3.

3 Replacement analysis and Sensitivity Analysis

Replacement Analysis
Replacement analysis always involve comparison of an existing asset with a new one.
In replacement analysis, the defender is an existing asset; the challenger is Defender - the existing
equipment previously implemented.
Challenger - the proposed replacement currently under consideration (the best available
replacement candidate.
The defender would have been purchased some years ago at some cost say Po. Today if it is traded
in or sold because of a consideration to buy a challenger, the value obtained will be lower say P
The term (Po – P) is called the sunk cost. The sunk cost is never taken into account in engineering
economic analysis.
Two basic approaches to analyzing replacement problems are the cash flow approach and the
opportunity-cost approach.
The cash flow approach explicitly considers the actual cash flow consequences for each
replacement alternative as it occurs.
The opportunity-cost approach views the net proceeds from the sale of the defender as an
opportunity cost of keeping the defender.

Example
An equipment which was purchased at a cost of 22,000birr four years ago is considered for
replacement against a challenger whose cost is 18,000birr. The existing equipment can be traded in
today at 6,000birr and if kept on for another 6 years, will have a salvage value of 2,000birr. The
annual maintenance cost of the existing asset is 7,000birr per year. The challenger has an annual
operating cost of 3,500birr and its salvage value 3,000birr at end of year 6, i = 15%.
• find if it is worth replacing the existing equipment with the new equipment.

Po = 22,000birr, P = 6,000birr and F = 2,000birr

AEC(Defender) = -6000(A/P, 15%,6) - 7000 + 2000(A/F,15%,6)
= -8356.8birr

AEC(Challenger) = -18,000(A/P,15%,6) - 3500 + 3000(A/F,15%,6)

= -7913birr
Please note that the sunk cost (Po – P) = 22000birr – 6000birr = 16000birr is not used anywhere in
the analysis.
Since the equivalent annual cost of challenger is less than the defender, it would be economical to
replace the existing equipment with the new equipment. This shows that replacement is desirable.

3.4 Project Risk and Uncertainties

Construction projects are initiated in complex and dynamic environments resulting in
circumstances of high uncertainty and risk, which are compounded by demanding time constraints.
Risk is exposure to the consequences of uncertainty. A risk is defined as the potential for
complications and problems with respect to the completion of a project and the achievement of a
project goal.
Risk assessment is a technique that aims to identify and estimate risks impacted upon by a project.
Uncertainty can be defined as a lack of certainty involving variability and/or ambiguity.
Construction industry has changed significantly over the past several years. It is an industry driven
primarily by private investors; the presence of securitized real estate has increased considerably. It
is vulnerable to the numerous technical & business risks that often represent greater exposures than
those that are traditional. Thus risk assessment need arises.
Risk assessment is a tool to identify those risks in a project and manage it accordingly with proper
treatment. Risk assessment is defined as a technique that aims to identify and estimate risks to
personnel and property impacted upon by a project.

Construction involves many variables, and it is often difficult to determine cause and effect,
dependence and correlations. Hence, those risks play a significant role in decision making and may
affect the performance of a project (wiguna and scott, 2005).
uncertainty management is concerned as managing perceived threats and opportunities and their
risk implications but also managing the various sources of uncertainty.
Investors are always looking for a sure thing, a risk-free way to get a big return for their money.
In business investment decisions, financial risk is by far the most critical element to consider.
Risk and Uncertainty (what effects do the uncontrollable elements have in the outcome)
Risks in construction projects can be defined as the probability of an event that impairs the viability of the
project. This probability, perhaps, is higher than in other industries. In the construction sector, as elsewhere,
various risks that affect business can be identified
Construction is a complex area involving many factors that can affect the final outcome, and being a
teamwork process whose common goal is the completion of the project, the risks are essentially due to the
uncertainty affecting the various participants in it.

Some categorize risks in construction projects broadly into external risks and internal risks while
others classify risk in more detailed categories of political risk, financial risk, market risk,
intellectual property risk, social risk, safety risk, etc.

Solutions to reduce an influence of the risk and uncertainty

Construction project can be described as a unique set of co-ordinated activities, with a definite
start and finish, performed by an individual or organization to meet specific objectives with
defined schedule, cost and performance parameters. It is dynamical process constantly
influenced by various factors and treats.
Project management techniques reduce risk in three fundamental ways:
• Active planning and future simulation (when you can see the future, you improve your odds
dramatically).
• Early problem recognition (structured tools of project management recognize problem earlier).
• Improved communication (common cause of project failure is communication breakdowns).

Sensitivity analysis
Sensitivity analysis determines the effect on the PW of variations in the input variables (such as
revenues. operating cost. and salvage value) used to estimate after-tax cash flows. Decision
making under uncertainty means there are two or
more values observable, but the chances of their occurring cannot be estimated or no one is
willing to assign the chances

Sensitivity analysis determines how a measure of worth—PW, AW, ROR, or B/C—and the
alternative may be altered if a particular parameter varies over a stated range of values.
For example if i* > MARR
Thus, the decision is relatively insensitive to MARR. However, variation in the estimated P value
may make selection from the same alternatives sensitive.
It is possible to examine the sensitivity to variation for one, two, or more parameters for one
alternative, as well as evaluating the impact on selection between mutually exclusive alternatives.
There are three types of sensitivity analyses
 Variation of one parameter at a time for a single project or for selecting between mutually
exclusive alternatives
 Variation of more than one parameter for a single project
 Sensitivity of mutually exclusive alternative selection to variation of more than one
parameter
In all cases, the targeted parameter(s) and measure of worth must be selected prior to initiating the
analysis.
A general procedure to conduct a sensitivity analysis follows these steps:
1. Determine which parameter(s) of interest might vary from the most likely estimated value.
2. Select the probable range (numerical or percentage) and an increment of variation for each
parameter.
3. Select the measure of worth.

4. Compute the results for each parameter using the measure of worth.
5. To better interpret the sensitivity, graphically display the parameter versus the measure of
worth.

CHAPTER FOUR
4. Economic analysis of multi-purpose projects
3.5.3 ANALYSIS OF MULTIPLE INVESTMENT OPPORTUNITIES
For the purpose of this initial discussion of investing in multiple projects, assume that all of the
prospective projects to be evaluated require the same initial investment, that the investor only has
enough funds to invest in one of the projects, and that the decision will be based solely on NPV
analysis. These assumptions will be removed in subsequent chapters and discussed further. In addition, if
at least one of the proposed projects has a positive NPV , then the “do nothing” project need
not be considered.
Example 3.3
Consider the following two investment opportunities. The investor’s MARR is 10% and the
investor only has enough funds to invest in one of the projects. Which one should be chosen?
Project A:
NPV for Project A = -800 + 215(P /A)10,5 = $15.0
NP V for Project B = -800 + 100(P /A)10,5 + 800(P /F )10,5 = $75.8
Both projects show positive values of NP V . Therefore, both would be acceptable as long as
the investor had at least $800 to invest. In addition, the “do nothing” alternative does not need to be
considered. If the investor only has enough funds to invest in one of the projects, the NP V values
indicate that Project B is the best economic choice.

CHAPTER FIVE
5. Project Appraisal and Case Studies in civil Engineering Projects
Project appraisal plays an important role in choosing the right project and is crucial to the final
success of public investment projects. The importance of project appraisal raises when the scale of
investments increases.
The project proposal should state the importance of the project, location size, estimation of
investment need, fund raising and primary social and economic impacts analysis. The
proposal should be made by those certified consulting companies. Quality of the proposal is
assumed to be guaranteed

Site appraisal for construction

Very early appraisals of potential sites for a development may be carried out by a surveyor,
before the appointment of the consultant team, during the business justification stage. Appraisal
of alternative sites may also be an important part of an environmental impact assessment.

Subsequent site appraisals by the consultant team will obtain details that might not have been
available in the site Information provided by the client. They are also an opportunity for the
consultant team to familiarize themselves with the site and assess the detailed surveys that might
be necessary.

Specific appraisals that might be made by individual consultants include:

Architect:

1. Desk review study of site history.

2. Study of site context including access, boundaries, levels, landscape (including possible
ecological issues such as the presence of Japanese knotweed), transport and traffic and an
assessment of neighboring properties and views.

3. Appraisal of possible hazardous substances such as asbestos and other deleterious materials.

4. Photographic studies.

5. Assessment of the local planning authority's local development plan.

6. Climatic conditions.

 Cost consultant:

1. Abnormal features that might impact on cost.

 Structural engineer:

1. Desk review study of geological issues or contaminated land.

2. Cursory study of neighboring or existing structures that might require demolition or might
otherwise be impacted by development.

3. Desktop study of foundation solutions adopted by adjacent developments.

 Services engineer:

1. Location and nature of underground site services.

2. Cursory investigation to establish 'cut off' for diversions of existing services.

3. Statutory utility drawings for the site.