Present value nflation Nominal amounts are valued according to the level of prices in the year the return occurs Real amounts are valued according to the level of prices in one particular year Inflation affects both the payout stream and the discount factor and these two cancel each other out
11 Present Value: Inflation • Nominal amounts are valued according to the level of prices in the year the return occurs. • Real amounts are valued according to the level of prices in one particular year. • Inflation affects both the payout stream, and the discount factor, and these two cancel each other out
Private Sector Project Evaluation Suppose there are two projects, X andY Each entails certain benefits and costs denoted as bx C by and CY · Need to ask: Is the project admissible? Is the project preferable? 12
12 Private Sector Project Evaluation • Suppose there are two projects, X and Y • Each entails certain benefits and costs, denoted as BX , CX , BY, and CY. • Need to ask: – Is the project admissible? – Is the project preferable?
Private Sector Project Evaluation Admissible: Are the benefits greater than the costs? Preferable: Are the net benefits the highest? Most projects involve a stream of benefits and costs over time 13
13 Private Sector Project Evaluation • Admissible: Are the benefits greater than the costs? • Preferable: Are the net benefits the highest? • Most projects involve a stream of benefits and costs over time
Private Sector Project Evaluation Define: B : Benefits from project i at time t t- Costs from project i at time t Then the present value of project iis Br-C Pri=(Bi-Ci+ B1-C1 +,, (1+r) T 1+ 14
14 Private Sector Project Evaluation • Define: Bt i = Ct i = Benefits from project i at time t Costs from project i at time t • Then the present value of project i is: ( ) ( ) ( ) ( ) ( ) PV B C B C r B C r i i i i i T i T i T = − + − + + + − + 0 0 1 1 1 1
Private Sector Project Evaluation The present value criteria for project evaluation are that A project is admissible only if its present value is positive When two projects are mutually exclusive the preferred project is the one with the highest present value 15
15 Private Sector Project Evaluation • The present value criteria for project evaluation are that: – A project is admissible only if its present value is positive – When two projects are mutually exclusive, the preferred project is the one with the highest present value