Project Management

NGUYEN HOANG LAN PHD. PMP

D E PA R T M E N T O F I N D U S T R I A L E C O N O M I C S
SCHOOL OF ECONOMICS AND MANAGEMENT
ROOM 206 – C9
E M A I L : L A N . N G U Y E N H O A N G @ H U S T. E D U .V N
0905169617
Business case analysis
Cost and Revenue
• Cost concept
• Cost classification
• Revenue
Cost Concept
• Manufacturing Costs:
◦ Direct materials
◦ Direct Labor
◦ Manufacturing overhead (indirect labor, indirect materials, maintenance
and repair on equipment; property taxes, depreciation, insurance, etc.)
• Non manufacturing Costs
◦ Marketing or selling costs (advertising, shipping, sales travel, sales
salary, etc.)
◦ Administrative costs (accounting, public relations, etc.)
Cost classification
• Fixed Costs (capacity cost): costs are expected to remain constant
when the output change in relevant range
◦ Example: insurance cost
• Variable Costs: relevant to the level of volume
◦ Example: fuel cost
• Mixed cost: semi-variable cost
◦ Example: depreciation, power consumption
• Average Unit Cost: activity cost per unit
◦ The variable cost per unit is constant
◦ Fixed cost per unit varies with the change in volume
◦ The mixed cost per unit varies as volume change
Cost classification – Example
• Consider the cost data of owning and operating a
typical passenger car in a company (table below)
• Requirement
◦Classify the cost: done
◦Group work: Develop a cost-volume chart and calculate the
average cost per mile as a function of annual mileage
(Suggestion: consider volumes level of 5000 miles, 10,000
miles, 15,000 miles and 20,000 miles)
 Cost classification – Exercise 1
Cost Reference Value ($) Cost Classification (VC, FC, MC)
Standard miles per gallon 20 miles/gallon
Average fuel price per gallon $1.34/gallon
Fuel and oil per mile ??? VC
Maintenance per mile 0.0360 VC
Tires per mile 0.0141 VC
Insurance- comprehensive 90 FC
Insurance – collision 147 FC
Insurance – Body injury &property damage 460 FC

License & registration 95 FC

Property tax 272 FC
Depreciation – fixed portion per year 3106 FC
Depreciation – variable portion per mile 0.04 VC
Break-even volume analysis
• Difference cost: The difference in costs between two
alternatives.
◦ Change in variable cost
◦ Fixed cost change only the volume be outside of relevant range
• Break-even volume is the point that the company change from
one option to another
Exercise 2:
A company has manufacturing plants operating on a single-shift 5-day week. The plant is
operating at its full capacity (24,000 units of output per week) without the use of
overtime or extra-shift operation. Fixed costs for single-shift operation amount to
$90,000 per week. The average variable cost is a $30 per unit, at all output rates, up to
24,000 units per week. The company has received an order to produce extra 4,000 units
per week beyond the current single-shift maximum capacity. Two options are being
considered to fill the new order:
Option 1: increase the plant’s output to 36,000 units a week by adding overtime
or by adding Saturday operations or both. No increase in fixed costs is entailed, but the
variable cost is $36 per unit for any output in excess of 24,000 units per week, up to
36,000-unit capacity.
Option 2: Operate a second shift. The maximum capacity of the second shift is
21,000 units per week. The variable cost on the second shift is $31.5 per unit, the fixed
costs of operating a second shift is $13,500 per week.
Determine the range of operation volume that will make option 2 profitable
Cost classification
• Opportunity Cost: potential benefit given up as seeking an alternative
option

• Sunk Cost: cost has been incurred by past action

• Marginal Costs: added cost resulting from increasing the rate of output
by a single unit
Exercise
• Exercise 3: You have a part-time job that pay you $200 per week.
You would like to spend a week at the beach during spring break
and your employer has agreed to give you the week off. Name the
cost and determine the value of cost.
• Exercise 4: You have an old car and want to sell. The market value
would be about $1,200 at best. While you are in the process of
advertising the car, you find that the car’s water-pump is leaking.
You decided to have the water-pump repaired, which cost $200. A
friend of yours is interested in buying your car, and has offered
$1,300. Would you take the offer? Or, decline the offer just because
you cannot recoup the repair cost with that offer. What kind of cost
you determine in this case?
• Exercise 5: Consider a company that purchases electricity at
the following rates. In this table, the unit variable cost in each
rate class represents the marginal cos per kWh. Suppose that
the current monthly consumption of electricity averages 3,200
kWh. Determine the marginal cost of adding one more kWh
and for the given operating volume (3,200 kWh), the average
cost per kWh.
kWh/mont First 1,500 Next 1,250 Next 3,000 All over
h 5,750
$/kWh 0.050 0.035 0.020 0.010
Revenue
• Revenue is the total amount of income generated by the sale
of goods or services related to the company's primary
operations.
R = Q*P

=
Time is money
• Interest: the cost of money
◦ Definition: a percentage that is periodically applied and added to an amount money
over a specified length of time. OR the cost of having money available for use.
◦ Example: A current annual interest rate is 10%. Amount of current money is $1
billion. After a year, the future amount of money is $1.1 billion. That is, $1 million
will earn $100,000 in interst in a year.
◦ Exercise 6:
◦ Amount of money: P = $200,000
◦ Annual Interest rate i = 10%
◦ How much is interest (I) after 1 year ?
◦ How much is amount of money (F) after 1 year?
Time is money
• Elements of Transaction Involving Interest
◦ Principal (P): An initial amount of money in transactions
◦ Interst rate (i): The cost or price of money and is expresssed as a percentage
per period of time
◦ The interest period: a period of time detemines how frequently interst is
calculated (year, month, quarter)
◦ Number of interst periods (N)
◦ A plan for receipts or disbursements: a particular cash flow pattern over a
specified length of time (for example:series of equal monthly payments that
repay the loan)
◦ A future amount of money (F): the amount of money results from cumulative
effects of interst rate over a number of interest periods
Time is money
• Example:
◦ An electronic manufacturing company buys a machine for $25,000 and
borrow $20,000 from the bank at a 9% annual interest rate. The
company pays $200 loan fee when the loan commences. The bank
offer two repayment
End of Year
plans, onePayment
Receipts
with equal payments
Payment
made at the end of
every year for the next 5 years, Plan and1 the other with
Plan 2 equal payments made
at the
Year 0end of every year for the next 5 years.
$20,000 $200.00 These payment
$200.00 plans are
summarized
Year 1 in table below. 5,141.85 0
Year 2 5,141.85 0
Year 3 5,141.85 0
Year 4 5,141.85 0
Year 5 5,141.85 30,772.48
Time is money
• In Plan 1 the principal amount, P, is $20,000, and the interest
rate, i, is 9%. The interest period is 1 year, and the duration of
the transaction is 5 years, which means there are five interest
periods (N=5). The disbursements planned over the duration
of this transaction yield a cash flow pattern of five equal
payments, A, of $5,141.85 each, paid at year-end during years
1 through 5.
• Plan 2 has most of the elements of Plan 1, except that instead
of five equal repayments we have a grace period followed by
a single future repayment, F, of $30,772.78.
 Time is money
• Methods of Calculating Interest
◦ Simple Interest:
I = (iP)N
F = P + I = P (1+iN)
◦ Compound Interest:
End of period 1: P+iP = P(1+i)
End of period 2: P(1+i)+i[P(1+i)]=P(1+i)(1+i)=P(1+i)2
End of period 3: ????????
F= ?????
Exercise 7: Suppose you deposit $1,000 in a bank savings account that pays interest at a
rate of 8%, compounded annually. Plan 1: You withdraw the interest at the end of each
year. How much is interest you get? Plan 2: you don’t withdraw the interest earned at
the end of each period (year), but let it accumulate. How much would you have at the
end of year 3.
Time is money
• Exercise 8: In 1626, Peter Minuit of the Dutch West India
Company paid $24 to purchase Manhattan Island in New York
from the Indians. If Mr. Minuit had invested the $24 in a
saving account that earns 8% interest, how much would it be
worth in 2000.
• Calculate in two cases: Simple interest and Compound interest
Time is money
• Types of Cash Flow
◦ Single Cash Flow
◦ Equal (uniform) Series
◦ Linear Gradient Series
◦ Geometric Gradient Series
◦ Irregular Series
 Time is money
• Single Cash Flow Formulas
◦ Given a present sum, P, invested for N interest periods at interest rate, i,
what sum will have accumulated at the end of the N periods (F)?

F = P(1+i)N
F = P(F/P,i,N)
(F/P,i,N): Single payment Compound amount factor
(F/P,i,N) = (1+i)N
◦ Example: P = $20,000, i = 12%, number of periods is 15. Find F
◦ Cash flow
◦ Know P, i, N -> F?
• Given a future value, F after N interest periods at interest rate, i, what
is the present value invested in present (P)?
◦ = = ( / , , )
( )
◦ (P/F,i,N): single payment present worth factor
◦( / , , )=
( )
• Exercise 9: Suppose that $1,000 is to be received in 5 years. At an
annual interest rate of 12%, what is the present worth of this amount?
◦ Draw cash flow
◦ Given: F, i, N -> Find P
• Exercise 10: Suppose you buy a share for $10 and sell it
for $20, your profit is $10. If that happens within a year,
your rate of return is an impressive 100% ($10/$10=1). If
that takes 5 years, what would be the average annual rate
of return on your investment?
◦ Given? Find?
• Solution: Given P, N, F -> Find i
◦ Method 1: Use calculator to solve the equation
◦ Method 2: Go through a trial-and-error process with different value
of i
◦ Method 3: Use function in Excel: RATE(N,0,P,F)
• Exercise 11: You have just purchased 100 shares of General
Electric stock at $60 per share. You will sell the stock when its
market price has doubled. If you expect the stock price to
increase 20% per year, how long do you expect to wait before
selling the stock?
• Solution: Given P, F, i -> Find N
◦ Method 1: Use calculator to solve the equation
◦ Method 2: Use function in Excel: NPER(i,0,P,F)
• Exercise 12: Wilson Technology, a growing machine shop, wishes
to set aside money now to invest over the next 4 years in
automating its customer service department. The company can
earn 10% on a lump sum deposited now, and it wishes to withdraw
the money in the following increments:
◦ Year 1: $25,000 to purchase a computer and database software designed for
customer service use;
◦ Year 2: $30,000 to purchase additional hardware to accommodate anticipated
growth in use of the system;
◦ Year 3: No expenses; and
◦ Year 4: $5,000 to purchase software upgrades.
How much money must be deposited now to cover the anticipated
payments over the next 4 years?
• Exercise 13: On December 2018, The famous goalkeeper Mr. A
agreed to a 5-year deal with a Football Club of Thailand. The
agreement calls for annual salaries of $120,000 per year. The
$30,000 signing bonus is prorated over 3 years of the
contract,$10,000 each year from 2019 to 2021.
• a. How much is Mr. A’s contract actually worth at the time of
signing? Assume that Mr. A’s interest rate is 6% per year.
• b. For the signing bonus portion, suppose that the FC allow Mr. A
to take either the prorated payment option as described above or a
lump sum payment option in the amount of $28,000 at the time of
contract. Should Mr. A take the lump sum option instead of the
prorated one?
• Equal payment Series
( )
• = = ( / , , )

Equal payment series/ uniform series compound amount

( )
factor: ( / , , ) =

• = = ( / , , )
( )

Sinking-Fund Factor: ( / , , ) =
( )
• Exercise 14: Suppose you make an annual contribution of $3,000 to your
savings account at the end of each year for 10 years. If your saving
account earns 7% interest annually, how much can be withdrawn at the
end of 10 years?
• Exercise 15: In Exercise 14, the first deposit of the 10-deposite was made
at the end of period 1 and the remaining nine deposits were made at the
end of each following period. Suppose that all deposits were made at the
beginning of each period instead. How would you compute the balance at
the end of period 10?
• Exercise 16: To help you reach a $5,000 goal 5 years from no, your father
offers to give you $500 now. You plan to get a part-time job and make
five additional deposits at the end of each year. (The first deposit is made
at the end of the first year). If all your money is deposited in a bank that
pays 7% interest, how large must your annual deposit be?
• Equal payment Serie
( )
• = = ( / , , )
( )
Equal payment series present worth factor: ( / , , ) =
( )
( )
( )
• = = ( / , , )
( )
Capital Recovery Factor/Annuity Factor: ( / , , ) =
( )
( )
• Exercise 17: BioGen Company, a small biotechnology firm,
has borrowed $250,000 to purchase laboratory equipment for
gene splicing. The loan carries an interest rate of 8% per year
and is to be repaid in equal installments over the next 6 years.
Compute the amount of this annual installment.
• Exercise 18: In Exercise 17, suppose that BioGen wants to
negotiate with the bank to defer the first loan repayment until
the end of year 2 (but still desires to make six equal
installments at 8% interest). If the bank wishes to earn the
same profit as in Exercise 17, what should be the annual
installment?
• P’= 250(1+8%)^2
• A=P’(A/P,8%,6)
• Exercise 19: Mrs. Setchfied gave up $32,639 a year for 9
years to receive a cash lump sum of $140,000. If she could
invest her money at 8% interest, did she make a right
decision? What should have been the fair amount to give up
her nine future lottery receipts?
• P=32,639* (P/A, 8%,9) ~???~ 140,000
• Exercise 20: Two payment options provided by The
Publishers’ Clearing House :
◦ Option A: $1,000,000 now, $20,000 yearly, plus a $3,400,000 final
payment at the end of year 29
◦ Option B: $500,000 now, $25,000 a year thereafter, plus a $2,500,000
final payment at the end of year 29.
Note that 30 payments are required in either option. Which option would
you prefer with an interest rate of 8%.
P(A) = 1000 + 20*(P/A,8%,29) + 3,400 * (P/F,8%, 29)
P(B) = 500 + 25*(P/A, 8%, 29) + 2500*(P/F, 8%, 29)
Project cash flow
Depreciation
• Asset Depreciation
• Fixed assets are used to provide the future cash flows. For example:
Equipment, machines, etc.
• Depreciation is defined as the gradual decrease in utility of fixed assets
with use and time.
◦ Physical depreciation: a reduction in an asset’s capacity to perform its intended
service due to physical impairment. (interaction with environment or because of
using)
◦ Functional depreciation occurs as a result of changes in the organization or in
technology that decrease or eliminate the need of an asset.
• Economics depreciation = purchase price - market value
• Accounting Depreciation: the systematic allocation of the initial cost of
and asset in parts over a time (depreciable life)
Depreciation
• Depreciable assets
◦ Be used in business or held for production of income
◦ Have a definite service life, and that life must be longer than 1 year
◦ Be something that wears out, decays, gets used up, loses from value from natural
causes
◦ Example: Buildings, machinery, equipment, vehicles.
• Cost basis: include the actual cost of an asset and all other incidental
expenses
• Example: Lanier Corporation purchased an automatic hole-punching
machine priced at $62,500. Lanier also paid the inbound transportation
charges of $725 on the new machine as well as labor cost of $2,150 to
install the machine in the factory. Lanier also had to prepare the site at the
cost of $3,500 before installation. Determine the cost basis for the new
machine for depreciation purpose.
Depreciation
• Asset’s depreciable life (useful life):
◦ the number of years over which an asset is to be depreciated
◦ Base on the service life of an asset
• Government issues guideline on lives for categories of assets
• Salvage Value:
◦ an asset’s estimated value at the end of its life
◦ Be estimated when the depreciation schedule for the asset is established
Depreciation
• Depreciation method
◦ Straight-line method: consider that the asset provides an equal amount
of service in each year of its useful life
( − )
=
◦ Dn: Depreciation charge during year n
◦ I: cost of the asset including installation expense
◦ S: Salvage value at the end of useful life
◦ N: useful life
The book value of the asset at the end of n years (Bn) = Cost basis – total
depreciation charges made to date
Example: Consider the following automobile data
Cost basis of the asset is $10,000; useful life is 5
years, estimated salvage value is $2000. Compute
the annual depreciation allowances and the
resulting book values using the straight-line
depreciation method.
 Depreciation
• Declining Balance Method (DB)
◦ Allocate a fixed fraction of the beginning book balance each year.
The fraction α=1/N*(multiplier)
Multiplier = 2: Double Declining Balance Method
Dn= αI(1- α)n-1
◦ The total Depreciation (TDB)at the end of n years:
TDB=I[1-(1- α)n]
◦ The book value, Bn=I(1- α)n
◦ Example: Consider the following accounting information for computer system.
Cost basis of the asset is $10,000; useful life is 5 years, estimated salvage value is
$778. Compute the annual depreciation allowances and the resulting book values
using the double declining depreciation method.
• Consider the following accounting information
for computer system. Cost basis of the asset is
$10,000; useful life is 5 years, estimated salvage
value is $778. Compute the annual depreciation
allowances and the resulting book values using
the double declining depreciation method.
 Depreciation
• If the final book value BN is different from salvage value (S):
◦ Case 1: BN>S: We have not depreciated the entire cost of the asset ->
switching from DB to SL when ever SL depreciation results in larger
depreciation charges. The rule is: If the depreciation by DB in any year is less
than (or equal to) I would be by SL; we should switch to and remain with the
SL method for the duration of the project’s depreciable life. The straight-line
depreciation in any year n is calculated by:
◦ Dn= (Book value at the beginning of year n – salvage value)/Remaining useful life at the
beginning of year n
Example: Consider the following accounting information for computer system.
Cost basis of the asset is $10,000; useful life is 5 years, estimated salvage value
is $0. Determine the optimal time to switch from DB to SL depreciation and the
resulting depreciation schedule.
Depreciation
◦ Case 2: BN<S: We depreciate assets below their salvage value -> Stop depreciating the asset
whenever you get down to Bn=S.

Example: Consider the following accounting information for computer system. Cost basis of the asset
is $10,000; useful life is 5 years, estimated salvage value is $2000. Determine the depreciation in each
year.

Exercise 21:
Consider the following data on an asset. Cost of the asset is $100,000, useful life is 5 years, Salvage
value is $10,000. Compute the depreciation allowances and the resulting book values using The
straight-line depreciation and Double declining balance method.
Corporate Income Tax
• After-tax cash flow
• The project revenue
• The project expenses
• Taxable Income = Gross income (revenues) – expenses
• Income taxes = (Tax rate) x (taxable income)
• Net income = Taxable income – income taxes
Corporate Income Tax
Gross income
Expenses
Cost of goods sold
Depreciation
Operating expenses
___________________________
Taxable income
Income taxes
____________________________
Net income
Corporate Income Tax
• Exercise 22: A company buys a numerically controlled (NC)
machine for $28,000 (year 0) and uses it for 5 years, after
which it is scrapped. The cost of good sold is $20,000. The
depreciation of machine follows straight line method. The
Operating expenses is $6,000. Gross income is $50,000.
• A. If the company pays taxes at the rate of 40% on its taxable
income, what is the net income during the first year from the
project?
• B. If the tax rate is 20%, what is the net income?
Corporate Income Tax
• Cash Flow and Net Income: Cash Flow is difference from Net
Income
• Example on Capital Cost – Depreciation ($10,000 for 5 years)
• Exercise 23: The same information from exercise 22. Compare
Cash Flow and Income.
• Exercise 24: The Omar Shipping Company bought a tugboat for
$75,000 (year 0) and expected to use it for 5 years, after which it
will be sold for $12,000. Suppose the company estimate the
revenues is $200,000 every year, the operating expenses is
$84,000. Using straight line method for depreciation. If the tax
rate is 30%, calculate the income and cash flow.
• Exercise 24: The Omar Shipping Company bought a tugboat
for $75,000 (year 0) and expected to use it for 5 years, after
which it will be sold for $12,000. Suppose the company
estimate the revenues is $200,000 every year, the operating
expenses is $84,000. Using straight line method for
depreciation. If the tax rate is 30%, calculate the income and
cash flow.
Developing Project Cash Flows
• Project cash flows
◦ Cash Outflows
◦ Cash Inflows
• Cash Outflows:
◦ Purchase of New Equipment
◦ Investments in Working Capital
◦ Manufacturing, Operating, and Maintenance Costs
◦ Leasing Expenses
◦ Interest and Repayment of Borrowed Funds
◦ Income Taxes and Tax Credits
Developing Project Cash Flows
• Elements of Cash Inflows
◦ Borrowed Funds
◦ Operating Revenues
◦ Cost Saving (Cost Reduction) – For the project with purpose is to
reduce operating cost.
◦ Salvage Value
Developing Project Cash Flows
◦ Exercise 25: A computerized machining center has been proposed for a
small tool manufacturing company. If the new system, which cost
$125,000, is installed, it will generate annual revenues of $100,000 and
will require $20,000 in annual labor, $12,000 in annual material
expenses, and another $8,000 in annual overhead (power and utility)
expenses. The company expects to phase out the facility at the end of 5
years, at which time it will be sold for $50,000. Use straight line
depreciation method. Tax rate is 40%. Determine the cash flow.
◦ If the firm interest (MARR) is 15%, calculate the present worth of
project. (NPV)
 Developing Project Cash Flows
• Projects are financed with Borrowed Funds
One payment at the end of loan period
Equal total payments per time period;
Equal principal payments per time period
• Example (excel file)
• Exercise 26: Use the information in Exercise 25. Assuming that $62,500 of the $125,000 paid for the
investment is obtained through debt financing, the interest rate is 10% over 3 years. The loan is to be repaid in
two ways (i) equal total payment (ii) equal principal payment. The remaining $62,500 will be provided by
equity.
Determine the Cash Flows in two repayment method.
• Exercise 27: An automobile manufacturing company is considering the purchase of an industrial robot to do
spot welding, which is currently done by skilled labor. The initial cost of the robot is $235,000, and the annual
labor savings are projected to be $122,000. The robot will be used for 7 years, at the end of which time the
firm expects to sell the robot for $50,000. The company’s marginal tax rate is 38% over the project period.
Apply straight-line depreciation method, determine the net after-tax cash flows for over the project life.
If the firm must borrow $40,000 to buy the robot. Determine the net after-tax cash flows if apply (i) the equal
total payment per time period method for repayment and (ii) equal principal payment; the interest rate is 11%
over 5 years (five payments)
NPV=??
 Criteria for project evaluation
• Net present value (NPV) method
NPV = ∑ /(1 + )
CFt = Bt - Ct
MARR: used as discounted rate (i= MARR)
NPV = present value of cash flows
NPV≥0: The project is attractive (worth to invest)
NPV<0: The project is not attractive
Example: A, B, C
NPVa = -100, NPVb = -150, NPVc = -1000.
• IRR
NPV =0->i* =IRR
IRR= 10%
MARR = 6%
IRR > MARR -> I like this project, attractive to me!!
• Cost – Benefit ratio Method (B/C ratio)
∑ /( )
B/C = ∑ /( )

B/C≥1: The project is attractive (worth to invest)

B/C<1: The project is not attractive
• IRR (internal rate of return) is the value of i (discounted rate) when NPV is equal 0
IRR≥ MARR: The project is attractive (worth to invest)
IRR<MARR: The project is not attractive
MARR: Minimum attractive rate of return
A,b,c
IRRa = 10%, IRRb = 5%, IRRc = 1%
• Payback period
• Exercise 28: Use the information of project in exercise 27,
calculate NPV, IRR, B/C and
determine that project is attractive or not.
Project risk and uncertainty
• Exercise 29: Consider the project on exercise 27, determine
the range of NPV when the initial cost is $258,500, other
factors are the same as on exercise 27.
• Exercise 30: Consider the project on exercise 27, determine
the range of NPV when the annual labor savings are projected
to be $109,800, other factors are the same as on exercise 27.
• Exercise 31: Consider the project on exercise 27, determine
the range of NPV when the initial cost is $258,500 and the
annual labor savings are projected to be $109,800, other
factors are the same as on exercise 27
Sensitivity analysis
• Consider effects of the output changing on the input’s
changing
• Output: NPV, IRR
• Input: Revenue, Cost, discounted rate