1. FINANCIAL MANAGEMENT SCHOOL
ECONOMIC ANALYSIS
STUDIES
SHOW SLIDE 1: ECONOMIC ANALYSIS
SECTION I. : Perform Economic Analysis
ADMINISTRATIVE DATA
All Courses Including This Lesson
Course Number Version Course Title
01 Planning Programming Budget & Execution Course (PPBE)
Task(s) Task Number Individual
Taught (*) or
Academic Hours
The academic hours required to teach this lesson are as follows:
Resident
Hours/Methods
Academic Hours/Method
0.1 hrs Introduction/Conference Discussion
5.8 hrs Conference Discussion
2.0 hrs Practical Exercise
0.1 hrs Summary
8.0 hrs Total Time
Test Lesson Number
Testing (to include test review)
Hours -0 hrs
Lesson Number -
Prerequisite Lesson(s)
Lesson Number
Lesson Title
Perform Economic Analysis Clearance Access
Security Level: Unclassified
Requirements: There are no clearance or access requirements for the lesson.
Foreign Disclosure Restrictions
FD5. This product/publication has been reviewed by the product developers in coordination with the Fort Jackson Soldier Support Institute foreign disclosure authority. This product is releasable to students from all requesting foreign countries without restrictions.
Instructor Requirements
Must meet physical qualifications IAW AR
Materials Required
Instructor Materials:
Lesson plan slides, DFAS-IN Regulation 37-1, DFAS-IN-MANUAL FY, Instructor copy 
Student Materials:
DoDI , Summary Sheet and Handouts, Practical Exercise 1, 2, 3 and 4, calculator and pencils.
Classroom, Training Area, and Range Requirements
General Purpose Classroom - 25 Seats
Instructional Guidance
Note: Before presenting this lesson, instructors must thoroughly prepare by studying this lesson and identified reference material.
Also, provide the students with situational awareness of the Operational Environment (OE) variables and actors.
Proponent Lesson Plan Approvals
Name Rank Position Date
Harris, Norman CTR Writer/Developer xx-xxx-xxxx
Bonig, Reid GS-12 Chief - FMITD xx-xxx-xxxx
Davis, Bobby LTC FM-DOT xx-xxx-xxxx
Zellars, Eric COL Commandant xx-xxx-xxxx
Motivator: Economic analysis (EA) is the best method of providing assistance in evaluating proposals. With economic analysis you can evaluate and rank alternative courses of action or proposals for investments, in a logical structured way. Since the Department of the Army (DA) has limited resources or funds we should have a way of ranking or setting priorities for investing or spending these funds.
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2. Terminal Learning Objective
Action:
Conditions:
Standard:
Perform Economic Analysis.
Given a summary sheet containing DoDI and slides.
With a minimum of 80% accuracy:
Define the purpose, limitation, definition, when and when not to perform economic analysis; interpret when to perform an economic analysis; identify cost; and determine formats and savings investment ratio (S/IR).
SHOW SLIDE 2: TERMINAL LEARNING OBJECTIVE
Note: State the TLO
Safety Requirements:  Everyone is responsible for safety. A thorough risk assessment must be completed prior to every mission or operation.
Risk Assessment Level: Low
Environmental Considerations: NOTE: It is the responsibility of all Soldiers and DA civilians to protect the environment from damage.
Environmental protection is not just the law but the right thing to do. It is a continual process and starts with deliberate planning. Always be alert to ways to protect our environment during training and missions. In doing so you will contribute to the sustainment of our training resources while protecting people and the environment from harmful effects.
Evaluation: Students will take a comprehensive test at the end of Week 1. Students must score 80% or higher and International officers must score 70% or higher.
Instructional Lead-In: At the completion of this lesson, you will perform economic analysis IAW DoD , Economic Analysis and Program Evaluation for Resource Management, and Economic Analysis for Decision Making Course Book.
This lesson will cover the purpose of an economic analysis and how it relates to both performance measurement and business process improvement.
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3. FINANCIAL MANAGEMENT SCHOOL
Economic Analysis
A systematic approach to a given problem of choice, designed to assist the decision maker by highlighting the economic or financial impact of his/her choice.
SHOW SLIDE 3: Economic Analysis
We can define an economic analysis (EA) as a systematic examination of the benefits and costs of a particular program, setting out the factors that should enter into the evaluation of the desirability of the program and frequently analyzing several alternatives for the attainment of the objective.
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4. FINANCIAL MANAGEMENT SCHOOL
Purpose
Examining alternatives
Gain insight into the decision process
Having a formal method to compare costs against anticipated benefits
Understand investment proposals
SHOW SLIDE 4: Purpose
Why do an Economic Analysis?
THE PURPOSES OF PERFORMING AN ECONOMIC ANALYSIS.
a. To examine alternative courses of action or opposing proposals for use of limited funds.
b. To avoid using the criteria of "absolute needs" or "money first" when making a decision with regards to investment decisions.
c. To have a formal method to compare proposed costs against anticipated benefits. To have an evaluation of costs and benefits of one
proposal versus another.
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5. Situation Requiring Economic
Analysis
Higher HQs, service regulations, or guidance requires EA
The organization is applying for capital budget funds
The decision involves a choice between two or more options
Prescribed by a specific functional agency
Open ended requirement for military need
Ongoing programs
SHOW SLIDE 5: Situations Requiring Economic Analysis
You are required to perform an economic analysis when:
a. It is required by a higher headquarters or service regulation.
b. An organization is applying for capital budget funds such as the Defense Business Operating Fund.
c. 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 or to
do nothing.
d. Service regulations, or guidance requires an economic analysis.
e. An economic analysis is prescribed by a specific functional agency directive.
A military necessity is cited as justification and the specific means of achievement is open to decision.
Ongoing programs must be periodically assess for cost effectiveness.
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6. Situations Not Requiring
Economic Analysis
Don’t Do
Economic Analysis
When.....
The effort is not worth the benefits
DoD/DA directs the investment
Legislation or prior decision directs investment
DoD instructions prescribe equipment age or condition replacement criteria
SHOW SLIDE 6: Situations Not Requiring Economic Analysis
There are times when you are not required to perform an economic analysis.
Typically these are:
a. 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.
b. When new or modified programs are directed by the DoD.
c. 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.
d. In cases where other DoD Instructions and issuances prescribe equipment age or condition replacement criteria, labor and equipment trade-off standards, or requirement computations which in terun have been based on an analysis
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7. FINANCIAL MANAGEMENT SCHOOL
Limitations
Economic analysis cannot:
Produce a result that is more valid than input data
Be performed with cookbook precision
Make final decisions
Provide solutions to irrelevant questions and problems
Substitute for sound judgment and management
SHOW SLIDE 7: Limitations
The limitations of economic analysis are:
a. An economic analysis will not produce a result that is more valid than input data.
b. An economic analysis will not make final decisions, that will be the responsibility of the decision maker.
c. An economic analysis can not be performed with cookbook precision, but must be tailored to fit the problem.
An economic analysis can not provide relevant solutions to irrelevant questions and problems.
An economic analysis is not a substitute for sound judgment, management or control.
CHECK ON LEARNING
Q. In what regulation is the basic guidance for economic analysis?
A. DoDI
Q. What are the purposes of economic analysis?
A. To examine alternative courses of action or opposing proposals for use of limited funds.
To avoid using the criteria of “absolute needs” or “money first” when making a decision with regards to investment decisions.
To have a formal method to compare proposed costs against anticipated benefits. To have an evaluation of costs and benefits of one proposal versus another.
Q. What are the limitations of economic analysis?
A. It cannot produce a result that is more valid than input data.
An economic analysis will not make final decisions, that will be the responsibility of the decision maker.
An economic analysis can not be performed with cookbook precision, but must be tailored to fit the problem.
An economic analysis is not a substitute for sound judgment, management, or control.
Q. When DoD directs new or modified programs, is an economic analysis required?
A. No.
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8. FINANCIAL MANAGEMENT SCHOOL
DASA-CE Mission
Implement Visibility and Management of Operating and Support Costs (VMOSC)
Provide cost and economic analysis support to the army PPBE system
Develop component cost analysis for weapons and information systems
Evaluate cost, cost risk, and economic analysis
Develop models, tools, and databases
Publish discount rates
SHOW SLIDE 8: ODASA-CE Mission
Office of the Deputy Assistant Secretary of the Army for Cost and Economics (DASA-CE) does the economic analysis for the Army. They develop cost models to predict everything from the cost to drive a tank one mile to the cost to fly one hour in a helicopter.
They also publish a manual of how to conduct an economic analysis as well as publishing the discount rates.
VMOSC = Visibility and Management of Operating and Support Costs.
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9. Economic Analysis Process
1. Define objective.
2. Formulate assumptions.
3. Identify possible alternatives.
4. Determine costs and benefits for each alternative.
5. Compare and rank alternatives.
6. Evaluate uncertainties and risk.
7. Make a decision.
SHOW SLIDE 9: Economic Analysis Process
Remember economic analysis is just a decision making tool.
The process is similar to the Military Decision Making Process (MDMP).
The economic analysis process has seven interrelated steps. They are:
a. development of an objective statement and an understanding of the problem you are trying to solve;
b. formulate assumptions and commander estimates of the situation and identify constraints from the situation and from the command
estimate or guidance;
c. identify alternatives;
d. determine cost and benefits for each alternative;
e. compare alternatives using common criteria;
f. prepare a recommendation for the decision maker.
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10. Characteristics of Cost
Tools of decision making
Represent effort and resources
A “common denominator” when expressed in $$
Opportunity costs- not always measurable
Sunk costs- once spent, it’s gone
Cost avoidance- cost “savings”
SHOW SLIDE 10: Characteristics of Cost
These are some things we need to consider when dealing with costs for Army Economic Analysis.
First, cost is a tool to use when making a decision. Cost is an important item to consider when decide which alternative to choose.
Cost is not just dollars, but also the effort and other resources, such as time, that are used by different alternatives.
You must use a Common Denominator when making a comparison so you’re not comparing apples and oranges. Try to define everything in terms of dollars. Why? Because it is easier to compare across items / projects.
Cost can also be the Opportunity Cost. This is the price for doing something and not having the opportunity to do something else. For example, I come to work in the morning with $20, I spend it on all on lunch. I have given up an opportunity to use it on something else later (like a haircut or gas). Opportunity cost is the Cost of making a decision.
Sunk Cost is money you’ve spent no matter what direction you take later. We don’t worry about sunk costs in Economic analysis.
Cost Avoidance means if you avoid costs you capture them as “savings”.
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11. FINANCIAL MANAGEMENT SCHOOL
Costs to Consider
Costs over life (economic) of the project:
One-time/nonrecurring costs
Investments
Refurbishments, overhauls, etc.
Recurring costs
Operations
Maintenance
Labor
Value of existing equipment used on the project
Salvage/terminal value
SHOW SLIDE 11: Costs to Consider
You consider all costs over the economic life of the project.
One Time/nonrecurring Costs could be initial investments to get a project started or it may be one time refurbishments to improve a process within a project.
Recurring Costs are things such as operations, maintenance and labor that are paid on a regular basis, such as annual or monthly costs.
Salvage/terminal Value and the value of your existing equipment are the compensation you’d receive when you get rid of the something.
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12. FINANCIAL MANAGEMENT SCHOOL
Investment
An investment is a commitment of resources in the present in hope of future benefits.
SHOW SLIDE 12: Investment
This is the definition of an investment. It is a commitment of resources now in hopes of getting a return on those resources later.
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13. FINANCIAL MANAGEMENT SCHOOL
Types of Investments
Alternatives:
Repair or replace
Lease versus buy
Renovation to reduce costs
Fuel conversion to reduce heat costs
Consolidate/Repair to increase efficiency
Modernize to improve work flow
Material and supply handling projects
Acquisition of ADPE
SHOW SLIDE 13: Types of Investments
You have different types of investments and different alternatives. A definition of an alternative is an approach, among two or more, that is a possible way of fulfilling an objective, mission, or requirement.
1st two (repair/replace and lease/buy involve comparisons (Comparing two options). Should I repair the generator or replace it. Should I buy the truck or lease it. Obviously, we’d have to compare the cost in order to make an intelligent decision.
The remaining alternatives listed involve taking action, or not taking that action. Not doing something that is also a choice. Will the cost be higher to take action versus doing nothing?
ADPE – Automatic Data Processing Equipment
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14. FINANCIAL MANAGEMENT SCHOOL
Economic Life
Starts - when the property begins being used.
Ends - when the cost of maintaining the property exceeds the benefits gained from the use of the property.
Cost > benefits
Period of comparison; must be equal.
SHOW SLIDE 14: Economic Life
Economic Life is the lifespan for which WE need the system – not its total lifespan.
For example, we may need a car for 5 years, it can last 10 years – we only consider it for 5 because that is the life we need for the system.
The economic life starts when we begin using the equipment and ends when the cost of maintaining it outweighs the benefits we are obtaining from it.
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15. FINANCIAL MANAGEMENT SCHOOL
Present Value of Money
In most analysis methods we are taking a number of future receipts or benefits that can be expressed in terms of dollars and reduce them to a single value
After accomplishing this, the single value of costs can be compared with the single value of benefits to determine which is greater
If the benefits exceed the costs, then the investment is economically sound
SHOW SLIDE 15: Present Value of Money
To explain the present value of money, let’s consider, is a $1 now worth the same as $1 will be worth in 5 years? No. Why? Because of the time
value of money, which is essentially inflation..
Ever go into Cracker Barrel and they have that store with all that antique stuff? I was walking around and I found this birthday card that tells you
how much stuff cost when you were born. In 1968 bread was 25 cents – now it’s $2.00 a loaf. Why - is bread that much better? No, it’s because
of inflation and the increase in costs over the years.
Present Value of Money is a process to express future benefits and future costs in today’s money - so that they can be compared.
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16. Present Value of Money Example
Assume you have an account that earns 10% interest compounded annually
Invested Amount Amount Amount Amount Amount
now end of end of end of end of end of
YR YR YR YR YR YR 5
$100
$110
$121
$133.10
$146.41
$161.05
$100 * 1.1 1
$100 * 1.1 2
$100 * 1.1 3
$100 * 1.1 4
$100 * 1.1 5
What if we knew that 2 years from now (end of year 2) that we would have a bill for $242 that we would have to pay, how much would we have to save now in our 10 % account in order to pay that bill 2 years later?
YR 0 = X
X * 1.1 = 2
$242 X=
$242 / 1.21
X= $200
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17. FINANCIAL MANAGEMENT SCHOOL
Present Value
Discount Factor Table
Column A Column B
Project Uniform
Year % Series
SHOW SLIDE 16: Present Value Discount Factor Table
To determine Present Value, we use what’s called a discount factor. You have one on the sheet we handed out to you.
1st column is broken down by year.
2d column (Column A) is the PV of a single one time amount that you would have to pay or would receive as a salvage value in the future. Column A tells us what $1 will be worth 1 year from today cents. Or 2 years from today, if we have to pay $1, will be worth 82.6 cents.
3d column (Column B) is the Uniform annual series. This is used when you have to pay as rent or you receive as rent the same amount every year. For example, if you want to know the value of paying $1 every year for 5 years in today’s dollars, you’d take $1 x = $ This tells you how much your payments are worth today.
Column A - Present Value of $1 (single amount to be used when cash flows accrue in different amounts each year).
Column B - Present Value of $1 (cumulative uniform series to be used when cash flows accrue in the same amount each year).
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18. Uniform Annual Cost (UAC)
The annual amount of money that a project would cost, if the total project could be divided equally over the years of operation of the project
A conceptual value; used for comparison only
UAC with Terminal =
Discounted Annual Cost at the End of Year
Discount Factor at the End of Maximum Year
SHOW SLIDE 24: Uniform Annual Cost (UAC)
The Uniform Annual Cost is the method we will be doing in class.
UAC is a comparison technique, kind of like an average, used to compare two different costs.
It provides one, single number for comparison purposes.
We use a form called Format A, which when completed provides the UAC.
To complete Format A you must have total life-cycle costs for each of the alternatives under consideration.
Let’s take a look at the overhead and the copy I have provided you showing a Format A and we’ll talk about it.
*** Walk students through PE 3 - do timeline then handout 1 format A’s - (refer to instructions)
PE 4 – Students do on their own in class. (They need 2 format A’s)
PE 5 – Students take home (They need 1 format A)
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19. Practical Exercise (PE)
At this time we’re going to do together our first PE, PE #2, you will also need Handout#1 Discount Factors.
***Note-Handout PE #2 and go over how to do it.
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20. Economic Analysis Methods
Benefit/Cost ratio
Marginal analysis
Break even (payback)
Rate of return (ROR)
Net present value
Uniform annual cost
Savings to investment ratio
SHOW SLIDE 17: Economic Analysis Methods
These are the different methods of doing an economic analysis that we’ll discuss them over the next few slides.
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21. Benefit/cost Ratio (BCR)
Comparison of the present value of costs compared to the present value of the benefits derived
Ratio greater than one is desired
PV Total Benefits
PV Total Costs
SHOW SLIDE 18: Benefit/Cost Ratio (BCR)
For the Benefit/Cost ratio, you are comparing the PV of the costs to the PV of the benefits you expect to derive.
You want to have an answer that is greater than 1 so that your benefits are greater than the costs.
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22. FINANCIAL MANAGEMENT SCHOOL
Marginal Analysis
Marginal or incremental analysis
Only considers the differences between two alternatives, not the total benefits or costs
Limited in scope and application
Marginal Cost = Total Cost (Project A) – Total Cost (Project B)
SHOW SLIDE 19: Marginal Analysis
Marginal Analysis is used only to consider the differences between two alternatives. It doesn’t consider the total cost or benefits.
You do this by subtracting the cost of one project from the cost of the other project. Rather simple math.
If answer is (-) or <1 = A is cheaper
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23. FINANCIAL MANAGEMENT SCHOOL
Break Even (Payback)
Used for high risk projects
Focuses on comparing when the costs of the projects will be recovered, not the overall savings
Projects with shorter payback periods are preferred
Example:
Investment: $200,000
Savings per year for 10 years: $50,000
Break even period: 4 years
SHOW SLIDE 20: Break Even (Payback)
Break Even or Payback Analysis is used to tell you when you will get your money back from a project.
It looks at when costs will be recovered. Obviously, the shorter payback is best.
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24. FINANCIAL MANAGEMENT SCHOOL
Rate of Return (ROR)
Rate where the present value of the costs is equal to the present value of the savings
The project with the highest rate of return is preferred
The rate is the variable in the formula
SHOW SLIDE 21: Rate of Return (ROR)
When choosing a project, you want to choose the option that has the highest Rate of Return.
You get rates from the Economic Analysis Manual published by CEAC (Cost and Economic Analysis Center).
You figure out the discount factor to have costs = savings.
You determine how much return you will get compared to how much it will cost by determining the PV of cost, which equals PV of savings + discount factor.
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25. FINANCIAL MANAGEMENT SCHOOL
Net Present Value
(NPV)
The amount of dollars that would have to be invested during the base year at the assumed discount (interest) rate to cover the costs or match revenues or savings at a specific point in the future
NPV = (PV savings + PV terminal value) - PV new investment costs
SHOW SLIDE 22: Net Present Value (NPV)
The popular business world technique is Net Present Value. This would tell you the benefit of making a new investment, such as buying new equipment.
NPV is determined by taking (PV savings + PV terminal value) - PV new investment costs.
You want the NPV to be a positive number. If comparing two alternatives, you choose the one with the Higher NPV.
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26. Savings Investment Ratio
(S/IR)
This ratio compares the savings or benefits of an alternative with the investment cost to see if the cost is offset by the savings
S/IR = OPERATING COST SAVINGS
COST OF INVESTMENT
If S/IR > 1, then cost effective
SHOW SLIDE 23: Savings Investment Ratio (S/IR)
The Savings Investment Ratio compares the savings or benefits of an alternative with an investment cost to see if the cost is offset by the savings.
The formula is:
S/IR = OPERATING COST SAVINGS
COST OF INVESTMENT
If S/IR > 1, then the alternative is cost effective.
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27. Check On Learning Q. What is a Investment?
A. An investment is a commitment of resources in the present in hope of future benefits.
Q. What is the equation for Marginal Cost?
A. Marginal Cost = Total Cost (Project A) – Total Cost (Project B)
Slide 24
Check on Learning
NOTE: Conduct a check on Learning
Q. What is a Investment?
A. An investment is a commitment of resources in the present in hope of future benefits.
Q. What is the equation for Marginal Cost?
A. Marginal Cost = Total Cost (Project A) – Total Cost (Project B) 27

28. Terminal Learning Objective
Action:
Conditions:
Standard:
Perform Economic Analysis.
Given a summary sheet containing DoDI and slides.
With a minimum of 80% accuracy:
Define the purpose, limitation, definition, when and when not to perform economic analysis; interpret when to perform an economic analysis; identify cost; and determine formats and savings investment ratio (S/IR).
SHOW SLIDE 25: Terminal Learning Objective
At the completion of this lesson, you will perform economic analysis IAW DoDI , Economic Analysis and Program Evaluation for Resource Management, and Economic Analysis for Decision Making Course Book.
This lesson will cover the purpose of an economic analysis and how it relates to both performance measurement and business process improvement.
1/3/2019
FINANCIAL MANAGEMENT SCHOOL