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- “Oil Contracts, Progressive Taxation, and Government Take in the Context of Uncertainty in Crude Oil Prices: The Case of Chad” by Guy Dabi Gab-Leyba and Bertrand Laport
- 09 Park ISM Ch09
- 13_Park_ISM_ch13.pdf
- 08_Park_ISM_ch08.pdf
- Capital Budgeting i
- Lectures Skeleton LTU
- 14_Park_ISM_ch14.pdf
- 10_Park_ISM_ch10.pdf
- 2-4_2006_jun_a
- 07_Park_ISM_ch07.pdf
- 12_Park_ISM_ch12.pdf
- 02_Park_ISM_ch02.pdf
- 15_Park_ISM_ch15.pdf
- 11_Park_ISM_ch11.pdf
- 03_Park_ISM_ch03.pdf
- 16_Park_ISM_ch16.pdf
- 05_Park_ISM_ch05.pdf
- 355936963-04-Park-ISM-ch04-pdf.pdf
- sensitivity analysis
- Cash Flow Waterfall

You are on page 1of 44

6.1

PW (12%) A $800 $1,500( P / F ,12%,1)

L $660( P / F ,12%,10)

$988.91

PW (12%) B $2, 635 $565( P / F ,12%,1)

L $840( P / F ,12%,10)

$1, 696.01

Select Project B.

6.2

(a)

$100( P / F ,15%, 4)

$467.52

PW (15%) B $1,500 $1, 000( P / F ,15%,1) L

$150( P / F ,15%, 4)

$586.26

Select Project B.

(b)

NFW (15%) D $1,500( F / P,15%,4) $450( F / A,15%, 4)

$376.49

NFW (15%) E $1,800( F / P,15%, 4) $600( F / A,15%, 4)

$152.18

Select Project D.

(c)

PW (15%)C $3, 000 $1, 000( P / F ,15%,1)

X ( P / F ,15%, 2)

$1,500( P / F ,15%,3) X ( P / F ,15%, 4)

1.3279 X $1,144.16

6-2

PW (15%)C 0

1.3279 X $1,144.16 0

X $861.63

(d)

PW (18%) D $1,500 $450( P / A,18%, 4)

$289.47 0

Yes, Project D is acceptable.

6.3

(a)

PW (12%) A $14,500 $12,610( P / F ,12%,1) $12,930( P / F ,12%,2)

$12,300( P / F ,15%,3) $15,821.54

PW (12%) B $12,900 $11,210( P / F ,12%,1) $11,720( P / F ,12%,2)

$11,500( P / F ,12%,3) $14,637.51

Select Project A.

(b)

FW (12%) A $15,821.54( F / P,12%,3) $22,228.13

FW (12%) B $14,637.51( F / P,12%,3) $20,564.65

Select Project A.

6.4

(a)

PW (15%) A $6,000 $800( P / F ,15%,1) $14,000( P / F ,15%,2)

$5,281.66

PW (15%) B $8,000 $11,500( P / F ,15%,1) $400( P / F ,15%,2)

$2,302.46

Select Project A.

6-3

(b) PW(i) function for each alterative on the same chart between 0% and 50%:

6.5

Method A:

CE (12%) A $60, 000 $92, 791.67

0.12

Method B:

CE (12%) B $150, 000 $150, 625.5

0.12

6.6

6-4

$1, 000( P / F , 0.5%, 24)

$30,560.10

$30, 612.82

Select the standard lease option as you will save $52.72 in present worth.

6.7

Machine A:

$21, 000( P / F ,13%, 6)

$101,891

Machine B:

$89,971

Machine B is a better choice.

*

6.8

(a)

Required HP to produce 10 HP:

Motor B: X 2 10 / 0.90 11.111 HP

Motor B: 11.111(0.7457)(1,500)(0.07) $869.97

Present Worth:

*

An asterisk next to a problem number indicates that the solution is available to students

on the Companion Website.

6-5

$50( P / F ,8%,15)

$8, 669

PW (8%) B $1, 200 $869.97( P / A,8%,15)

$100( P / F ,8%,15)

$8, 614

Motor B is preferred.

$50( P / F ,8%,15)

$13,925

PW (8%) B $1, 200 $1, 449.97( P / A,8%,15)

$100( P / F ,8%,15)

$13,579

Motor B is still preferred.

6.9 Given: Required service period = infinite, analysis period = least common

multiple service periods (six years)

Project A:

$15, 000( P / F ,12%,3)

$19,854.00

PW (12%) total $19,854[1 ( P / F ,12%,3)]

$33,985.69

Project B:

$12,117.35

PW (12%) total $12,117.35[1 ( P / F ,12%, 2) ( P / F ,12%, 4)]

$29, 478.02

Project A is preferred.

6-6

6.10

(a) Without knowing the future replacement opportunities, we may assume that

both alternatives will be available in the future with the identical investments

and expenses. We further assume that the required service period will be

indefinite.

Project A1:

$200( P / F ,10%,3)

$1, 744.48

PW (10%) total $1, 744.48[1 ( P / A,33.10%, 7)]

$6,302.63

(1.10)3 1 33.10%

Project A2:

$500( P / F ,10%,8)

$3,167.22

PW (10%) total $3,167.22[1 ( P / F ,10%,8)

( P / F ,10%,16)]

$5,334.03

Project A2 is preferred.

(c)

PW (10%) A1 $1,744.48

PW (10%) A 2 $1,800 $300( P / A,10%,3) S ( P / F ,10%,3)

$2,546.06 0.7513S

S $1, 067

6-7

6.11

Project B1:

$24, 075

PW (12%) total $24, 075[1 ( P / A, 76.23%, 2)]

$45, 487

Note: (1.12) 5 1 76.23%

Project B2:

$19,332

PW (12%) total $19,332[1 ( P / A,40.49%,4)]

$54,826

Note: (1.12) 3 1 40.49%

(b)

Project B1 with two replacement cycles:

$37, 736

Project B2 with four replacement cycles where the fourth replacement ends

at the end of the first operating year:

[$15, 000 ($2,100 $6, 000)( P / F ,12%,1)]( P / F ,12%,9)

$47, 040

6.12 Since only Model A is repeated in the future, we may have the following

sequence of replacement cycles:

6-8

Option 2: Purchase Model B now and replace it at the end of year 2 by

Model A. Then repeat Model A forever.

$1,991.29

A $1,991.29( A / P,15%,3)

$872.14

PW (15%)Model B $15, 000 $10, 000( P / A,15%, 2)

$1, 257.09

A $1, 257.09( A / P,15%, 2)

$773.26

(a)

Option 1:

$872.14

PW (15%) AAAL

0.15

$5,814.27

Option 2:

$872.14

PW (15%) BAAL $1, 257.09 ( P / F ,15%, 2)

0.15

$5, 653.51

Option 1 is a better choice.

S $2, 072.50

6.13

Since either tower will have zero salvage value after 20 years, we may select

the analysis period of 35 years:

$154, 710

PW (11%)Bid B $128, 000 $3,300( P / A,11%,35)

$157, 222

6-9

If you assume an infinite analysis period, the present worth of each bid will

be:

[$137, 000 $2, 000( P / A,11%, 40)]( A / P,11%, 40)

PW (11%) Bid A

0.11

$157, 296

[$128, 000 $3,300( P / A,11%,35)]( A / P,11%,35)

PW (11%) Bid B

0.11

$161,367

6.14

(a)

PW (15%) A1 $15, 000 $9,500( P / F ,15%,1)

$12,500( P / F ,15%, 2) $7,500( P / F ,15%,3)

$7, 644.04

(b)

PW (15%) A 2 $25, 000 X ( P / F ,15%, 2)( P / F ,15%,1)

$9,300

X $24, 263

(c) Note that the net future worth of the project is equivalent to its terminal

project balance.

$11, 625.63

6.15

(a) Project balances as a function of time are as follows:

Project Balances

n A D

0 $2,500 $5,000

1 2,100 6,000

2 1,660 7,100

6-10

3 1,176 3,810

4 694 1,191

5 163 1,690

6 421 3,859

7 763 7,245

8 1,139

FW (10%) A $1,139

FW (10%) D $7, 245

$1, 000( P / F ,10%,1) $500( P / F ,10%, 2)

$1,500( P / F ,10%, 7) $1,500( P / F ,10%,8)

$17, 794

PW (10%)C $5, 000 $2, 000( P / A,10%, 7)

$3, 000( P / F ,10%,8)

$16,136

Select Project C.

6.16

$304,320

$160, 000( P / F ,12%,5) $15, 000( P / A,12%,3)( P / F ,12%,5)

$140, 000( P / F ,12%,8)

$258,982

Option 2 is a better choice.

6-11

*

6.17

$0.85M ( P / F ,15%, 25)

$32,559,839

$12 M ( P / F ,15%,15) $1.5M ( P / F ,15%, 25)

$0.25M ( P / A,15%, 25)

$0.10M ( P / A,15%,15)( P / F ,15%,10)

$0.10 M ( P / A,15%,10)( P / F ,15%,15)

$17, 700, 745

Select Alternative B.

6.18

end of 20 years at the same cost

($12, 000 $1, 000)( P / F ,12%, 20)

$1, 000( P / F ,12%, 40) $1, 000( P / A,12%, 40)

$141,373

6-12

*

6.19

Let T denote the total operating hours in full load.

Motor I (Expensive)

150

(0.746) (0.05) T $6.741T

0.83

Equivalent annual cost of operating the motor:

$1, 286.41 $6.741T

150

(0.746) (0.05) T $6.9938T

0.80

$1, 026.11 6.9938T

6.20

Option 1: Purchase units from John Holland

PW (15%)dl $190,800( P / A1 , 6%,15%,5) $709, 491

PW (15%) vo $139, 050( P / A1 ,3%,15%,5) $490,888

AEC (15%) ($230, 241 $709, 491 $490,888)( A / P,15%,5) $70, 000

$496, 776

6-13

6.21

(a) Determine the unit profit of air sample test by the TEM (in-house).

Subcontract Option:

$6, 000 $18, 000 $20, 000)

$188, 600

Unit profit $300 $188.60 $111.40

(b) Let X denote the break-even number of air samples per year.

$400 ($300 $0.50 ) $300

X X

Note: If SECs goal is simply to minimize per unit cost of sampling, then the

break-even point would be calculated without including the revenue:

6.22

(a)

6-14

$1,892.95

AE (15%) B $12, 000( A / P,15%, 4) $6,350

$2,146.82

Process B: $2,146.82 / 2, 000 $1.0734 / hour

*

6.23

CR (13%)CV $13, 000( A / P,13%, 20) $1,851

CR(13%)PE $15, 600( A / P,13%, 20) $2, 221

CV : $4,551

0.895 kWh year

18.650 kW $0.07 3,120 hrs

PE : $4,380

0.93 kWh year

AEC (13%) PE $2, 221 $4,380 $6, 601

additional $370, but energy savings are only $171, which results in a $199

loss from each motor. The total output power is 58,188 kWh per year (25

HP 0.746 kW/HP 3120 hrs/year). Therefore, the savings (losses) per

operating hour from switching from conventional motor to the PE is

($199 / yr)

($0.034) / kWh

58,188 kWh/yr

(b)

6-15

0.0549T 370

T 6, 737 hours

6.24

New Lighting System Cost:

AEC (12%) $50, 000( A / P,12%, 20) ($8, 000 $3, 000)

$17, 694

Annual savings from installing the new lighting system $2,306

interest (1.005)12 1 6.17% per year, effective semiannual

interest (1.005)6 1 3.04% per semiannual

$39.20 per semiannual

AE (6.17%) $39.20( F / A,3.04%, 2)

$79.59 per year

$107.17

$126.60

6.26

Equivalent Annual Cost:

6-16

(0.13)($60, 000) $50, 000 $40, 000

$260, 083

AEC (13%) B ($750, 000 $30, 000)( A / P,13%,10)

(0.13)($30, 000) $80, 000 $30, 000

$216,395

CB $216,395 /(20)(365) $29.64 per tonne

Incinerator B is a better choice.

6.27

(a)

AE (15%) A [$2,500 $1, 000( P / F ,15%,1)

$400( P / F ,15%, 4)]( A / P,15%, 4)

$216.06

AE (15%) B [$4, 000 $100( P / F ,15%,1)]( A / P,15%, 4) $1,500

$129.40

Project A is a better choice.

(b)

AE (15%) B $129.40

$134.79

Project C is a better choice.

6-17

6.28 Assumption: Jet Fuel Cost = $1.50/L

hours)(2,000 hours) $480, 000 (assuming an end of-year convention)

$507, 494

AEC (10%) A ($100, 000 $10, 000)( A / P,10%,3)

(0.10)($10, 000) $507, 494

$544, 684

hours)(2,000 hours = $384,400

$405,995

AEC (10%) B ($200, 000 $20, 000)( A / P,10%,3)

(0.10)($20, 000) $405,995

$480,376

System B $480,376 / 2, 000 $240.19 per hour

6.29 Since the required service period is 12 years and the future replacement cost

for each truck remains unchanged, we can easily determine the equivalent

annual cost over a 12-year period by simply finding the annual equivalent cost

of the first replacement cycle for each truck.

(0.12)($5, 000) $3, 000

$7, 763.50

6-18

(0.12)($8, 000) $2, 000

$6,910.80

6.30

Alternative Description

A1

Then lease the machine for one year.

A4 Then buy another Machine A and use it

for just one year.

A5

Then buy Machine B and use it for one year.

consider these alternatives, we need to know the salvage values of the

machines after one-year use.

(b) With lease, the O&M costs will be paid by the leasing company:

For A1:

6-19

$800( P / A,10%, 4) $200( P / F ,10%,3)

$100( P / F ,10%, 2) ($3, 000 $100)( P / F ,10%,5)

$10,976

AEC (10%)1 $10,976( A / P,10%,5)

$2,895.44

For A2:

$520( P / A,10%,5) $280( P / F ,10%, 4)

$10, 042

AEC (10%) 2 $10, 042( A / P,10%,5)

$2, 649

For A3:

$3,300

A2 is a better choice.

*

6.31

Option 1:

$(0.08)(125,000)(300)( A / F ,18%, 20)

(0.01 0.473)(80,000,000)

$52,824,600

cost/kg $52,824,600 / 80,000,000

$66.0 cents/kg

Option 2:

$45,840,000

cost/kg $45.84 / 80

57.34 cents/kg

6-20

Capital Investment :

$49,576

Supporting Equipment:

( A / P,10%, )

$565

(1 0.1)15 1 3.1772

Operating Cost:

$62, 000( P / A,10%,5)( P / F ,10%,15)]

$63, 000

[ $1, 000( P / G,10%, )]

0.10

( P / F ,10%, 20)]( A / P,10%, )

$40, 056

Capital Investment:

6-21

$55, 000

Supporting Equipment:

$150, 000

AEC (10%) 2 ( A / P,10%, )

16.4494

$912

(1 0.1)30 1 16.4494

Operating Cost:

$55, 000( P / A,10%, )( P / F ,10%,15)]

( A / P,10%, )

$39, 788

Design Economics

*

6.33

(a)

Energy Loss:

(24 365)($0.0825)

A A

Material Weight:

(60)(8894) A 533640 A

6-22

5870040 A A / P,11%, 25 117400.8 A

814175 A

3.03813

AEC (11%) $814175 A

A

$814175 0

dA A2

A 0.00193172m 2 19.3172 cm 2

AEC (11%)

2 3.03813 $3,145.52

0.00193172

(c) Graphs of the capital cost, energy-loss cost, and the total cost as a function of

the cross-sectional area A:

6-23

Mixed Investments

6.34

Project A Project B B-A

0 $300 $800 $500

1 0 $1,150 $1,150

2 $690 $40 $650

i* B A 0% or 30%

6-24

Since this is a mixed incremental investment, we need to find the RIC using an

external interest rate of 15%.

Project B is preferred.

6-25

6.35

Project B: IRR 19.15%

n Option 1 Option 2 Option 1 Option 2

0 -$10,000 -$10,000 0

1 0 1,000 -1,000

2 0 1,000 -1,000

3 0 1,000 -1,000

4 0 1,000 -1,000

5 16,105 11,000 5,105

i*1 2 10% 9%

n Project A Project B B-A

0 -$2,000 -$3,000 -$1,000

1 1,400 2,400 1,000

2 1,640 2,000 360

i* B A 28.11% 15%

Select Project B.

6-26

6.38

n Project A1 Project A2 A2 A1

0 10,000 12,000 $2,000

1 5,000 6,100 1,100

2 5,000 6,100 1,100

3 5,000 6,100 1,100

i* A 2 A1 29.92%

Therefore, select Project A2.

6.39

n

A1 A2 A2 A1

0 -$15,000 -$20,000 -$5,000

1 7,500 8,000 500

2 7,500 15,000 7,500

3 7,500 5,000 -2,500

need to find the RIC at 10%, which is RIC A 2 A1 7.36% 10% . So, select A1.

(b) We can verify the same result by applying the NPW criterion.

$3, 651

PW (10%) A 2 20, 000 $8, 000( P / F ,10%,1) $15, 000( P / F ,10%2)

$5, 000( P / F ,10%,3)

$3, 426

6-27

n AB

0 $2,376

1 0

2 0

3 0

4 2,500

IRR A B 1.28%

*

6.41

6.42

(a) The least common multiple project lives = six years analysis period six

years

n

Project A Project B BA

0 $100 $200 100

1 60 120 60

2 50 150-200 100

3 50100 120 170

4 60 150-200 110

5 50 120 70

6 50 150 100

Since the incremental cash flow series indicates a nonsimple investment, but it

is a pure incremental investment.

6-28

n

Project C Project D CD

0 $4,000 $2,000 $2,000

1 2,410 1,400 1,010

2 2,930 1,720 1,210

n

Project E Project F F E

0 $2,000 $3,000 $1,000

1 3,700 2,500 1,200

2 1,640 1,500 140

system.

n A0 A1 A1 A0

0 0 -$2,500,000 -$2,500,000

1-8 -5,000,000 -2,900,000 2,100,000

A1 is a better choice.

n A2 A1 A2 A1

0 -$5,000,000 -$2,500,000 -$2,500,000

1-8 -1,400,000 -2,900,000 1,500,000

6-29

A2 is a better choice. That means that the stockless supply system is the final

choice.

6.44

(a)

Project A vs. Project B

n

Project A Project B BA

0 $1,000 $1,000 0

1 900 600 -$300

2 500 500 0

3 100 500 400

4 50 100 50

n

Project B Project C CB

0 $1,000 $2,000 $1,000

1 600 900 300

2 500 900 400

3 500 900 400

4 100 900 800

(b)

$1, 000 $300( P / A, i, 4)

i 7.71%

(c) Since borrowing rate of return (BRR) is less than MARR, Project D is

acceptable.

(d)

n

Project C Project E CE

6-30

1 900 400 500

2 900 400 500

3 900 400 500

4 900 400 500

6.45

(a)

i1* 85.08%, i2* 48.11%, and i3* 44.31%

(b)

Project 1 vs. Project 2:

n Project 1 Project 2 21

0 $1,000 $5,000 $4,000

1 500 7,500 7,000

2 2,500 600 1,900

15%.

Select Project 2.

n Project 2 Project 3 23

0 -$5,000 -$2,000 -$3,000

1 7,500 1,500 6,000

2 600 2,000 -1,400

RIC on the incremental investment.

Again, select Project 2.

6.46

6-31

n Project A Project B BA

0 $10,000 $20,000 $10,000

1 5,500 0 5,500

2 5,500 0 5,500

3 5,500 40,000 34,500

6.47 Select Model C. Note that all three projects would be acceptable individually,

as each projects IRR exceeds the MARR. The incremental IRR of Model (C

B) is 40%, indicating that Model C is preferred over Model B at MARR = 12%.

Similarly, the incremental IRR of Model (C A) is 15%, which exceeds the

MARR. Therefore, Model C is again preferred.

6.48 All projects would be acceptable because individual ROR exceed the MARR.

Based on the incremental analysis, we observe the following relationships:

IRR A3 A1 18% 15% (Select A3)

IRR A3 A 2 23% 15% (Select A3)

Therefore, A3 is the best alternative.

6.49 From the incremental rate of return table, we can deduce the following

relationships:

IRR A3 A 2 42.8% 15% (Select A3)

IRR A 4 A3 0% 15% (Select A3)

IRR A5 A 4 20.2% 15% (Select A5)

IRR A6 A5 36.3% 15% (Select A6)

It is necessary to determine the preference relationship among A1, A3, and A6.

6-32

IRR A6 A1 18.24% 15% (Select A6)

A6 is the best alternative.

6.50 For each power saw model, we need to determine the incremental cash flows

over the by-hand operation that will result over a 20-year service life.

Power Saw

Category Model A Model B Model C

Investment cost $4,000 $6,000 $7,000

Salvage value $400 $600 $700

Annual labour savings $1,296 $1,725 $1,944

Annual power cost $400 $420 $480

Net annual savings $896 $1,305 $1,464

n Model A Model B Model C

0 -$4,000 -$6,000 -$7,000

1 896 1,305 1,464

2 896 1,305 1,464

20 400+896 600+1,305 700+1,464

IRR 22.03% 21.35% 20.46%

PW(10%) $3,688 $5,199 $5,568

0

IRR B A 19.97% 10%

Select Model B.

0

IRR C B 15.03% 10%

Select Model C.

6-33

n Project A Project B BA

0 -$100 -$200 -$100

1 60 120 60

2 50 150-200 -100

3 50-100 120 170

4 60 150-200 -110

5 50 120 70

6 50 150 100

abandon the IRR analysis and use the PW decision rule.

$100( P / F ,15%, 6)

$3.48

Comments: Even though the incremental flow is a nonsimple, it has a unique rate

of return. As shown in Problem 7.39, this incremental cash flow series will pass the

net investment test, indicating that the incremental cash flow is a pure investment.

6.52

(a) Since there is not much information given regarding the future replacement

options and the required service period, we may assume that the required

service period is indefinite and both projects can be repeated at the same cost

in the future.

(b) The analysis period may be chosen as the least common multiple of project

lives, which is three years.

n A2 A1

0 -$5,000

1 0

2 0

6-34

3 15,000

IRR A 2 A1 44.195%

The MARR must be less than 44.195% for Project A1 to be preferred.

ST6.1

Option 1: Process device A lasts only four years. You have a required

service period of six years. If you take this option, you must consider how you

will satisfy the rest of the required service period at the end of the project life.

One option would subcontract the remaining work for the duration of the

remaining required service period. If you select this subcontracting option

along with Device A, the equivalent net present worth would be

$10, 000( P / F ,12%, 4)

$100, 000( P / A,12%, 2)( P / F ,12%, 4)

$383, 292

Option 2: This option creates no problem because its service life coincides

with the required service period.

$30, 000( P / F ,12%, 6)

$340,371

available over the next six years at the same cost, the equivalent present worth

would be

$411,141

alternative.

the problem interesting with the following embellishments.

6-35

If the required service period is changed from six years to five years, what would

be the best course of action?

If there are price differentials in the subcontracting option (say, $55,000 a year for

a six-year contract, $60,000 for a five-year contract, $70,000 a year for a four-

year contract, and $75,000 a year for any contract lasting less than four years),

what would be the best option?

If both Processes A and B would be available in the subsequent years, but the

required investment and salvage value would be increasing at the annual rate of

10%, what would be the best course of action?

If both Device A and B will be available in the subsequent years, but the required

investment and salvage value (as well as the O & M costs) would be decreasing at

the annual rate of 10%, what would be the best course of action?

ST6.2

Note to Instructors: This case problem requires several pieces of information. (1)

No minimum attractive rate return figure is given for Northern Electric. (2) What

would be a typical number of accidents in line construction work? (3) How does a

typical electric utility handle the nesting problems? If there is some cleaning cost,

how much and how often?

First, we may calculate the equivalent present value (cost) for each option

without considering the accident costs and nesting problems.

Design Options

Factors Option 1 Option 2 Option 3 Option 4

Cross Arm Triangular Horizontal Stand Off

Line

Investment:

Construction cost $495,243 $396,813 $402,016 $398,000

Accident cost

Annual cost:

Flashover repair $6,000 $3,000 $3,000 $3,000

Cleaning nest

Annual savings:

Inventory 0 $4,521 $4,521 $4,521

Assume that Northern Electrics required rate of return would be 12%. The

equivalent present value cost for each option is as follows:

6-36

$540, 060

PW (12%)2 $396,813 $3, 000( P / A,12%, 20)

$4,521( P / A,12%, 20)

$385, 452

PW (12%)3 $402, 016 $3, 000( P / A,12%, 20)

$4,521( P / A,12%, 20)

$398, 654

PW (12%)4 $398, 000 $3, 000( P / A,12%, 20)

$4,521( P / A,12%, 20)

$386, 639

economical.

If we consider the potential accident costs ($65,000 per accident) during line

construction work, it is likely to change the outcome. If we expect only a

couple of accidents, Option 2 still appears to be the best. However, if you

expect more than three accidents, the conventional cross-arm design appears

to be more economical. If the nest cleaning cost were factored into the

analysis, the accident cost would be reduced to the extent of the annual

cleaning cost, indicating the preference of the triangular design.

ST6.3

(laser blanking method) dominates the other (conventional method). The

problem of this nature (from an engineers point of view) involves more

strategic planning issues than comparing the accounting data. We will first

calculate the unit cost under each production method. Since all operating costs

are already given in dollars per part, we need to convert the capital expenditure

into the required capital recovery cost per unit.

Conventional method:

$22, 031 per year

$22, 031

Unit capital recovery cost

3, 000

$7.34 per year

6-37

$17,173 per year

$17,173

Unit capital recovery cost

3, 000

$5.72 per part

Blanking Method

Description Conventional Laser

Steel cost/part $14.98 $8.19

Transportation cost/part $0.67 $0.42

Blanking cost/part $0.50 $0.40

Capital cost/part $7.34 $5.72

Total unit cost $23.49 $14.73

technique would save about $8.76 for each part produced. If Ford decides

to make the window frame in house, the part cost would range between

$14.73 and $23.49, depending upon the blanking method adopted. If Ford

relies on an outside supplier, the subcontracting work should be in this

cost range. If Ford were producing the window frames by the conventional

method, the die investment had already been made. In this case, one of the

important issues is to address if it is worth switching to the laser blanking

this time or later. If Ford decides to go with the laser blanking, it will take

six months to reach the required production volume. What option should

Ford exercise to meet the production need during this start-up period?

ST6.4

demolishing the old boiler unit $1, 000

Annual Energy Requirement 66 2.32 153.12 TJ

Alternative 1:

153,12 TJ

Weight of dry coal

(0.75)(33.24 MJ/kg)

6,142 tonnes

= $7,67,750

Alternative 2:

6-38

153.12 TJ(0.94)

Natural Gas cost 40 / m3 3

(0.78)(39 MJ/m )

= $1,892,608

153.12 TJ(0.06)

Heating Oil cost $864 / L

(0.81)(38.6 MJ/L)

= $252,702

= $2,145,310

$1, 000)( A / P,10%, 20)

$767, 750

$10, 71,970

$10, 71,970

Unit cost $1.62 /kg

66106 kg

Alternative 2:

AEC (10%) ($889, 200 $1, 000)( A / P,10%, 20)

$2,145,310

$2, 249, 638

Unit cost 3.41 /kg

66106 kg

(c) Select Alternative 1.

ST6.5

There is no information regarding the analysis period; we will assume that the

firm will be in business for an indefinite period.

There is no information regarding the future plastics technology options; we

will assume that the best one available will be the technology introduced n

months from now.

6-39

We will assume that the annual revenue/costs are spread evenly throughout

the year.

Present Worth Analysis: First we will determine the equivalent present worth for

each option, and its value at MARR = 15%

Option 1:

Option 2:

[1+0.05n](P/F,i,96-n)}(P/F,i,n) + [15/12 6/12](P/A,i,n)

n)}(P/F,i,n)) + 0.75(P/A,i,n)

Although Option 1 (switching now) bestows a great present worth ($36.53 M), it

can be seen that the best time to retrofit would be to wait the full 96 months,

which would yield a PW of $48.22 M. The worst time to retrofit would be after

41 months ($186.43 M).

6-40

n PW n PW n PW n PW n PW n PW

1 $24.64 17 -$116.43 33 -$179.01 49 -$180.47 65 -$134.77 81 -$53.08

2 $13.14 18 -$122.44 34 -$180.73 50 -$178.86 66 -$130.61 82 -$47.00

3 $2.02 19 -$128.16 35 -$182.22 51 -$177.08 67 -$126.32 83 -$40.81

4 -$8.72 20 -$133.57 36 -$183.48 52 -$175.12 68 -$121.90 84 -$34.52

5 -$19.09 21 -$138.69 37 -$184.51 53 -$172.98 69 -$117.34 85 -$28.13

6 -$29.09 22 -$143.53 38 -$185.31 54 -$170.68 70 -$112.65 86 -$21.64

7 -$38.73 23 -$148.08 39 -$185.90 55 -$168.20 71 -$107.83 87 -$15.06

8 -$48.01 24 -$152.36 40 -$186.27 56 -$165.56 72 -$102.89 88 -$8.38

9 -$56.95 25 -$156.36 41 -$186.43 57 -$162.75 73 -$97.82 89 -$1.61

10 -$65.54 26 -$160.09 42 -$186.39 58 -$159.79 74 -$92.63 90 $5.25

11 -$73.79 27 -$163.56 43 -$186.13 59 -$156.67 75 -$87.32 91 $12.20

12 -$81.70 28 -$166.76 44 -$185.67 60 -$153.39 76 -$81.90 92 $19.24

13 -$89.29 29 -$169.71 45 -$185.02 61 -$149.96 77 -$76.36 93 $26.36

14 -$96.55 30 -$172.41 46 -$184.17 62 -$146.38 78 -$70.70 94 $33.57

15 -$103.49 31 -$174.85 47 -$183.12 63 -$142.65 79 -$64.94 95 $40.85

16 -$110.12 32 -$177.05 48 -$181.89 64 -$138.78 80 -$59.06 96 $48.22

6-41

ST6.6

There is no information regarding the expected cash flows from the current

operation if Chiller Cooling decides to defer the introduction of the

absorption technology for three years. Therefore, we need to make an

explicit assumption of the expected cash flows for the first three years if

Chiller Cooling decides to defer the decision. Assume that the annual cash

flow during this period would be X.

Another assumption we have to make is about the analysis period.

Assuming that the firm will be in business for an indefinite period, we also

need to make an explicit assumption regarding the future cooling technology.

Since there is no information about the future cooling technology options,

we may assume that the best cooling technology will be the absorption

technology that will be introduced three years from now. Therefore, if

Chiller Cooling decides to select Option 1, we could assume that, at the end

of eight years, Option 2 (the best cooling technology at that time) will be

adopted for an indefinite period.

worth for each option:

[$5 $4( P / A, i,8) $2( P / F , i,8)]( A / P, i,8)

i

( P / F , i,8)

PW (i ) 2 X ( P / A, i,3)

[$5 $4( P / A, i,8) $2( P / F , i,8)]( A / P, i,8)

i

( P / F , i,3)

Now we can determine the value X that makes the two options economically

equivalent at an interest rate of 15%. In other words, if we evaluate the two

present worth functions at i 15% , we have

PW (15%)1 $41.31

PW (15%)2 2.2832 X $13.28

6-42

X $12.28

$12.28 millions for three years, Option 2 is a better choice.

Rate of return analysis: The present worth analysis above indicates that, if

X $12.28 , the break-even rate of return on incremental investment is

i*1 2 15%

Therefore, the ultimate choice will depend on the level of annual revenues

generated during the first three years when the advanced cooling technology is

deferred. Clearly, if

ST6.7

0 $0 -$1,600,000 -$1,600,000

1 $10,000,000 $20,000,000 $10,000,000

2 $10,000,000 $0 -$10,000,000

IRR = 25%

400%

The incremental cash flows result in multiple rates of return (25% and 400%), so

we may abandon the rate of return analysis. Using the PW analysis,

$0.21 0

Reject the larger pump.

PB(i, 20%)1 $1, 600, 000(1 i ) $10, 000, 000

8, 400, 000 1, 600, 000i

6-43

PB (i, 20%) 2 (8, 400, 000 1, 600, 000i)(1 0.20) $10, 000, 000

80, 000 1,920, 000i

0

i 4.17% 20%

If i 525%, then PB(i, 20%)1 0 , no RIC exists. So the RIC on the incremental

cash flows should be 4.17%, which indicates Select a smaller pump.

ST6.8

(a) Whenever you need to compare a set of mutually exclusive projects based

on the rate of return criterion, you should perform an incremental analysis.

In our example, the incremental cash flows would look like the following:

n B-A

0 -$10,000

1 +23,000

2 -13,200

i* B A 10% or 20%

We could abandon the IRR analysis and use the PW analysis to rank the

projects.

(b) If we plot the present worth as a function of interest rate, we will observe

the following:

6-44

If 10% MARR 18.1%, select Project B.

If MARR > 18.1%, do nothing.

Return on Invested Capital: The true rate of return can be found as a function of

MARR.

PB(i, MARR)1 $10, 000(1 i ) $23, 000

$13, 000 10, 000i

PB(i, MARR) 2 ($13, 000 10, 000i)(1 MARR)

$13, 200

0

(Note that, if, i 1.3, there will be no feasible solution.) Rearranging the terms

in PB(i, MARR) 2 gives an expression of IRR as a function of MARR.

1.32

IRR 1.3

1 MARR

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