Abstract
The authors will show that using present value ratio combined with a minimum hurdle rate for economic decision making can lead to erroneous economic conclusions. Two examples are presented.
Highlights
WHY THIS PAPER WAS WRITTEN A recent painful experience between a nameless consultant and an nameless mining house prompted this article
The purpose of this paper is to provide some examples of PVR combined with minimum hurdle rates that give, demonstrably, erroneous conclusions
Following Stermole [2] we will use in the examples a condensed notation for the single payment present worth factor and the uniform series present worth factor. we use, P/Fi,n as the single payment present worth factor whose value is calculated from the formula
Summary
Where i* is the company's minimum (acceptable) after tax rate of return. The only costs included in the denominator are those costs not covered by current or prior revenues. We use, P/Fi,n as the single payment present worth factor whose value is calculated from the formula. P/Ai,n as the uniform series present worth factor (assuming end-of-period payments) whose value is calculated from the formula (l+i)n-1 i ( 1 + i )n. Suppose that a firm has specified that the minimum acceptable after tax rate of return is i* = 20%, and that a project must have a minimum PVR of .3 in order to be considered acceptable. This second criterion is added in the hope of selecting only the more durable projects. The distributions of after tax cash flows are shown on the time diagrams below
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