Future Worth Method
FUTURE WORTH METHOD
In
this method, the future worth of various alternatives will be computed. Then,
the alternative with the maximum future worth of net revenue or with the
minimum future worth of net cost will be selected as the best alternative for
implementation.
Future
worth method is used particularly in an investment situation where we need to
compute the equivalent worth of the project at the end of its investment period
For
Example: Building a nuclear power plant, where it is time consuming. In such
situation it is more common to measure the worth of the investment at the time
of commercialization
Revenue-Dominated Cash Flow
Diagram
The profit/revenue, salvage value of all
inflows to an organization will be assigned with positive sign and the cost
outflows will be assigned with negative sign is called revenue dominated cash
flow.
A generalized revenue-dominated cash flow
diagram to demonstrate the future worth method of comparison is presented in
Fig.
 |
| Revenue dominated cash flow diagram |
Here,
P
= Initial investment
Rj
= Revenue at the end of the ‘j’th year
i
= Interest rate compounded annually
S
= Salvage value at the end of ‘n’th year
The
future worth amount of the above revenue dominated cash flow diagram for a
given interest rate i is
FW(i) = -P (1 + i)n +
R1(1 + i)n-1 + R2 (1 + i) n-2 + ... + Rj (1 + i)n-j
+ Rn + S
The above equation can be simplified
as,
FW(i) = -P (F/P, i, n) + R1 (F/P,
i, n-1) + R2 (F/P, i, n-2) + . . . + Rj (F/P, i, n-j) + Rn + S
Incase if revenue is equal for all the
given years (R1 = R2 = … = Rj = Rn = A) then the above formula is rewritten as,
FW(i) = -P (F/P, i, n) + A (F/A,
i, n) + S
The corresponding future worth amount
of different alternatives are calculated and compared. The alternative which
has maximum
future worth amount should be selected as the best alternative.
Cost-Dominated Cash Flow
Diagram
The cost outflows of an organization will
be assigned with positive sign and the profit/revenue, salvage value of all
inflows to an organization will be assigned with negative sign is called cost
dominated cash flow.
A generalized cost - dominated cash flow
diagram to demonstrate the future worth method of comparison is presented in
Fig.
 |
| Cost dominated cash flow diagram |
Here,
P
= Initial investment
Cj
= Revenue at the end of the ‘j’th year
i
= Interest rate compounded annually
S
= Salvage value at the end of ‘n’th year
The
future worth amount of the above cost dominated cash flow diagram for a given
interest rate i is
FW(i) = P (1 + i)n + C1(1
+ i)n-1 + C2 (1 + i) n-2 + ... + Cj (1 + i)n-j
+ Cn - S
The above equation can be simplified
as,
FW(i) = P (F/P, i, n) + C1 (F/P,
i, n-1) + C2 (F/P, i, n-2) + . . . + Cj (F/P, i, n-j) + Cn - S
Incase if revenue is equal for all the
given years (C1 = C2 = … = Cj = Cn = A) then the above formula is rewritten as,
FW(i) = P (F/P, i, n) + A (F/A,
i, n) - S
The corresponding future worth amount of different
alternatives are calculated and compared. The alternative which has minimum
future worth amount should be selected as the best alternative.
