PRESENT WORTH METHOD OF COMPARISON
4.1 INTRODUCTION
In this method of comparison, the cash flows of each alternative will be
reduced to time zero by assuming an interest rate i. Then, depending on the
type of decision, the best alternative will be selected by comparing the
present worth amounts of the alternatives.
In a cost dominated cash flow diagram, the costs (outflows) will be
assigned with positive sign and the profit, revenue, salvage value (all
inflows), etc. Will be assigned with negative sign.
In a revenue/profit-dominated cash flow diagram, the profit, revenue,
salvage value (all inflows to an organization) will be assigned with positive
sign. The costs (outflows) will be assigned with negative sign.
In case the decision is to select the alternative with the minimum cost, then
the alternative with the least present worth amount will be selected. On the
other hand, if the decision is to select the alternative with the maximum
profit, then the alternative with the maximum present worth will be selected.
FUTURE WORTH METHOD
5.1 INTRODUCTION
In the future worth method of comparison of alternatives, the future worth of
various alternatives will be computed. Then, the alternative with the
maximum future worth of net revenue or with the minimum future worth of
net cost will be selected as the best alternative for implementation.
ANNUAL EQUIVALENT METHOD
6.1 INTRODUCTION
In the annual equivalent method of comparison, first the annual equivalent
cost or the revenue of each alternative will be computed. Then the
alternative with the maximum annual equivalent revenue in the case of
revenue-based comparison or with the minimum annual equivalent cost in
the case of cost-based comparison will be selected as the best alternative.
RATE OF RETURN METHOD
7.1 INTRODUCTION
The rate of return of a cash flow pattern is the interest rate at which the
present worth of that cash flow pattern reduces to zero. In this method of
comparison, the rate of return for each alternative is computed. Then the
alternative which has the highest rate of return is selected as the best
alternative.
In this type of analysis, the expenditures are always assigned with a negative
sign and the revenues/inflows are assigned with a positive sign.
DEPRECIATION
9.1 INTRODUCTION
Any equipment which is purchased today will not work for ever. This may be
due to wear and tear of the equipment or obsolescence of technology.
Hence, it is to be replaced at the proper time for continuance of any
business. The replacement of the equipment at the end of its life involves
money. This must be internally generated from the earnings of the
equipment. The recovery of money from the earnings of an equipment for its
replacement purpose is called depreciation fund since we make an
assumption that the value of the equipment decreases with the passage of
time. Thus, the word “depreciation” means decrease in value of any physical
asset with the passage of time.
9.2 METHODS OF DEPRECIATION
9.2.1 Straight Line Method of Depreciation
In this method of depreciation, a fixed sum is charged as the depreciation
amount throughout the lifetime of an asset such that the accumulated sum
at the end of the life of the asset is exactly equal to the purchase value of
the asset. Here, we make an important assumption that inflation is absent
9.2.2 Declining Balance Method of Depreciation
In this method of depreciation, a constant percentage of the book value of
the previous period of the asset will be charged as the depreciation amount
for the current period. This approach is a more realistic approach, since the
depreciation charge decreases with the life of the asset which matches with
the earning potential of the asset. The book value at the end of the life of the
asset may not be exactly equal to the salvage value of the asset. This is a
major limitation of this approach.
While availing income-tax exception for the depreciation amount paid in
each year, the rate K is limited to at the most 2/n. If this rate is used, then
the corresponding approach is called the double declining balance method of
depreciation.
9.2.3 Sum-of-the-Years-Digits Method of Depreciation
In this method of depreciation also, it is assumed that the book value of the
asset decreases at a decreasing rate. If the asset has a life of eight years,
first the sum of the years is computed as
9.2.4 Sinking Fund Method of Depreciation
In this method of depreciation, the book value decreases at increasing rates
with respect to the life of the asset.
,