Present Worth in Exclusive Choice: Why It Works

Why exclusive choice criteria works. What I’ve done for you is I’ve created an Asset A, which costs you \$10 in period 0 and gets you \$12 in period 1. I also have this other alternative asset over here, Asset B, which costs you \$20 gets you \$24 in time period 1. So what we’re going to do is give you a rationale on why the exclusive choice criteria really should be take the asset with the largest present worth. Here’s the way we’re going to think about it. You are altogether going to have \$20 to invest in time period 0, and with \$20 you can buy Asset B right here and buy it for \$20 and it gets you \$24 in period 1. What you can do is you can buy Asset A for \$10 and then stick the remaining \$10 in the MARR account and the interest rate on that is 10%. So what happens is with this bundle of \$20 you can buy Asset A and you get \$12 in the next period and you can stick the remaining \$10 you had available and stick it into the MARR account.

Now if you add these two together, you’re going to find that in period 1 you’re going to end up with \$23, which is great. However, if you stick the whole \$20 into the purchase of Asset B, you’re going to end up with is \$24. So please note that buying Asset B makes you better off than buying Asset A and then sticking the rest of the dollars into the MARR account. What’s important, however, is just to take a look at the present worth of these two assets. The present worth of Asset A is 0.91, and it doesn’t matter to do the calculations for the extra \$10 into the MARR account, that’s still going to be 0 no matter what you do. What’s important is that the present worth of Asset B is larger, it’s 1.82. So you’ve got to remember, this is just a way of showing you why it works. The criteria is going to be, if you’re in that exclusive choice environment, you’re better off choosing the asset that has the highest present worth.

page revision: 1, last edited: 20 May 2011 03:27