Evaluating Business and

Engineering Assets
 “Scientists investigate that which
already is; Engineers create that
which has never been.”

-Albert Einstein
Loan versus Project Cash Flow
Loan Cash Flow
• e.g. Bank loan
• the future return takes the
form of interest plus
repayment of the principal
Project Cash Flow
• future return takes the form of
profits generated by the
productive use of the asset
• includes capital expenditures
and annual expenses
Independent versus Mutually Exclusive
Independent Mutually Exclusive
• the decision on any one project • any one of several alternatives
has no effect on the decision will fulfill the same need,
made on another selecting one alternative
• more than one viable project means that the others will be
may be selected excluded
• only one of the viable projects
can be selected
IMPORTANT NOTE
• In the following calculations, it is of utmost
importance to identify which are cash
OUTFLOWS and cash INFLOWS
Project Screening
• payback method screens projects on the basis of
how long it takes for net receipts to equal
investment outlays
• payback period is the number of years
required to recover the investment made
in the project
• projects are only considered if the payback
period is SHORTER than the maximum
acceptable period
• Payback period:

▫= initial cost_____
uniform annual benefit
▫ 300,000/75,000 = 4 years

If the company policy is to consider only projects

with a payback period of 5 years or less, this project
PASSES the initial screening
If max payback period is 3 years or
less...
Period Cash Flow Cumulative Cash Flow

-1000
0 -1000

-500
1 -1500

500
2 -1000

700
3 -300

1000
4 +700

1500
5 +2200

500
6 +2700
Net Present Worth Method
• PW of all cash inflows in comparison with PW of all
cash outflows
• Basic Procedure:
▫ Determine the interest rate that the firm wishes to
earn
▫ Estimate the economic life of the project
▫ Estimate the cash inflow & outflow for each period
over the whole economic life
▫ Find the present worth of each net cash flow at the
MARR
▫ If:

PW(i)>0 ; accept the investment

PW(i)=0 ; remain indifferent

PW(i)<0 ; reject the investment
Example 1
• Tiger Machine Tool Company is considering the
proposed acquisition of a new metal cutting
machine. The required initial investment of
75,000PhP and the projected cash benefits over
the project’s 3-year life are as follows:
End of Year Cash Flow
0 -75,000
1 24,000
2 27,340
3 55,760

• If MARR is 15%, Find NPW

▫ 3,205.65PhP
Example 2
• Perform a PW analysis of equal-service
machines with the costs shown below, if the
MARR is 10% per year. Revenues for all 3
alternatives are expected to be the same.
Electric Gas Powered Solar Powered
Powered
First Cost -2,500 -3,500 -6,000
Annual Operating
-900 -700 -50
Cost
Salvage Value 200 350 100
Life, years 5 5 5
Example 3
• A project engineer with EnvironCare is assigned
to start-up a new office in a city where a 6-year
contract has been finalized to take and to
analyze ozone-level readings. Two lease options
are available, each with a first cost, annual lease
cost and deposit-return estimates shown below.
MARR=15% Location A Location B
First Cost -15,000 -18,000
Annual Lease Cost -3,500 -3,100
Deposit Return 1,000 2,000
Lease Term, years 6 9
Future Worth Analysis and Capitalized Equivalent Worth
Analysis
Future Worth Method
• compute the equivalent worth of a project at the
end of its investment period, rather than its
beginning

• If:
▫ FW(i) >0 ; accept the investment
▫ FW(i) = 0 ; remain indifferent
▫ FW(i) <0 ; reject the investment
Example 4
• A pressure vessel was purchased for $16000,
kept for 5 years, and sold for $3000. Annual
operating and maintenance costs were $4000.
Using a 12% MARR, what was the present worth
of the investment?

▫ PW(12%)=-$28,717
▫ FW(12%)=-$50,608.39
Example 5
• Improved tooling for numerical control machinery
will cost 10,000php, last for 6 years, and have no
salvage value at that time. Due to this investment,
net income will increase by 2,525PhP during each of
the first 3 years and by 3,840PhP during each of the
remaining 3 years. Using a 15% MARR, what is the
present worth for the investment?

▫ PW(15%)=1,529.97php
▫ FW(15%)=3,538.92php
Capitalized Equivalent Method
• useful when the life of a proposed project is
perpetual or the planning horizon is extremely
long

▫ PW(i) = A(P/A , i, N
infinity) = A/i

Example 6
• An engineering school has just completed a new
engineering complex worth $50M. A campaign,
targeting alumni, is planned to raise funds for future
maintenance costs, which are estimated to be $2M
per year. Any unforeseen costs above $2M would be
obtained by raising tuition. Assuming that the
school can create a trust-fund that earns 8% interest
annually, how much has to be raised now to cover
the perpetual string of $2M costs?

▫ $25,000,000
Example 7
i=6% Suspension Bridge Truss Bridge
First Cost 50M 25M
Annual Inspection and
35,000 20,000
Maintenance Costs
Resurfacing Costs 10,000 every 10 years -
Painting Costs - 40,000 every 3 years
Sandblasting Costs - 190,000 every 10 years
Cost of Purchasing
2M 15M
Right-of-Way
Procedure
1. Draw a cash flow diagram showing all nonrecurring (one-
time) cash flows and at least 2 cycles of all recurring
(periodic) cash flows.

2. Find the PW of all nonrecurring amounts. This is their CC

value.

3. Find the equivalent A value through one life-cycle of all

recurring amounts

4. Divide the A obtained above by the interest rate to obtain

CC value

5. Add all the CC values