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INCREMENTAL ANALYSIS

A good investment analysis includes the identification of other
alternatives to a proposed project.
Incremental analysis is to study the differences among alternative
courses of action which we expressed in Dollar values.

Example:

YEARS CASE X CASE Y
FROM CASH CASH
START FLOW FLOW
0 (460) (190)
1 100 50
2 100 50
3 100 50
4 200 75
5 450 200
TOTAL 490 235

The profit indicators:
NCR (M$) 490 235
PAY OUT (YEARS) 3,8 3,5
PIR 1,07 1,24
NPV AT 15% (M$) 147 85
IRR (%) 26 31
PVR, AT 15% 0,32 0,45

NOTE: CASE - X = BUY NEW COMPRESSOR
CASE - Y = REPAIR THE OLD COMPRESSOR-

YEARS CASE X CASE Y
FROM CASH CASH INCREMENTAL
START FLOW FLOW CASH FLOW
0 (460) (190) (270)
1 100 50 50
2 100 50 50
3 100 50 50
4 200 75 125
5 450 200 250
TOTAL 490 235 255

Engineering Economics Halaman 1 dari 10

24 0. USUALLY. SENSITIVITY ANALYSIS IS A WAY OF LOQKING AT THE EFFECT OF CHANGES IN ASSUMPTIONS TO SEE IF THESE ARE SEVERE ENOUGH TO CHANGE THE DECISION OF ACCEPTING A PROJECT. Engineering Economics Halaman 2 dari 10 . ETC) CAN CHANGE.THEREFORE. THE SENSITIVITY ANALYSIS EXAMINE THE MAJOR ASSUMPTIONS. THE ECONOMIC ANALYSIS IS ONLY AS GOOD AS THE ASSUMPTIONS.32 0. COSTS. SENSITIVITY ANALYSIS RECOGNIZED THAT ONE OR MORE ASSUMPTIONS ON VARIABLES (PRICE. INVESTMENTS. THE CASH FLOW OF A PROPOSED PROJECT IS AN ESTIMATE.23 SENSITIVITY ANALYSIS INTRODUCTION DEFINITION SENSITIVITY ANALYSTS IS THE EVALUATION OF CHANGES IN A PROJECTS PROFITABILITY AS A RESULT OF POSSIBLE CHANGES IN THE ASSUMPTIONS USED.PROFIT INDICATORS NCR : 490 235 255 PAYOUT : 3.0 PIR : 1. AND THESE CHANGES AFFECTS PROJECTS PROFITABILITY.45 0.8 3. REVENUES. AND THE ESTIMATE IS BASED ON ASSUMPTIONS.5 4.07 1.94 NPV : 147 85 62 IRR : 26 31 23 PVR : 0.

THE IRR CHANGED FROM 70 % TO OVER 100 % Engineering Economics Halaman 3 dari 10 .000) THE IRR WENT FROM 70% TO 47 % IF INVESTMENT IS CHANGED 50 % DOWN (BECOME $ 6.000). FROM RE NCR START 0 0 0 (12) 0 (12) (12) 1 10 (6) 0 (1) 3 (9) 2 20 (6) 0 (6) 8 (1) 3 30 (6) 0 (10) 14 13 4 30 (6) 0 (10) 14 27 5 10 (6) 0 (1) 3 30 TOTAL 100 (30) (12) (28) 30 IF INVESTMENT IS CHANGED 50 % UP (BECOME $ 18. EXAMPLE HOT DOG STAND CASH FLOW FOR CASH YEAR REVENUE EXPEDITU INVESTMENT TAX NCR cum.

Engineering Economics Halaman 4 dari 10 . ON THE BEST ASSUMPTION WE CAN COLLECT AND THEN GO FURTHER STEP OF CONSTRUCTING A SPIDER DIAGRAM THE EXAMPLES OF SPIDER DIAGRAM FOR BRAZORIA COUNTY WILD CAT WHICH HAVE 6 DIFFERENT ASSUMPTION THAT COULD BE CHANGED. WE CAN CONCLUDE THAT THE PROJECT IS MOST SENSITIVE TO REVENUE FORECAST AND TO REFINE THE ESTIMATE BEFORE MAKING A DECISION A CAREFUL LOOK AT THE ASSUMPTIONS AS WELL AS A GOOD SENSITIVITY ANALYSIS ARE CRITICAL PARTS OF ECONOMIC ANALYSIS THE METHOD IS TO BUILD A GOOD BASE CASE. THE RESULT WILL BE AS FOLLOWS (IS CALLED SPIDER DIAGRAM): ANALYZING THE RESULTS THE SPIDER DIAGRAM IS A USEFUL METHOD FOR PRESENTING THE RESULTS OF THE SENSITIVITY ANALYSIS FROM THE SPIDER DIAGRAM ABOVE. CAN BE SEEN ON THE NEXT PAGE.IF WE PLOT THE IRR CURVE AS EACH OF THEIR VARIABLE CHANGE.

CONTINGENCY DEFINITION: Contingency is a provision for those variations to the estimate basis which are likely to occur but which can not be specifically identified at the time the estimate is prepared. Engineering Economics Halaman 5 dari 10 .

In other words. it belongs in the base estimate.  Contingency covers those variations which can not specifically be identified. Therefore.SEVERAL VIEWS OF CONTINGENCY: • Funds which are not to be used under ordinary circumstances • Something you can have it you've been good • There is no such thing as contingency → The existence of contingency is completely denied. we can explains all uses of contingency funds in terms of variations to the estimate basis. are not covered by contingency. such as a major design change. not contingency. Some examples of likely variations that. by definition would be covered by contingency are: • Design changes (minor) • Variations in the way the project is managed • Estimating variations and errors The whole subject of contingency deals with uncertainty Project today. low probability occurrences such as force majeurs. if we can identify a likely variation.  Contingency covers those variations which are likely. as compared to those in the past are often: • Marginal. • There to be spent → the "Blank Check" view of contingency 3 KEY ELEMENTS TO THE DEFINITION:  The Basis of an estimate is the design of the execution plan and the pricing levels that are defined at the time it is made. posing more risk to profitability • Longer term. with profit further in the future • Based on New Technology with associated risk • Subject to larger Market Fluctuation Engineering Economics Halaman 6 dari 10 . In other words. The actual costs will vary from the estimate to the exact extent that variations are experienced in the basis.

contain a significant amount of uncertainty.  All estimates by definition. control and communicate the following: • Risk • Uncertainty • Contingency Engineering Economics Halaman 7 dari 10 . UNCERTAINTY DEFINITION:  Uncertainty is the range of values within which the actual value is expected to fall.  It is important that project engineers and managers be able to quantify.  According to Webster's: "To estimate is to calculate approximately the cost".  The basic purpose of estimate is to aid in decision making.

the user defines equations which duplicate or model the way the estimate has been done.SUMMARY CONTINGENCY IS THE WAY WE DEAL WITH UNCERTAINTY AND RISK. In the Monte Carlo Simulation. Example: Cost of excavation labor = Variable Cost For each cost variable: Process repeated 'N' times to generate costs vs probability curve/distribution. risk of overrun and contingency Engineering Economics Halaman 8 dari 10 . The distribution can then be used to calculate accuracy. AND IT SHOULD BE ADDRESSED IN THE SAME WAY WE DEAL WITH ANY OTHER PROJECT MANAGEMENT ISSUE: • FIRMLY • CLEARLY • WITH THE BEST TECHNOLOGY AVAILABLE MONTE CARLO SIMULATION Monte Carlo simulation is a technique of performing sampling experiment on the mathematical model of a system to determine the range or optimum value.

Example: Engineering Economics Halaman 9 dari 10 . A Decision Tree is a graphical representation of a sequence of events and the possible outcomes. HAND CALCULATIONS USING STATISTICAL APPROXIIWATIONS PERT = Program Evaluation and Review Technique. PERT FORMULA: MIN  4 MOST LIKELY  MAX Expected Value  6 A  4M  B  6 DECISION TREES The Decision Tree is a tool to help in laying out the EV (Expected Value) calculation for making decision under uncertainty.

Your travel plans are uncertain. This problem can be set up using a decision tree.00 725 The expected cost if you decide to buy the discount ticket is $725. depending on some pending business commitment.(penalty).. This compares favorably with the $900.The drawback is that you have to buy the discount ticket 30 days in advance for a specific flight on a particular day.50 500 TOTAL 1. And if it comes to pass that you can't go on that flight. The EV table to determine the expected cost of buying the discount fare ticket. Assume there is no problem in getting any flight you want. you would buy the discount ticket.. In fact.50 225 • FAILURE 1. there is only 50% chance you will be able to go. Engineering Economics Halaman 10 dari 10 .. OUTCOMES VALUE PROBABILITY EV • SUCCESS 450 0.Suppose you want to plan a vacation trip to your favorite resort. (cost for full fare). If you make your decisions based upon EV. you lose $100. as long as you pay full fare.or a discount ticket costing $450. and you are trying to decide whether to by a full-fare ticket costing $900.000 0.