BASIC METHODS FOR

MAKING ECONOMY
STUDIES
Basic Methods for Making
Economy Studies
 Rate of Return (ROR) Method

 Annual Worth (AW) Method

 Present Worth (PW) Method

 Future Worth (FW) Method

 Payback (Payout) Period Method

Rate of Return (ROR) Method
 Rate of return is a measure of the effectiveness
of an investment of capital.

 A rate of return equivalent from 20% to 25% of

the investment is adequate to justify the
investment.

𝒏𝒆𝒕 𝒂𝒏𝒏𝒖𝒂𝒍 𝒑𝒓𝒐𝒇𝒊𝒕

 𝑹𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 =
𝒄𝒂𝒑𝒊𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒆𝒅
Annual Worth (AW) Method
 Interest on the original investment (minimum
required profit) is included as a cost.

 If the excess of annual cash inflows over annual

cash outflows is not less than zero, the
proposed investment is justified (valid).
Present Worth (PW) Method
 If the present worth of the net cash flows is
equal to or greater than zero, the project is
justified economically.
Future Worth (FW) Method
 All cash inflows and outflows are compounded
forward to a reference point in time called future.

 If the future worth of the net cash flows is equal

to or greater than zero, the project is justified
economically.
Payback (Payout) Period Method

 The payback period is defined as the length of

time required to recover the first cost of an
investment from the net cash flow produced by
that investment for an interest rate of zero.

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡−𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒
 𝑃𝑎𝑦𝑜𝑢𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑦𝑒𝑎𝑟𝑠 =
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤
Example 1
 An investment of P270,000 can be made in a
project that will produce a uniform annual
revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out
of pocket costs for operation and maintenance
will be P81,000 per year. Taxes and insurance
will be 4% of the first cost per year. The
company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period of the
investment?
Example 1
 An investment of P270,000 can be made in a
project that will produce a uniform annual
revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out
of pocket costs for operation and maintenance
will be P81,000 per year. Taxes and insurance
will be 4% of the first cost per year. The
company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period of the
investment?
Example 1
 An investment of P270,000 can be made in a
project that will produce a uniform annual
revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out
of pocket costs for operation and maintenance
will be P81,000 per year. Taxes and insurance
will be 4% of the first cost per year. The
company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period of the
investment?
Example 1
 An investment of P270,000 can be made in a
project that will produce a uniform annual
revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out
of pocket costs for operation and maintenance
will be P81,000 per year. Taxes and insurance
will be 4% of the first cost per year. The
company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period of the
investment?
Example 2
 An investment of P270,000 can be made in a
project that will produce a uniform annual
revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out
of pocket costs for operation and maintenance
will be P81,000 per year. Taxes and insurance
will be 4% of the first cost per year. The
company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period of the
investment?
Example 2
 A project is estimated to cost P100,000, lasts
8 years, and have a P10,000 salvage value.
The annual gross income is expected to
average P24,000 and annual expenses,
excluding depreciation, will total P6,000. If
capital is earning 10% before income taxes,
determine if this is a desirable investment
using (a) ROR, (b)AWM, (c) PWM, and (d)
FWM.
Example 2
 A project is estimated to cost P100,000, lasts
8 years, and have a P10,000 salvage value.
The annual gross income is expected to
average P24,000 and annual expenses,
excluding depreciation, will total P6,000. If
capital is earning 10% before income taxes,
determine if this is a desirable investment
using (a) ROR, (b)AWM, (c) PWM, and (d)
FWM.
Example 2
 A project is estimated to cost P100,000, lasts
8 years, and have a P10,000 salvage value.
The annual gross income is expected to
average P24,000 and annual expenses,
excluding depreciation, will total P6,000. If
capital is earning 10% before income taxes,
determine if this is a desirable investment
using (a) ROR, (b)AWM, (c) PWM, and (d)
FWM.
Example 2
 A project is estimated to cost P100,000, lasts
8 years, and have a P10,000 salvage value.
The annual gross income is expected to
average P24,000 and annual expenses,
excluding depreciation, will total P6,000. If
capital is earning 10% before income taxes,
determine if this is a desirable investment
using (a) ROR, (b)AWM, (c) PWM, and (d)
FWM.
Seatwork
 A project requires an investment of P400,000,
lasts 15 years, and is estimated that the sales
will be P800,000 per year. The operating
expenses are as follows:
 Materials: P160,000 per year
 Labor: P280,000 per year
 Overhead: P40,000 per year + 10% of sales of
year
 Selling expense: P60,000 per year
 If it is expected to earn atleast 20% of the
capital, is the investment desirable?