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Department of Chemical Engineering

& Energy Sustainability


Faculty of Engineering

KNC 3262 ENGINEERING ECONOMY

CASE STUDY
ON
APPLICATION OF MONEY-TIME RELATIONSHIP

By

Dayangku Nur Hamiza Binti Awang Kedari (45221)


Ahmad Auzaee Bin Mohamed Ali (45428)
Nor Liyana Binti Yusop (48052)
Nur Jihan Nazihah Binti Amin (45886)
Mohd Fazlieman Bin Gurahman (45688)

Bachelor of Engineering with Honours


(Chemical Engineering)
2017

TABLE OF CONTENTS

1.0 Overview of the case 1


2.0 Problem Statement 2
3.0 Solution Methodology (Formula) 2
a) By using the Present Worth (PW) method
b) By using the Future Worth (FW) method
c) By using the Annual Worth (AW) method
4.0 Recommendations and Conclusion 5
5.0 References 6
6.0 Learning Outcomes 7
1.0 Overview of the case

2.0 The case study shows an application of Money-Time

Relationship. New equipment has been proposed by process engineers to

increase the productivity of a certain manual welding operation. The

investment cost is RM 25,000. Investment cost means the amount of

money spent for the investment, investment expenditure required

to exercise the option. The equipment will have a market value of RM

5000 at the end of a study period of five years. Market value refers to the

current or most recently-quoted price for a market-traded security.

Increased productivity attributable to equipment will amount to RM

8000 per year after extra operating costs have been subtracted from the

revenue generated by the additional production. Revenue is the income

generated from sale of goods or services, or any other use of capital or

assets associated with the main operations of an organization before any

costs or expenses are deducted. While operating cost is expenses

associated with the maintenance and administration of a business.

3.0 A cash-flow diagram for this investment opportunity is

given in Figure 1.1. Noted, the firms MARR is 20% per year. An analysis

to the investment of new equipment is prepared by using three different

method which are Present Worth (PW), Future Worth (FW) and Annual

Worth (AW) method. PW is all cash inflows and outflows are

discounted to the present time at the MARR. FW is the value of an

3
asset at a specific date. AW of project is the equivalent annualized

series of dollar amounts for the cash inflows and outflows at a

given interest rate or MARR. From this analysis, it can be decided

whether this investment is economically feasible or not.

4.0

5.0

6.0 Problem Statement

7.0 New equipment has been proposed to increase the

productivity of a certain manual welding operation. The investment cost

is RM 25,000, and the equipment will have a market value of RM 5000 at

the end of a study period of five years. Increased productivity

attributable to equipment will amount to RM 8000 per year after extra

operating costs have been subtracted from the revenue generated by the

additional production.

8.0 However, the managing director must be convinced that

the investment of new equipment is economically feasible. Thus, an

investment analysis is documented in this report. By using method such

as the present worth method, future worth method and annual worth

method, the investment analysis can be made.

9.0
10.0 Solution Methodology (Formula)

11.0 Question 1:

4
12.0 New equipment has been proposed by process engineers to

increase the productivity of a certain manual welding operation. The

investment cost is RM 25,000, and the equipment will have a market

value of RM 5000 at the end of a study period of five years. Increased

productivity attributable to equipment will amount to RM 8000 per year

after extra operating costs have been subtracted from the revenue

generated by the additional production. A cash-flow diagram for this

investment opportunity is given in Figure 1.1. Noted, the firms MARR

is 20% per year.

13.0

14.0

15.0
RM 5000
16.0

17.0

18.0 RM 8000 RM 8000 RM 8000 RM 8000 RM 8000

19.0

20.0
1 2 3
21.0 4 5
Years
22.0
i=20 / yr
23.0
RM
24.0

25.0 Figure 1.1: Cash Flow Diagram for the investment of new
equipment

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26.0

27.0 As process engineers you must prepare an analysis to the

investment of new equipment to convince the Managing Director (MD)

whether this is economically feasible or not by using different methods as

mentioned below:

a) By using the Present Worth (PW) method


b) Evaluate the Future Worth (FW) of the potential improvement project.
c) By using the Annual Worth (AW) method

28.0 Solution

29.0 The table below summarizes the equivalency factors.

The Name column shows the traditional names for the factors. Each

factor has a formula that depends on i, the interest rate per compounding

period, and N, the number of compounding periods in the interval. The

factors are valid for i strictly greater than zero and N integer.

30.0 Table 1: Factor formula

6
31.0

32.0 The solution for the questions above are shown in table below

33.0 34.0 Met 35.0 Calculation

N hod

36.0 37.0 Pres 38.0

7
1 ent Worth
PW =PV ( PP , 20 , 5)+ AV ( PA ,20 ,5)+ FV ( PF ,20 ,5)
(PW)

( 1+i )n1
39.0
PW =PV (1 ) + AV
( )
i ( 1+ i )
n
n
+ FV ( (1+i ) )

40.0

( 1+i )n1
PW =25000+8000
( i ( 1+i )
n)+5000 ( 1+i )
n

41.0

( 1+0.2 )51
PW =25000+8000
( i ( 1+0.2 )
5 )
+5000 ( 1+0.2 )
5

42.0
PW =2009.3879+23924.897125000

43.0
PW =RM 934.28

44.0 45.0 Futu 46.0

2 re Worth

(FW) FW =PV ( FP ,20 ,5)+ AV ( FA , 20 , 5)+ FV ( FF , 20 , 5)


( 1+i )n1
47.0
FW =PV
1
(
( 1+ i )n
+ AV
) ( i
+ FV ( 1 ) )
( 1+i )n1
48.0
FW =PV
( 1
) (
( 1+ i )n
+ AV
i )
+ FV ( 1 )

8
49.0

( 1+i )n 1
FW =25000
( 1
)
( 1+ i )n
+ (
8000
i ) +5000

50.0

5
FW =25000
( 1
( 1+ 0.2 )5 )
+8000 (
( 1+0.2 ) 1
0.2
+5000 )
51.0
FW =8359.492+59532.8+5000

52.0
FW =RM 2324.8

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53.0 54.0 Ann 55.0

3 ual Worth

(AW) AW =PV ( AP ,20 ,5)+ AV ( AA , 20 , 5)+ FV ( FA , 20 , 5)


56.0

n
AW =PV
(
i ( 1+ i )
n
( 1+i ) 1 )
+ AV ( 1 ) + FV
i
(
i ( 1+i )n1 )
57.0

n
AW =25000
(
i ( 1+i )
n
( 1+i ) 1 )
+8000+5000
i
n
i ( 1+ i ) 1 ( )
58.0

5
AW =25000
(
0.2 ( 1+ 0.2 )
5
( 1+0.2 ) 1
+8000+5000
) 0.2
(
0.2 ( 1+ 0.2 )51 )
59.0
AW =8359.492+8000+671.8985

60.0
AW =RM 312.41

61.0

62.0 Recommendations and Conclusion

63.0 Recommendation

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64.0 Using the present worth method, there are 2 analyses that

can be done which is if the value obtained is negative or less than zero,

the investment is deemed unprofitable and if the value obtained is

positive, the investment can bring profit. From the calculation done

previously, the value obtained is positive which means that the future

value of the machine will be greater than the future cost and it is

suggested that the equipment should be bought and it is economically

feasible.

65.0 Using the future worth method, there are also 2 possible

analyses that can be made which is the same as the present method.

Based on the calculations done previously using the future worth

method, the suggested answer is also the same which is the investment is

recommended and it is economically feasible.

66.0 Last but not least, using the annual worth method, there

are also 2 possible analyses that can be made whether it is greater or less

than zero. From the calculations done previously, the value obtained is

positive and the suggestion is also the same where the equipment should

be bought and it is economically feasible.

67.0 Conclusion

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68.0 For this case, there are various ways to determine the

economic feasibility of the investment which is through the present worth

method, future worth method and the annual worth method. Each of the

methods have different calculations and formula used but for this case,

all the methods points to a single answer where the investment of the

new equipment is economically feasible and can bring profit to the

company. Hence it is suggested that the managing director invest on the

new equipment to increase the productivity of the manual welding

operation

69.0

70.0 References

71.0 Utexas (2017) Factor Formulas Available at:

https://www.me.utexas.edu/~me353/lessons/S2_Evaluation/L02_Equivale

nce/factor_formulas.html Accessed on 14 March 2017.

72.0 Learning Outcomes


73.0

74.0 75.0 Learning/Idea/Recomme 76.0 Reference

Key ndation

wor

d
77.0 78.0 Definition: The amount of 79.0 IGI Global

Investm money spent forthe investment, (2017), What is

ent investment expenditure required Investment Cost,

cost to exercise the option (cost of Available at:

12
converting the investment http://www.igi-

opportunity into the options global.com/dictiona

underlying asset. ry/investment-

cost/15660,

Accessed on 12

March 2017

80.0
81.0 82.0 Definition: The income 83.0 Business

Revenu generated from sale of goods or Dictionary (2017),

e services, or any other use of Revenue, Available

capital or assets associated with at:

the main operations of an http://www.busines

organization before any costs or sdictionary.com/de

expenses are deducted. finition/revenue.ht

ml, Accessed on 12

March 2017
84.0 85.0 Definition: Operating costs 87.0 Investopedia

Operati are expenses associated with the (2017), Operating

ng maintenance and administration Cost Definition,

cost of a business on a day-to-day Available at:

basis. http://www.investo

86.0 pedia.com/terms/o/

operating-

cost.asp#ixzz4b5r

VJZkX, Accessed on

12 March 2017

88.0
89.0 90.0 All cash inflows and 99.0 Berrado, A.

Present outflows are discounted to the (2017), Chapter 5:

13
wort present time at the MARR Present Worth

h 91.0 Analysis,

92.0 If PW(i %) 0, then the http://www.aui.ma/

project is economically justified personal/~A.Berrad

93.0 o/EGR2302/EGR23

94.0 02_Ch05.pdf,

Accessed on 12

P P P March 2017
PW =PV ( P ) (
, i, n + AV
A )
, i, n + FV ( , i, n)
F 100.0 Blank, L. &

n Tarquin, A. (2005),
P (1+ i) 1
95.0 =
A i(1+ i)n Engineering

Economy, New
P n
96.0
=(1+i)
F York, McGraw Hill.

97.0

98.0
101.0 102.0 If FW (i %) 0, then the 111.0 Man-Cho So,

Future project is economically justified A. (2016),

wort 103.0 Engineering

h 104.0 Economics,

105.0 Department of

106.0 System

107.0 Engineering &

Engineering

F F F Management, Hong
PW =PV ( P ) (
,i , n + AV
A )
,i , n + FV ( ,i , n)
F Kong, China.

112.0 Blank, L. &


F
108.0
=(1+i)n
P Tarquin, A. (2005),

14
n
F (1+ i) 1 Engineering
109.0 =
A i
Economy, New

110.0 York, McGraw Hill.


113.0 114.0 AW of project is the 120.0 Man-Cho So,

Annual equivalent annualized series of A. (2016),

wort dollar amounts for the cash Engineering

h inflows and outflows at a given Economics,

interest rate or MARR Department of

115.0 If AW (i %) 0, then the System

project; is economically justified Engineering &

116.0 Engineering

Management, Hong

A A A Kong, China.
PW =PV ( P ) (
, i ,n + AV
A )
, i ,n + FV ( , i, n)
F 121.0 Blank, L. &

n Tarquin, A. (2005),
A i(1+ i)
117.0 =
P (1+ i)n1 Engineering

Economy, New
A i
=
118.0 F i(1+i)n 1 York, McGraw Hill.

119.0
122.0

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