Engineering economy ]1 [ Prepared by Mohammed Ali Alsarori

Payback period:
‫ هي الفترة الزمنية التي تمر على مشروع استثماري لكي يكون دخالً اضافيا ً إجماليا ً يعادل رأس مال‬:Payback period
Cash out‫ مع ال‬Cash in‫ هو إيجاد النقطة الزمنية التي عندها يتعادل ال‬Payback ‫ اذن الغرض من‬.‫المستثمر فيه‬
‫ والبد أن تكون نقطة التساوي أثل من مدة المشروع لكي‬.‫والمسافة بينها وبين بداية المشروع تسمى بفترة االسترداد‬
‫ هذه الطريقة ال تأخذ الفوائد بعين االعتبار وتستخدم في تقييم‬.‫يستطيع المستثمر استرداد نقوده قبل انتهاء فترة المشروع‬
‫( وذلك ألنه يوجد بها اهمال لألموال‬Build-operator-transfer) BOT‫مشروعات البنية التحتية والمبنية على نظام ال‬
.‫واألرباح والتي تؤثر بدورها على زمن استرداد النقود‬
Cash out‫ مع ال‬Cash in‫ في هذا الدرس نريد الوقت الذي يتعادل فيه ال‬:‫مالحظة‬
:payback period‫هناك نوعين من التحليل بال‬
‫ ال يأخذ معدل الفائدة بعين االعتبار‬Simple payback period .1
Example: For the investment project represented by the net cash flow shown in the
table below, calculate the simple payback period. End of
Cash Flow
Solution: Year
At year 1: 0 -4,000
Cash in = + 900 1 +900
At year 2: 2 +1,000
Cash in = 900 + 1,000 = 1,900 3 +1,200
At year 3:
4 +1,000
Cash in = 1,900 + 1,200 = 3,100
5 +900
At year 4:
Cash in = 3,100 + 1,000 = 4,100 6 +1,500
The payback period is between year 3 and 4:
By interpolation we find Payback period = 3.9 years
Cash ‫ بعين االعتبار وذلك بإرجاع المبالغ ال‬i ‫ في هذا التحليل نأخذ الفائدة‬Discounted payback period .2
‫ ثم حساب فترة استرداد النقود‬A w ‫ أو‬Pw ‫ جميعها للصفر اما بطريقة‬in
For net cash flow (NCF) varies annually: 0 = - P + ∑ NCF (P/F, i%, n)
For net cash flow (NCF) annual uniform : 0 = - P + NCF (P/A, i%, n)
Example: For the ivestment project represented by the net cash flows shown in table
below. Using the interest rate of 12% per year calculate discounted payback period:
End of Year 0 1 2 3 4 5 6
Cash Flow $ -13,000 5,000 5,000 6,000 7,000 8,000 9,000
Solution:
(Cash out‫ أكبر من ال‬16000 ‫ يساوي‬3 ‫ عند السنة‬Cash in‫سنبدأ الحل من السنة الثالثة (ألن مجموع ال‬
At year 3:
-13000 + 5000´ (P/F, 12%,1) + 5000´ (P/F, 12%,2) + 6000´ (P/F, 12%,3)
= - 13000 + 5000´ (0.8929) + 5000´ (0.7972) + 6000´ (0.7118) = - 278.7 < 0
At year 4
 Engineering economy ]2 [ Prepared by Mohammed Ali Alsarori

- 278.7 + 7000(P/F, 12%, 4) = - 278.7 + 7000(0.6355)=4169.8 > 0

By interploation we find payback period = 3.063 years
Example: For the ivestment project represented by the net cash flows shown in table
below. Using the interest rate of 10% per year calculate discounted payback period:
End of Year 0 1 2 3 4 5 6
Cash Flow $ -25,000 4,000 5,000 6,000 7,000 7,000 7,000
Solution:
(Cash out‫ أكبر من ال‬29000 ‫ يساوي‬3 ‫ عند السنة‬Cash in‫سنبدأ الحل من السنة الخامسة (ألن مجموع ال‬
At year 5:
Pw = - 25000 + 4000´ (P/F, 10%,1) + 5000´ (P/F, 10%,2) + 6000´ (P/F, 10%,3)
+ 7000´ (P/F, 10%,4) + 7000´ (P/F, 10%,5)
= - 25000 + 4000´ (0.9091) + 5000´ (0.8264) + 6000´ (0.7513) + 7000´ (0.6830)
+ 7000´ (0.6209) = - 3596.5 < 0
At year 6
Pw = - 3596.5 + 7000´ (P/F, 10%,6) = - 3596.5 + 7000´ (0.5645) = 355 > 0
By interploation we find payback period = 5.91 years
 Engineering economy ]3 [ Prepared by Mohammed Ali Alsarori

Theory of cost:
.)‫ (تكاليف التشغيل‬Operating cost ‫ (تكاليف الملكية) و‬Ownership cost ‫تكاليف المشروع تعتمد على‬
‫ تتضمن أعمال الصيانة‬Operating cost ‫ بينما‬Depreciation and investment cost‫ تتضمن ال‬Ownership
.‫وقيمة الوقود والزيوت الالزمة للمعدة‬
:Ownership cost
:Depreciation ‫أوالً حساب قيمة‬
:‫( نذكر طريقتين هما‬Depreciation) ‫هناك عدة طرق لحساب تكلفة انخفاض المعدة بسبب مرور الزمن‬
:‫ حيث قيمة انخفاض المعدة تعطى بالعالقة التالية‬Straight line method .1
Initial cost (P) - Salvage cost
Dn = Where:
N
D n = Depreciation at any time (years). ( n = 1, 2, 3, etc.)
N = Equipment life (years)

‫ في هذه الطريقة تعطي لنا قيمة انخفاض ليست متساوية حيث تكون‬Sum of the Year's Digit method .2
:ً‫عالية في السنة األولى ومن ثم يتناقص تدريجيا‬
Year Digit
Dn = ´ (Initial cost (P) - Salvage cost)
Sum of Year Digits
N- n + 1
= ´ (Initial cost (P) - Salvage cost)
N(N + 1) / 2
Year Digit
Dn = ´ (Initial cost (P) - Salvage cost)
Sum of Year Digits
N- n + 1
= ´ (Initial cost (P) - Salvage cost)
N(N + 1) / 2

Example 1: Using the straight method, find the annual depreciation and book value at
the end of each year for an equipment having an initial cost of $ 250,000, a salvage
value of $ 25,000, and an expected life of 5 years?
Solution:
Depreciation
250,000 - 25,000
Dn = Year (D) Book Value (Bv) (end of Period)
5
= 45000
0 0 250,000
1 45,000 205,000
2 45,000 160,000
3 45,000 115,000
4 45,000 70,000
5 45,000 25,000
 Engineering economy ]4 [ Prepared by Mohammed Ali Alsarori

Example 2: Solve example (1) by using the sum of the years’ digits method.
Solution:
Sum of years’ digit = 5 * (5+1) / 2 = 15
D1 = 5/15 * (250,000 – 25,000) = 75,000
D2 = 4/15 * (250,000 – 25,000) = 60,000
D3 = 3/15 * (250,000 – 25,000) = 45,000
D4 = 2/15 * (250,000 – 25,000) = 30,000
D5 = 1/15 * (250,000 – 25,000) = 15,000
Year Depreciation Book Value (Bv)
(D) (end of Period)
0 0 250,000
1 75,000 175,000
2 60,000 115,000
3 45,000 70,000
4 30,000 40,000
5 15,000 25,000

Investment cost:
Investment cost (n) = Bv (n- 1) ´ i%
Eample 3: Find the investment cost for example (1) assuming i = 10%.

Year Book Value (Bv) (end of Period) Investment cost

0 250,000 -
1 205,000 25,000
2 160,000 20,500
3 115,000 16,000
4 70,000 11,500
5 25,000 7,000

Operating cost:
(a) Maintenance & Repair cost (M & R cost):
M &R cost = (0.8 to 1.2) ´ (Initial cost – Salvage cost)
(b) Fuel Cost:
Q = 0.06 ´ hp ´ f (engine work by petrol)
Q = 0.04 ´ hp ´ f (engine work by diesel)
Where:
Q = Quantity (gallon / hour).
hp = Rated horsepower of the engine.
f = Operating factor, depends on the conditions of the work ( 0.6 – 0.75).
 Engineering economy ]5 [ Prepared by Mohammed Ali Alsarori

(c) Oil cost:

0.006´ h p ´ f c
Q= + where
7.4 t
Q = Quantity (gallon / hour).
c = Capacity of crankcase in gallon.
t = No. of hours between oil change.

Example 1: Using the sum of the year digit method, find the hourly owing and
operating cost at the end of each year for an equipment described below:
Initial cost = $ 125,000 ,Salvage value = $ 10,000, Expected life of 5 years.
hp = 160 , c = 6 gallon , t = 100 hours , f = 0.6 , i% = 0.15 ,
M & R cost = 0.8 * total depreciation.
End of Year 1 2 3 4 5
No. of working hours 2,000 1,900 1,900 1,700 1,600
Solution:
1) Ownership and investment cost:
Year Deprciation Book value Investment cost
0 - 125,000 -
1 38,333.33 86,666.67 18,870
2 30,666.67 56,000 13,000
3 23,000 33,000 8,400
4 15,333.33 17,666.67 4,950
5 7,666.67 10,000 2,650
2) Operating cost:
a) M & R cost:
Total M & R cost = 0.8´ (125,000 - 10,000) = 92,000
n
M & R cost for each year is given by ´ Total M & R cost
Sum of Year's digit
M & R Cost (1) = (1/ 15) ´ 92,000 = 6,133.33
M & R Cost (2) = (2/ 15) ´ 92,000 = 12,266.67
M & R Cost (3) = (3/ 15) ´ 92,000 = 18,400
M & R Cost (4) = (4/ 15) ´ 92,000 = 24,533.33
M & R Cost (5) = (5/ 15) ´ 92,000 = 30,666.67

(b) Fuel Cost:

Q = 0.04 ´ 160 ´ 0.6 = 3.84 gal. / hr
= 3.84 ´ 4.25 = 16.36 litre / hr
 Engineering economy ]6 [ Prepared by Mohammed Ali Alsarori

Cost per hour = 16.36 ´ 0.58 = $ 9.49 / hr

(c) Oil Cost:
Q = [(0.006 ´ 160 ´ 0.6 )/7.4] + (6 /100) = 0.14 gal. / hr
= 0.14 ´ 4.25 = 0.6 litre /hr
Cost per hour = 0.6 ´ 5 = $3 / hr
 Hourly Owing and Operating Cost:
Cost / hour (1) = ((38,333.33 + 18,870 + 6,133.33) / 2000) + 9.49 + 3 = $ 44.16 / hr.
Cost / hour (2) = ((30,666.67 + 13,000 + 12,266.67) / 1900) + 9.49 + 3 = $ 41.93 / hr.
Cost / hour (3) = ((23,000 + 8,400 + 18,400) / 1900) + 9.49 + 3 = $ 38.70 / hr.
Cost / hour (4) = ((15,333.33 + 4,950 + 24,533.33) / 1700) + 9.49 + 3 = $ 38.85 / hr.
Cost / hour (5) = ((7,666.67 + 2,650 + 30,666.67) / 1600) + 9.49 + 3 = $ 38.10 / hr.

Example 2: Using the Stright Line method, find the hourly owing and operating cost at
the end of each year for an equipment described below:
Initial cost = $ 130,000 ,Salvage value = $ 15,000, Expected life of 5 years.
hp = 170 , cranck capacity = 8 gallon , t = 100 hours , f = 0.8 , i% = 0.16 , Engine work
by diesel. M & R cost = 0.95 * total depreciation.
End of Year 1 2 3 4 5
No. of working hours 2,100 2,000 1,900 1,800 1,800
Solution:
1) Ownership and investment cost:
Year Deprciation Book value Investment cost
0 - 130,000 -
1 23,000 107,000 20,800
2 23,000 84,000 17,120
3 23,000 61,000 13,440
4 23,000 38,000 9,760
5 23,000 15,000 6,080
2) Operating cost:
a) M & R cost:
Total M & R cost = 0.95´ (130,000 - 15,000) = 109,250
Total M & R cost
M & R cost for each year is given by
N
Year 1 2 3 4 5
M & R cost 21850 21850 21850 21850 21850

(b) Fuel Cost:

Q = 0.04 ´ 170 ´ 0.8 = 5.44 gal. / hr
= 5.44 ´ 4.25 = 23.12 litre / hr
 Engineering economy ]7 [ Prepared by Mohammed Ali Alsarori

Cost per hour = 23.12 ´ 0.58 = $ 13.41 / hr

(c) Oil Cost:
Q = [(0.006 ´ 170 ´ 0.8 )/7.4] + (8 /100) = 0.19 gal. / hr
= 0.19 ´ 4.25 = 0.81 litre /hr
Cost per hour = 0.81 ´ 5 = $ 4.1 / hr
 Hourly Owing and Operating Cost:
23000 + 20800 + 21850
cost / hour (1) = + 13.41 + 4.1 = 48.772 $ / h
2100
23000 + 17120 + 21850
cost / hour (2) = + 13.41 + 4.1 = 48.495 $ / h
2000
23000 + 13440 + 21850
cost / hour (3) = + 13.41 + 4.1 = 48.19 $ / h
1900
23000 + 9760 + 21850
cost / hour (4) = + 13.41 + 4.1 = 47.85 $ / h
1800
23000 + 6080 + 21850
cost / hour (5) = + 13.41 + 4.1 = 45.8 $ / h
1800
 Engineering economy ]8 [ Prepared by Mohammed Ali Alsarori

Breakeven analysis:
A fundamental of accounting is that all revenues and costs must be accounted for and the
difference between the revenues and costs is the profit, or loss, of the business. Costs can be
classified as either a fixed cost or a variable cost. A fixed cost is one that is independent of
the level of sales; rather, it is related to the passage of time. Examples of fixed costs include
rent, salaries and insurance. A variable cost is one that is directly related to the level of sales,
such as cost of goods sold and commissions. In planning and managing your business it is
important to know what level of sales must be achieved in order to meet total costs. Every $
of sales above this will contribute to profits.
Advantages of Break-even Analysis:
- It is simple to conduct and understand.
- It shows profit and loss at different levels of output.
- It can cope with changing circumstances, e.g. the following changes in the business
environment can be shown in a break even chart.

Disadvantages of Break-even Analysis:

- It assumes that all output is sold at the given price (this may well be untrue).
- Although it can cope with changes in circumstances, these factors change regularly
reducing its usefulness as a forecasting tool.
- The model assumes that costs increase constantly and do not benefit from economies of
scale. If the firm obtains purchasing economies of scale then its total cost line will no longer
be straight.
- Break-even analysis is only as good as the data upon which it is based. Poor quality data
will lead to inaccurate conclusions being drawn.

Example: A factory produces a certain unit. Each unit sells for $ 15 and costs $ 5. The
annual maintenance and operation costs are $ 75,000. Calculate the number of units
that should be produced to justify keep this business
running.
Solution:
Assume that total cost = revenue (let unit express as X)
75000  5X  15X
 X  7500 units
The investment in this project would be acceptable when
the production increases than 7500 units per year, otherwise it is rejected.
Value of X Total cost Total revenue
0 75000 0
7500 112500 112500
 Engineering economy ]9 [ Prepared by Mohammed Ali Alsarori

In case of evaluating alternatives using the breakeven analysis, the breakeven point
represents the point at which the total cost for alternatives are equal considering that all
alternatives have equal revenue. In case of having alternatives with different revenues, the
breakeven for each alternative is identified first, then the breakeven between each two
alternatives is identified as follows:
- Identify the common criterion (IRR, NPW, etc.) among alternatives.
- Calculate the cost in one of these criteria.
- For each two alternatives, find the value at which the two alternatives have equal cost.
- Represent the results graphically and compare between alternatives on the breakeven point.

Example: There are two proposals for a new project. The information related to both
alternatives is shown in the following table. If the interest rate is 10%, find:
a. The volume of production that justifies the purchase of alternative A.
b. If the production of this project is 2000 ton annually, which alternative do you
recommend for purchasing?
Solution:

1. Find the annual worth for this projects:

AWA = -230000 (A/P, 10%, 10) - 35000 + 40000(A/F, 10%, 10) = - 69,922
AWB = - 80000 (A/P, 10%, 5) -15000 = - 36,103
2. To choose where the project is better than the other should be find break point (N.O.
of tone) which A is equal B by assume that:
Total cost for A = Total cost for B

69,922  15X  36,103  40X  X  1353 tone

Value of X Alternative A Alternative B
0 69922 36103
1353 90217 90223

a. Thus means that, if the annual production is

more than 1353 ton, then alternative A is better.

b. In case of the required production is 2000, then alternative A is better. As shown in the
figure, if the production is less than 1353 ton annual then it is better to use alternative B.
While alternative A is better in case of production is more than 1353 ton annually.
Engineering economy ]10[ Prepared by Mohammed Ali Alsarori

Example (‫)مهم‬: It is required to calculate the breakeven point for the three options
listed in the table below. Which alternative do you recommend?

Solution:
1. Breakeven point calculation:
For A 30,000  17X  27X  X  3000 units
For B 50,000  12X  35X  X  2174 units
For C 60,000  10X  40X  X  2000 units
2. To select which alternative is best find breakeven point for each alternatives:
For A and B:
Total cost A = Total cost B
30,000  17X  50,000  12X  X  4000 units
For A and C:
Total cost A = Total cost C
30,000  17X  60,000  10X  X  4286 units
For C and B:
Total cost C = Total cost B
60,000  10X  50,000  12X  X  5000 units
Draw the relationship between the total cost and unit for each alternatives:
From the fig. we find:
Value of X 0 4000 4286 5000
Alternative A 30,000 98,000 102,862 115,000
Alternative B 50,000 98,000 101,432 110,000
Alternative C 60,000 100,000 102,860 110,000

- If the production is less than 4000

units, then alternative A is the best.
- If the production is greater than 4000
and less than 5000, then alternative B is
the best.
- Finally, if the production is greater
than 5000 units, then alternative C is the
best.
Engineering economy ]11[ Prepared by Mohammed Ali Alsarori

Example (‫)مهم‬: It is required to calculate the breakeven point for the three options
listed in the table below. Which alternative do you recommend?
Annual Fixed cost Variable Cost Sell price
Alternative
($) ($/Unit) ($/Unit)
A 45,000 19 23
B 57,000 15 33
C 67,000 11 46

Solution:
1. Breakeven point calculation:
For A 45,000  19X  23X  X  11250 units
For B 57,000  15X  33X  X  3167 units
For C 67,000  11X  46X  X  1915 units
2. To select which alternative is best find breakeven point for each alternatives:
For A and B:
Total cost A = Total cost B
45,000  19X  57,000  15X  X  3000 units
For A and C:
Total cost A = Total cost C
45,000  19X  67,000  11X  X  2750 units
For C and B:
Total cost C = Total cost B
67,000  11X  57,000  15X  X  2500 units
Draw the relationship between the total cost and unit for each alternatives:
From the fig. we find:
Value of X 0 3000 2750 2500
Alternative A 45,000 102,000 97,250 92,500
Alternative B 57,000 102,000 98,250 94,500
Alternative C 67,000 100,000 97,250 94,500

- If the production is less than 2750 units,

then alternative A is the best.
- If the production is greater than 2750
units alternative C is the best.