Question

1.In your own words, what is the difference between a salvage cost and a salvage value? How do each contribute to the overall PW of a project?

2.In your own words, describe the difference between simple payback and discounted payback.

Answer 1

1.

Salvage value and Salvage cost: Every Asset / Alternative has a predetermined life (Excepts assets having infinite life), when the Asset / Alternative reaches the end of its value it has to be disposed as it may no longer serve the purpose for what it was procured. The value that is obtained when the Asset / Alternative is scraped at the end of its life is salvage value or Scrap value. On the contrary, if the Asset / Alternative requires some money to expended to salvage or scrap at the end of its life the same is called Salvage cost.

Salvage value is a positive (Inflow) cash flow to the owner and Salvage cost is a negative (outflow) cash flow to the owner.

The contribution to present worth is as follows

Present worth = Present worth of benefits - Present worth of costs

If Salvage value increases, it will increase the Present worth of benefits and therefore increasing the Present worth.

If Salvage cost increases, it will increase the Present worth of costs and therefore decreasing the Present worth.

2.

Payback period: It is a period by which the investments are received back by the investor on a particular Asset / Alternative.

The basic difference between simple payback period and discounted payback period is consideration of time value of money. Although the formula for both remain same, the treatment in case of discounted payback period is different in the sense that all the cash flows are discounted with respect to their existence on the time line.

Payback period = Initial Investment / [Annual Benefits – Annual Costs]