW (( A
A // F,
F, ii %,
%, N
N ))
IfIf AW
AW >> 0,
0, project
project is
is economically
economically attractive
attractive
AW
AW == 00 :: annual
annual return
return == MARR
MARR earned
earned

CAPITAL RECOVERY ( CR )
CR is the equivalent uniform annual cost of the
capital invested
CR is an annual amount that covers:
Loss
Loss in
in value
value of
of the
the asset
asset
Interest
Interest on
on invested
invested capital
capital (( i.e.,
i.e., at
at the
the MARR
MARR ))

CR ( i % ) = I ( A / P, i %, N ) - S ( A / F, i %, N )
I = initial investment for the project
S = salvage ( market ) value at the end of the
study period
N = project study period

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR solves for the interest rate that equates the
equivalent worth of an alternatives cash
inflows (receipts or savings) to the equivalent
worth of cash outflows (expenditures)
Also referred to as:
investors
investors method
method
discounted
discounted cash
cash flow
flow method
method
profitability
profitability index
index

IRR is positive for a single alternative only if:

both
both receipts
receipts and
and expenses
expenses are
are present
present in
in the
the cash
cash
flow
flow pattern
pattern
the
the sum
sum of
of receipts
receipts exceeds
exceeds sum
sum of
of cash
cash outflows
outflows

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

R kk = net revenues or savings for the kth year

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

R kk = net revenues or savings for the kth year

E kk = net expenditures including investment
costs for the kth year

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

R kk = net revenues or savings for the kth year

E kk = net expenditures including investment
costs for the kth year
N = project life ( or study period )

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

R kk = net revenues or savings for the kth year

E kk = net expenditures including investment
costs for the kth year
N = project life ( or study period )
If i > MARR, the alternative is acceptable

INTERNAL RATE OF RETURN METHOD ( IRR )

IRR is i %, using the following PW formula:
N
N
R kk ( P / F, i %, k ) = E kk ( P / F, i %, k )
k=0

k=0

R kk = net revenues or savings for the kth year

E kk = net expenditures including investment
costs for the kth year
N = project life ( or study period )
If i > MARR, the alternative is acceptable
To compute
IRR for alternative,
set net PW = 0
N
N
PW
PW ==k
R kk (( P
P // F,
F, i
i %,
%, kk )) --k= 0E
E kk (( P
P // F,
F, i
i %,
%, kk )) == 00
= 0R
i
i is
is calculated
calculated on
on the
the beginning-of-year
beginning-of-year unrecovered
unrecovered
investment through the life of a project

INTERNAL RATE OF RETURN PROBLEMS

The IRR method assumes recovered funds, if
not consumed each time period, are reinvested
at i %, rather than at MARR
The computation of IRR may be
unmanageable
Multiple IRRs may be calculated for the same
problem
The IRR method must be carefully applied and
interpreted in the analysis of two or more
alternatives, where only one is acceptable

THE EXTERNAL RATE OF RETURN METHOD

( ERR )

ERR directly takes into account the

interest rate ( ) external to a project at
which net cash flows generated over the
project life can be reinvested (or
borrowed ).
If the external reinvestment rate, usually
the firms MARR, equals the IRR, then
ERR method produces same results as
IRR method

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )

1.
1. All
All net
net cash
cash outflows
outflows are
are discounted
discounted to
to the
the present
present
(time
(time 0)
0) at
at %
% per
per compounding
compounding period.
period.
2.
2. All
All net
net cash
cash inflows
inflows are
are discounted
discounted to
to period
period N
N at
at %.
%.
3.
3. ERR
ERR --- the
the equivalence
equivalence between
between the
the discounted
discounted cash
cash
inflows
inflows and
and cash
cash outflows
outflows --- is
is determined.
determined.
The
The absolute
absolute value
value of
of the
the present
present equivalent
equivalent worth
worth of
of
the
the net
net cash
cash outflows
outflows at
at %
% is
is used
used in
in step
step 3.
3.
A
A project
project is
is acceptable
acceptable when
when ii %
% of
of the
the ERR
ERR method
method
is
is greater
greater than
than or
or equal
equal to
to the
the firms
firms MARR
MARR

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0 receipts
R
Rkk == excess
excess of
of
receipts over
over expenses
expenses in
in period
period kk

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0 receipts
R
Rkk == excess
excess of
of
receipts over
over expenses
expenses in
in period
period kk
E
Ekk == excess
excess of
of expenses
expenses over
over receipts
receipts in
in period
period kk

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0 receipts
R
Rkk == excess
excess of
of
receipts over
over expenses
expenses in
in period
period kk
E
Ekk == excess
excess of
of expenses
expenses over
over receipts
receipts in
in period
period kk

N
N == project
project life
life or
or period
period of
of study
study

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0 receipts
R
Rkk == excess
excess of
of
receipts over
over expenses
expenses in
in period
period kk
E
Ekk == excess
excess of
of expenses
expenses over
over receipts
receipts in
in period
period kk

N
N == project
project life
life or
or period
period of
of study
study
== external
external reinvestment
reinvestment rate
rate per
per period
period

CALCULATING EXTERNAL RATE OF

RETURN ( ERR )
N

Ekk ( P / F, %, k )( F / P, i %, N )
k=0
=
N
Rkk ( F / P, %, N - k )
k=
0 receipts
R
Rkk == excess
excess of
of
receipts over
over expenses
expenses in
in period
period kk
E
Ekk == excess
excess of
of expenses
expenses over
over receipts
receipts in
in period
period kk

N
N == project
project life
life or
or period
period of
of study
study
N
== external
external reinvestment
reinvestment rate
rate per
per period
period R
0
N

i %= ?
Time

Ek ( P / F, %, k )( F / P, i %, N )

k=0

k = 0k

( F / P, %, N - k )

ERR ADVANTAGES
ERR has two advantages over
IRR:
1. It can usually be solved for
directly, rather than by trial and
error.
2. It is not subject to multiple rates
of return.

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method
Indicates
Indicates liquidity
liquidity (riskiness)
(riskiness) rather
rather than
than profitability
profitability

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method
Indicates
Indicates liquidity
liquidity (riskiness)
(riskiness) rather
rather than
than profitability
profitability
Calculates
Calculates smallest
smallest number
number of
of years
years ((
)) needed
needed for
for
cash
cash inflows
inflows to
to equal
equal cash
cash outflows
outflows --- break-even
break-even life
life

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method
Indicates
Indicates liquidity
liquidity (riskiness)
(riskiness) rather
rather than
than profitability
profitability
Calculates
Calculates smallest
smallest number
number of
of years
years ((
)) needed
needed for
for
cash
cash inflows
inflows to
to equal
equal cash
cash outflows
outflows --- break-even
break-even life
life

ignores
ignores the
the time
time value
value of
of money
money and
and all
all cash
cash flows
flows
which
which occur
occur after
after

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method
Indicates
Indicates liquidity
liquidity (riskiness)
(riskiness) rather
rather than
than profitability
profitability
Calculates
Calculates smallest
smallest number
number of
of years
years ((
)) needed
needed for
for
cash
cash inflows
inflows to
to equal
equal cash
cash outflows
outflows --- break-even
break-even life
life

ignores
ignores the
the time
time value
value of
of money
money and
and all
all cash
cash flows
flows
which
which occur
occur after
after

( Rkk -Ekk) - I > 0

k=1

PAYBACK PERIOD METHOD

Sometimes
Sometimes referred
referred to
to as
as simple
simple payout
payout method
method
Indicates
Indicates liquidity
liquidity (riskiness)
(riskiness) rather
rather than
than profitability
profitability
Calculates
Calculates smallest
smallest number
number of
of years
years ((
)) needed
needed for
for
cash
cash inflows
inflows to
to equal
equal cash
cash outflows
outflows --- break-even
break-even life
life

ignores
ignores the
the time
time value
value of
of money
money and
and all
all cash
cash flows
flows
which
which occur
occur after
after

( Rkk -Ekk) - I > 0

k=1

IfIf
is
is calculated
calculated to
to include
include some
some fraction
fraction of
of aa year,
year, itit
is
is rounded
rounded to
to the
the next
next highest
highest year
year

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

( Rk - Ek) ( P / F, i %, k ) - I > 0
k=1

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

( Rk - Ek) ( P / F, i %, k ) - I > 0
k=1
i
i is
is the
the MARR
MARR

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

( Rk - Ek) ( P / F, i %, k ) - I > 0
k=1
i
i is
is the
the MARR
MARR
II is
is the
the capital
capital investment
investment made
made at
at the
the present
present time
time

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

( Rk - Ek) ( P / F, i %, k ) - I > 0
k=1
i
i is
is the
the MARR
MARR
II is
is the
the capital
capital investment
investment made
made at
at the
the present
present time
time
(( kk == 00 )) is
is the
the present
present time
time

PAYBACK PERIOD METHOD

The
The payback
payback period
period can
can produce
produce misleading
misleading results,
results,
and
and should
should only
only be
be used
used with
with one
one of
of the
the other
other
methods
methods of
of determining
determining profitability
profitability
A
A discounted
discounted payback
payback period
period
(( where
where
<< N
N ))
may
may be
be calculated
calculated so
so that
that the
the time
time value
value of
of money
money is
is
considered
considered

( Rk - Ek) ( P / F, i %, k ) - I > 0
k=1
i
i is
is the
the MARR
MARR
II is
is the
the capital
capital investment
investment made
made at
at the
the present
present time
time
(( kk == 00 )) is
is the
the present
present time
time

is
is the
the smallest
smallest value
value that
that satisfies
satisfies the
the equation
equation

INVESTMENT-BALANCE
DIAGRAM

Describes how much money is

tied up in a project and how the
recovery of funds behaves over
its estimated life.

INTERPRETING IRR USING

INVESTMENT-BALANCE
DIAGRAM
P (1 + i)
[ P (1 + i) - (R1 - E1) ] (1 +i)
Unrecovered 1 + i
1 + i
Investment
1 + i
Balance, $ (R1 - E1)
(R2 - E2)

(R3 - E3)

Initial investment
=P
0

(RN-1 - EN-1)

1 + i
(RN - EN)

$0

downward
downward arrows
arrows represent
represent annual
annual returns
returns (R
(Rkk -- E
Ekk)) :: 11 << kk << N
N
dashed
dashed lines
lines represent
represent opportunity
opportunity cost
cost of
of interest,
interest, or
or interest
interest
on
on BOY
BOY investment
investment balance
balance
IRR
IRR is
is value
value ii that
that causes
causes unrecovered
unrecovered investment
investment balance
balance to
to
equal
equal 00 at
at the
the end
end of
of the
the investment
investment period.
period.

INVESTMENT-BALANCE
DIAGRAM EXAMPLE
Capital Investment ( I ) = $10,000
Uniform annual revenue = $5,310
Annual expenses = $3,000
Salvage value = $2,000
MARR = 5% per year

Investment
Balance, $

MARR = 5%

5,000

$2,001 ( = FW )

+ $4,310

Years
0
1

- 5,000

Area of Negative
Investment
- $4,294
Balance
- $6,290

- $8,190
- $2,310
- 10,000
-$10,500

- $2,310
- $2,310

- $2,310
- $2,310 - $6,604
- $8,600

4
- $2,199

- $4,509

WHAT INVESTMENT-BALANCE
DIAGRAM PROVIDES

Discounted payback period ( ) is 5 years

FW is $2,001
Investment has negative investment balance
until the fifth year
Investment-balance diagram provides
additional insight into worthiness of proposed
capital investment opportunity and helps
communicate important economic information