IA- static methods

IA- static methods

1. Cost comparison method

   • answers to: 1. which project should be realized & 2. what is the optimal replacement time for an already realized asset
   • choose the one with lowest costs!!!
   • calculate total costs: variable costs + fixed costs
   • depreciation: initial outlay/economic life
   • Average tied-up capital: initial outlay/2 (for calculating interest)
   • fixed costs= capital costs
   • if investment sold after the economic life- liquidation!!!
     • depreciation: (initial outlay - liquidation value)/ economic life
     • ATC: (initial outlay + liquidation value)/ 2
   • critical quantity =volume of production which leads to equal costs
     • fixed c + variab/unit *x = fixed c. + variab/unit *x
     • lower fixed costs = lower costs before critical quantity
     • higher fixed costs = lower costs after critical quantity

2. basics

   • values represented through costs and revenues
   • average value of a representative period (not the whole economic life
   • time value of money not considered

3. profit comparison method

   • target measure: average annual profit (profit/period)
     • average annual profit: annual revenue - annual total costs
   • absolute profitability = profit greater than zero
   • relative profitable = the one with the higher profit
   • critical quantity of output
     • leads an equal profit of both alternative investment projects
     • (revenue/unit- variable cost/unit)* x - fixed costs = (rev./u-var.cost/u)* x -fixed cost)
   • evaluation of the model
     • acknowledges the fact of different revenues
     • allows individual project evaluations
     • impossible to allocate revenues to the projects
     • usage of average values is questionable
     • investment assessed only according to the realized profit

4. average rate of return

   • target measure is the average rate of return
     • = ((average profit + average interest)/ ATC) *100
   • can be used for a single investment or to compare
   • absolute profitability= average rate of return higher than a given %
   • relative profitability= investment leads to a higher ARR than alternative investment project
   • risk premium!! add to the fixed interest

5. static payback period method

   • target measure is the time it takes to recover the capital invested to the project
   • payback period = initial outlay + (if so) liquidation value/ average annual cash flow
   • absolute profitability= payback period is shorter than the target length of time
   • relative profitability= investment project has a shorter payback period than alternative investment project
   • result in years!!
   • equity financed--> add interest!!!
     • profit + depreciation + interest = average annual cash flow)
   • debt financed: average annual cash flow = profit + depreciation
   • evaluation of the model
     • advantage: provides some indication of the risk
     • disadvantage: excludes profits and cash flows after the payback beriod
     • disadvantage: can't be used for evaluation of long-term assets, difficult to determine an objective acceptable payback period