ECONOMIC ANALYSIS



FINANCIAL MANAGEMENT SCHOOLU.S. ARMY SOLDIER SUPPORT INSTITUTEFORT JACKSON, SOUTH CAROLINA 29207ECONOMIC ANALYSISSUMMARY SHEETOBJECTIVES:Explain the basic definition, purposes, and limitations of economic analysis.Explain when to perform and not perform economic analysis. Explain the seven steps of the economic analysis process.Explain the time value of money and use formats A and A-1 to perform economic analysis.REFERENCES:AR 11-8, Cost and Economic Analysis Program.Department of the Army Economic Analysis Manual.Army Management Engineering College "Economic Analysis for Decision Making" Course Book.Department of Defense Instruction (DODI) 7043.1, Economic Analysis and Program Evaluation for Resource Management.DEFINITION OF AN ECONOMIC ANALYSIS: We can define an economic analysis (EA) as a systematic approach to a given problem involving choices in the employment of scarce resources. Economic analysis provides a formal method to identify, analyze and compare the costs and benefits of alternative means of satisfying an objective. Economic analysis is designed to assist the decision maker by highlighting the financial impact of his/her choice. THE PURPOSES OF PERFORMING AN ECONOMIC ANALYSIS.Gain insight into the decision process.Understand investment proposals.Make better investment decisions.LIMITATIONS OF AN ECONOMIC ANALYSIS. An economic analysis can NOT:Produce a result that is more valid than input data.Make final decisions--those will be the responsibility of the decision maker.Be performed with cookbook precision, but must be tailored to fit the problem.Provide relevant solutions to irrelevant questions and problems.Act as a substitute for sound judgment, management, or control.SITUATIONS REQUIRING AN ECONOMIC ANALYSIS. Perform an economic analysis when:A higher headquarters or service regulation requires it.An organization is applying for capital budget funds such as the Defense Business Operations Fund.The decision involves a choice or trade-off between two or more options, even when one of the options is to maintain the status quo.Service regulations or guidance require an economic analysis.A specific functional agency directive prescribes an economic analysis.SITUATIONS NOT REQUIRING YOU TO PERFORM AN ECONOMIC ANALYSIS. Do NOT perform an economic analysis when:It can be shown that the minimum level of effort required to do the analysis would not be worth the benefits to be gained from such an analysis.The Department of Defense instructions or directives waive the requirement.Actions are specifically directed by legislation or prior irrevocable management decisions which preclude any choice or trade-off among alternatives, including alternative ways to accomplish a program/project.Other DoD Instructions and issuance’s prescribe equipment age or condition replacement criteria, labor and equipment trade-off standards, or requirement computations which in turn have been based on an analysis.OVERVIEW OF THE SEVEN STEPS OF AN ECONOMIC ANALYSIS.The economic analysis process has seven interrelated steps. They are:Develop an objective statement. Formulate assumptions and identify constraints. Identify alternatives.Determine cost and benefits for each pare alternatives using common criteria.Evaluate uncertainties and risk.Prepare a recommendation for the decision maker.THE TIME VALUE OF MONEY. Money has a time value associated with it and therefore a dollar received today is worth more than a dollar received in the future.The future value and present value of a dollar is based on the number of periods involved and the interest rate.THE PURPOSE OF FORMAT A AND A-1. The purpose of Format A and A-1 is to organize the results of an economic analysis. Format A and A-1 focus on the same kinds of basic cost information. Format A will determine the Uniform Annual Cost for a specific project. Format A-1 will determine the Savings to Investment Ratio for a proposed RMATION REQUIRED TO COMPLETE A FORMAT A. To complete a Format A you must have total life-cycle costs for each of the alternatives under consideration, including any approved project. Life-cycle costs associated with an alternative provide a relatively complete picture of the overall resource implications of the acquisition of goods and RMATION REQUIRED TO COMPLETE A FORMAT A-1. To complete a Format A-1 you must have determined the differences in costs between alternatives. Often it is critical for an analysis to focus on the amount of difference in those costs affected by alternatives. END OF YEAR DISCOUNT FACTORSPROJECT YEARColumn A - 10%Present Value of $1 (single amount - to be used when cash flows accrue in different amounts each year).Column B - 10%Present Value of $1 (cumulative uniform series - to be used when cash flows accrue in the same amount each year).0123456789101112131415161718192021222324251.0000.9090.8260.7510.6830.6210.5640.5130.4660.4240.3860.3500.3190.2900.2630.2390.2180.1980.1800.1640.1490.1350.1230.1120.1020.0921.0000.9091.7352.4863.169 3.7904.3544.8675.3335.7576.1436.4936.8127.1027.3657.6047.8228.0208.2008.3648.5138.6488.7718.8838.9859.077The discount factors presented in the table above implicitly assure end-of-year lump sum costs and returns. When costs and returns occur in a steady stream, applying mid-year discount factors may be more appropriate. The factors in this table can be converted to a mid-year basis by multiplying them by 1.048809. ................
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