Module 5 Evalution of Single Project

Chapter 5.
EVALUATION OF
SINGLE PROJECT
©2028017Batangas State
University
Introduction
All engineering economy studies of capital projects should consider

the return that a given project will or should produce. A basic question this
book addresses is whether a proposed capital investment and its associated
expenditures can be recovered by revenue (or savings) over time in addition
to a return on the capital that is sufficiently attractive in view of the risks
involved and the potential alternative uses.
In this chapter, we concentrate on the correct use of five methods for
evaluatingthe economic profitability of a single proposed problem solution.
The five methods are Present Worth (PW), Future Worth (FW), Annual
Worth (AW), Internal Rate of Return (IRR), Payback Period
209 ©2017 Batangas State University

Learning Objectives
Discuss methods of evaluation.
Critique contemporary methods of

evaluation.
Evaluate single project in determining
project profitability.
Make a decision based on the evaluation.

Rate of Return
Rate of return is a measure of the effectiveness of an investment of
capital. It is a financial efficiency. When this method is used, it is necessary
to decide whether the computed rate of return is sufficient to justify the
investment. The advantage of this method is that it is easily understood by
management and investors. The applications of the rate of return method is
controlled by the following conditions. A single investment of capital at the
beginning of the first year of the project life and identical revenue and cost
data for each year. The capital invested is the total investment required to
finance the project, whether equity or borrowed.
Net Annual Profit

ROR 
Capital Invested
Rate of Return
Example. An investment of P270,000 can be made in a project that will
produce a uniform annual revenue of P185,400 for 5 years and then have a
salvage value of 10% of the investment. Out-of-pocket cost for operation
and maintenance will be P81,000 per year. Taxes and insurance will be 4%
of the first cost per year. The company expects capital to earn not less than
25% before income taxes. Is this a desirable investment? Use ROR Method
Given:
Investment = P270,000
Annual Revenue = P185,400 for 5 years
Salvage Value = 10% of investment
Operation and Maintenance Cost = P81,000 per year
Taxes and Insurance Cost = 4% of Investment
Rate of Return
Solution:
Step 1: Identify the Given

Given:
Salvage Value = 10% of investment = 0.10(P270,000) = P27,000
Taxes and Insurance Cost = 4% of Investment = 0.04(P270,000) = P10,800
Step 2: Analyze what method will be used

Net Annual Profit
ROR  Note: Annual Proft = Annual Revenue - Annual Cost
Capital Invested Capital Invested = First Cost or Investment Cost
Rate of Return
Solution:
Step 3: Determine the Total Annual Cost and Total Annual Revenue
Based from the problem, annual revenue = P185,400, then we need to
determine what is the total cost to determine the Net Annual Profit
Remember: In ROR Method, Depreciation Cost is included in the Total Cost
Operation and Maintenance Cost = P81,000

Taxes and Insurance Cost = P270,000(0.04) = P10,800
Depreciation Cost = P29,608.7577 (used SFM where i = 25%)
Total Cost = P121,408.7577
Rate of Return
Solution:
Step 4: Determine the Net Annual Profit
Net Annual Profit = Total Annual Revenue - Total AnnualCost

= P185,400 - P121,408.7577
= P63,991.2423
Step 5: Use the formula to determine the rate of return

Net Annual Profit
ROR  RoR =
63,991.2423
x100
Capital Invested 270,000
RoR = 0.2370 = 23.70%
Rate of Return
Solution:
Step 6: Make a Decision
*Since the computed rate of return is less than the

minimum required rate of return of 25%, the investment
is not desirable or not accepted.

Rate of Return
Solution using tabulated form:
Determine the inflows such as income and outflows such

as expenses.
Annual revenue P185,400
Annual costs:
D ep reciatio n P29,608.7577
O p e r a t i o n a n d maintenance P81000
T a x e s a n d in s u r a n c e P10800
Total Annual Cost P121,408.7577
N e t a n n u a l profit P63,591.2423
P63,591.2423
RoR
P270,000
X100 23.55%

Rate of Return
Example. A company estimates that insulation of steam pipes in the factory
will reduce the fuel bill by as much as 25%. The cost of the insulation is
P100,000 installed and the annual cost of taxes and insurance is 6% of the
first cost. Without the insulation, the annual fuel bill is P200,000. If the
insulation is worthless after 5 years of use, and a minimum return on
investment of 10% is desired, would it be worthwhile to invest in the
insulation? Solve using the ROR method.
Given:
Annual fuel bill = P200,000
Salvage Value = 0
Return on investment = 10%
Rate of Return
𝑺𝒐𝒍𝒖𝒕𝒊𝒐𝒏: 𝑵𝒆𝒕 𝑨𝒏𝒏𝒖𝒂𝒍 𝑷𝒓𝒐𝒇𝒊𝒕 = 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 – 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕
𝑪𝒐𝒎𝒑𝒖𝒕𝒊𝒏𝒈 𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒐𝒔𝒕: (𝐹𝐶 − 𝑆𝑉)(𝑖)
𝐷𝐸𝑃𝑁 =
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛: P16,379.7481 1+𝑖 𝐿−1
𝑇&𝐼 = 0.06(P100,000) = P6,000

𝑇𝐴𝐶 = 𝑃22,379.7481
ANNUAL SAVINGS = 0.25(P200,000) = P50,000
𝑁𝑒𝑡 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 𝑆𝑎𝑣𝑖𝑛𝑔𝑠 − 𝐶𝑜𝑠𝑡 𝑃50,000 − 𝑃22,379.7481

𝑹𝑶𝑹 = = =
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑃100,000
ROR = 27.62%, RECOMMEND TO INVEST

Annual Worth Method
In this method, interest on the original investment (sometimes
called minimum required profit) is included as a cost. If the
excess of the annual cash inflows over annual cash outflows is
not less than zero the proposed investment is justified-is valid.
This method is covered by the same limitations as the rate of
return pattern a single initial investment of capital and uniform
revenue and cost throughout the life of the investment.
Excess  Annual Cash Inflows - Annual Cash Outflows

Annual Worth Method
Example. An investment of P270,000 can be made in a project that will
produce a uniform annual revenue of P185,400 for 5 years and then have
a salvage value of 10% of the investment. Out-of-pocket cost for
operation and maintenance will be P81,000 per year. Taxes and
insurance will be 4% of the first cost per year. The company expects
capital to earn not less than 25% before income taxes. Is this a desirable
investment? Use Annual Worth Method
Given:
Annual Worth Method
Solution:

Given:

Note: Annual Cash Inflows includes Annual Revenue
Annual Cash Outflows includes Total Cost including depreciation and interest on capital
Annual Worth Method
Solution:
Step 3: Determine the Annual Cash Inflow and Annual Cash Outflow
Based from the problem, annual revenue = P185,400 which is the cash
inflow, we need to determine the total annual cash outflows
Operation and Maintenance Cost = P81,000

Taxes and Insurance Cost = P270,000(0.04) = P10,800
Depreciation Cost = P29,608.7577 (used SFM where i = 25%)
Interest on Capital = P270,000(0.25) = P67,500
Total Annual Cash Outflows = P188,908.7577
Annual Worth Method
Solution:
Step 4: Determine the Excess using Annual Worth Method

= P185,400 - P188,908.7577
Excess = -P3,508.7577
Step 5: Make a Decision

*Since the excess of annual cash inflows over annual cash outflows is less
than zero (-P3,509) the investment is not desirable or not ideal.
Note: If excess is positive value, then the investment is advisable, otherwise, do not invest.
Annual Worth Method
Solution using tabulated form:
Annual revenue P185,400
Annual costs:
Depreciation P29,608.7577
Operation and maintenance P81000

Taxes and insurance P10800
Interest on capital P67,500
Total Annual Cost P188,908.7577
Excess -P3,508.7577

Annual Worth Method
Example. An investment of P3M can be made in a business that will produce a
uniform annual revenue of P1.2M for five years and then have a salvage value of
10% of the investment. Operations and maintenance will be P100,000 per year.
Taxes and insurance will be 5% of the first cost per year. The investor expects to
earn not less than 20% before income taxes. Is this a good investment? Use the
annual cost method.
Given:
Investment = P3M
Annual Revenue = P1.2M for 5 years
Salvage Value = 10% of investment = P300,000
Taxes and Insurance Cost = 5% of Investment = P150,000
Interest on Capital = 20% = P600,000
Annual Worth Method
Solution using tabulated form: DO NOT RECOMMEND TO INVEST
Annual revenue P1.2M

Annual costs:
Depreciation P362,825.1989
Operation and maintenance P100,000
Taxes and insurance(5%) P150,000
Interest on capital (20%) P600,000
Total Annual Cost P1,212,825.1990
Excess -P12,825.1990

Present Worth Method
This pattern for economy studies is based on the concept of present worth.
If the present worth of the net cash flows is equal to, or greater than zero,
the project is justified economically. The present worth method is flexible
and can be used for any type of economy study. It is extensively in making
economy studies in the public works field, where long-lived structures are
involved.
Present worth Method = PW inflows – PW outflows
Here, we will just get the present value of money using the formula in money-time
relationship.

Example. An investment of P270,000 can be made in a

project that will produce a uniform annual revenue of
P185,400 for 5 years and then have a salvage value of
10% of the investment. Out-of-pocket cost for operation
and maintenance will be P81,000 per year. Taxes and
insurance will be 4% of the first cost per year. The
company expects capital to earn not less than 25%
before income taxes. Is this a desirable investment? Use

Solution:
Given:
Present worth Method = PW inflows – PW outflows
Note: Inflows includes the annual revenue and salvage value

Outflows includes the investment and overhead cost excluding depreciation
Solution: 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑖𝑛𝑔 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
1− 1+0.25 −5 −5
PW of cash inflows = 𝑃185,400 + 𝑃27,000 1 + 0.25 = 𝑃507,439.8720
0.25
Annual Cost (excluding depreciation ) = P81,000 + P10,800 = P91,8000

1− 1+0.25 −5
PW of cash outflows = 𝑃270,000 + 𝑃91,800 = 𝑃516,875.9040
0.25
PW = PW of cash inflows – PW of cash outflows
PW = 𝑃507,439.8720 - 𝑃516,875.9040 = −P9,436.0320
DECISION: DO NOT RECOMMEND TO INVEST

1− 1+𝑖 −𝑛 −𝑛
PW of cash inflows = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 + 𝑆𝑎𝑙𝑎𝑣𝑔𝑒 𝑉𝑎𝑙𝑢𝑒 1 + 𝑖
𝑖
1− 1+𝑖 −𝑛
PW of cash outflows = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐶𝑜𝑠𝑡 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝑖
PW = PW of cash inflows – PW of cash outflows

Example 2: Mr. M is considering building a 25-unit apartment in a progressive area in
Quezon City. He felt that because of the location of the apartment it will be occupied 90% at
all time. He desires a rate of returm of 20%. Other pertinent data are the following:
Land investment……………………...P5,000,000
Building investment………………….P7,000,000
Study period…………………………...20 years
Cost of land after 20 years…………...P20,000,000
Cost of building after 20 years……….P2,000,000
Rent per unit per month………………...P6,000
Upkeep per unit per year……………..P500
Property taxes…………………………..1%
Insurance………………………..….......0.50%
Is this a good investment? Calculate using the five methods of evaluation

P167,500

Future Worth Method
The future worth method for economy studies is exactly comparable to the
present worth method except that all cash inflows and outflows are
compounded forward to a reference point in time called the future. If the
future worth of the net cash flow is equal to, or greater then zero, the project
is justified economically.
Future worth Method = FW inflows – FW outflows
Here, we will forward the value of money in future time using also the formula in
money-time relationships.

Future Worth Method
Example. An investment of P270,000 can be made in a

project that will produce a uniform annual revenue of
10% of the investment. Out-of-pocket cost for operation
and maintenance will be P81,000 per year. Taxes and
insurance will be 4% of the first cost per year. The
company expects capital to earn not less than 25% before
income taxes. Is this a desirable investment? Use Future
Worth Method

Future Worth Method
Solution.
Given:
Future worth Method = FW inflows – FW outflows

Note: Inflows includes the annual revenue and salvage value
230
Outflows includes the investment and overhead cost excluding depreciation
©2017 Batangas State University
Future Worth Method
Solution. 1+0.25 5 −1
FW of cash inflows = 𝑃185,400 + 𝑃27,000 = 𝑃1,548,583.5940
0.25
Annual Cost (excluding depreciation) =P91,800

5 1+0.25 5 −1
FW of cash outflows = 𝑃270,000 1 + 0.25 + 𝑃91,800( )=
0.25
P1,577,380.0780
FW= FW of cash inflows – FW of cash outflows
FW = 𝑃1,548,583.5940 - P1,577,380.0780 = -P28,796.4841
DECISION: DO NOT RECOMMEND TO INVEST

Future Worth Method
1+𝑖 𝑛 −1
FW of cash inflows = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 + 𝑆𝑎𝑙𝑎𝑣𝑔𝑒 𝑉𝑎𝑙𝑢𝑒
𝑖
𝑛 1+𝑖 𝑛 −1
FW of cash outflows = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐶𝑜𝑠𝑡 1 + 𝑖 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝑖
FW = FW of cash inflows – FW of cash outflows

Payback Period
The payback period is commonly defined as the length of time required
to recover the first cost of an investment from the net cash flow produced
by that investment for an interest rate of zero.
•Payback period (years) = investment – salvage

net annual cash flow

Payback Period
Example. An investment of P270,000 can be made in
a project that will produce a uniform annual revenue of
10% of the investment. Out-of-pocket cost for
operation and maintenance will be P81,000 per year.
Taxes and insurance will be 4% of the first cost per
year. The company expects capital to earn not less than
25% before income taxes. Is this a desirable
investment? What is the payback period?

Payback Period
Total annual cost = P81,000 +P270,000(0.04) =
P91,800
Net annual cash flows = P185,400 – P91,800 =
P93,600
Payback period:= investment-salvage value

Net annual cash flows
Months = (Payback period-
= P270,000-P27,000 years)*12
Days = (Computed Months-
P93,600 months)*30
= 2.5962 years or 2 years and 7 months and 5 days

The shorter the payback period the better investment.
Chapter Test
Direction. Read and understand the given situation. Solve the problem using the given
methods of evaluation.
A man is considering P500,000 to open a semi-automatic auto washing business in a city of

400,000 population. The equipment can wash on the average of 12 cars per hour., using two
men to operate it and to do small amount of hand work. The man plans to hire two men, in
addition to himself and operate the station on an 8 hour basis, 6 days/week, 50weeks/year. He
will pay his employees P25 per hour. He expects to charge P25.00 for a car, wash out of
pocket miscellaneous cost would be P8500/month. He would pay his employees for 2 weeks
for vacation each year. Because of the length of his lease, he must write off his investment
with 5 years. His capital now is earning 15% and he is employed at a steady job that pays
P25,000/month. he desires a rate of return of at least 20% on his investment. Would you
recommend the investment? Use the following method (ROR, Annual worth, Present, Future
and Payback Period)
Cost = Labor, Vacation Leave, Miscellaneous Fee, Depreciation and Owners Salary
Interest = 0.15%
Chapter Test
ROR:
Given:
Revenue = 12cars/hr(8hr/day)(6days/wk)(50wks/yr)(P25/car) = P720,000
COST:
Labor = P25/employee(2employee)(8hr/day)(6days/wk)(50wks/yr)= P120,000
Vacay Leave = P25/employee(2employee)(8hr/day)(6days/wk)(2wks)= P4,800
Misc. Fee = P8500/month(12months) = P102,000
𝑃500,000−0 0.15
Dep. = = 𝑃74,157.7762
1.155 −1
Owner’s Salary = P25000(12months) = P300,000
TAC = P600,957.7762
𝑃720,000−𝑃600,957.7762
ROR = 𝑥 100% = 23.81%, therefore should recommend to invest
𝑃500,000

Chapter Test
Annual Worth:
Given:
COST:
𝑃500,000−0 0.15
Dep. = = 𝑃74,157.7762
1.155 −1
Owner’s Salary = P25000(12months) = P300,000
Interest on Capital = 0.15(P500,000) = P75,000
TAC = P600,957.7762 + P75,000 = P675,957.7762
AW = P720,000 – 675,957.7762 = 44,042.2238, recommend to invest

Chapter Test
Present Worth:
COST:
Owner’s Salary = P25000(12) = P300,000
TAC =P526,800
𝟏− 𝟏+𝟎.𝟏𝟓 −𝟓
Inflows = 𝑷𝟕𝟐𝟎, 𝟎𝟎𝟎( ) = 𝑷𝟐, 𝟒𝟏𝟑, 𝟓𝟓𝟏. 𝟔𝟕10
𝟎.𝟏𝟓
𝟏− 𝟏+𝟎.𝟏𝟓 −𝟓
Outflows = 𝑷𝟓𝟎𝟎, 𝟎𝟎𝟎 + 𝑷𝟓𝟐𝟔, 𝟖𝟎𝟎( 𝟎.𝟏𝟓
) = 𝟐, 𝟐𝟔𝟓, 𝟗𝟏𝟓. 𝟑𝟎𝟔𝟎
PW = P2,413,551.6710 - P2,265,915.3060 = P147,636.3654, recommend to invest

Chapter Test
Future Worth:
COST:
Owner’s Salary = P25000(12) = P300,000
TAC =P526,800
𝟏+𝟎.𝟏𝟓 𝟓 −𝟏
Inflows = 𝑷𝟕𝟐𝟎, 𝟎𝟎𝟎( )= P4,854,514.50
𝟎.𝟏𝟓
𝟓 𝟏+𝟎.𝟏𝟓 𝟓−𝟏
Outflows = 𝑷𝟓𝟎𝟎, 𝟎𝟎𝟎(𝟏. 𝟏𝟓 ) + 𝑷𝟓𝟐𝟔, 𝟖𝟎𝟎( ) = 𝑷𝟒, 𝟓𝟓𝟕, 𝟓𝟔𝟓. 𝟎𝟑𝟔𝟎
𝟎.𝟏𝟓
FW = P4,854,514.50 - P4,557,565.04 = P296,949.4638, recommend to invest

Chapter Test
Payback Period:
COST:
Owner’s Salary = P25000(12) = P300,000
TAC =P526,800
𝑷𝟓𝟎𝟎,𝟎𝟎𝟎 − 𝟎
Payback Period = (𝑷𝟕𝟐𝟎,𝟎𝟎𝟎−𝑷𝟓𝟐𝟔,𝟖𝟎𝟎) = 2.5880 years = 2 years 7 months and 2 days

Module 5 Evalution of Single Project

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Module 5 Evalution of Single Project

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Chapter 5.

All engineering economy studies of capital projects should consider

209 ©2017 Batangas State University

Discuss methods of evaluation.

Critique contemporary methods of

Make a decision based on the evaluation.

210 ©2017 Batangas State University

Net Annual Profit

Step 1: Identify the Given

Step 2: Analyze what method will be used

Remember: In ROR Method, Depreciation Cost is included in the Total Cost

Operation and Maintenance Cost = P81,000

Step 4: Determine the Net Annual Profit

Net Annual Profit = Total Annual Revenue - Total AnnualCost

Step 5: Use the formula to determine the rate of return

Step 6: Make a Decision

*Since the computed rate of return is less than the

216 ©2017 Batangas State University

Solution using tabulated form:

Determine the inflows such as income and outflows such

217 ©2017 Batangas State University

𝑇&𝐼 = 0.06(P100,000) = P6,000

ANNUAL SAVINGS = 0.25(P200,000) = P50,000

𝑁𝑒𝑡 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 𝑆𝑎𝑣𝑖𝑛𝑔𝑠 − 𝐶𝑜𝑠𝑡 𝑃50,000 − 𝑃22,379.7481

ROR = 27.62%, RECOMMEND TO INVEST

212 ©2017 Batangas State University

Excess  Annual Cash Inflows - Annual Cash Outflows

218 ©2017 Batangas State University

Step 1: Identify the Given

Step 2: Analyze what method will be used

Operation and Maintenance Cost = P81,000

Step 4: Determine the Excess using Annual Worth Method

Step 5: Make a Decision

Operation and maintenance P81000

223 ©2017 Batangas State University

Annual revenue P1.2M

223 ©2017 Batangas State University

Present worth Method = PW inflows – PW outflows

224 ©2017 Batangas State University

Example. An investment of P270,000 can be made in a

225 ©2017 Batangas State University

Step 2: Analyze what method will be used

Present worth Method = PW inflows – PW outflows

Note: Inflows includes the annual revenue and salvage value

Annual Cost (excluding depreciation ) = P81,000 + P10,800 = P91,8000

PW = PW of cash inflows – PW of cash outflows

PW = 𝑃507,439.8720 - 𝑃516,875.9040 = −P9,436.0320

DECISION: DO NOT RECOMMEND TO INVEST

227 ©2017 Batangas State University

PW = PW of cash inflows – PW of cash outflows

227 ©2017 Batangas State University

225 ©2017 Batangas State University

225 ©2017 Batangas State University

Future worth Method = FW inflows – FW outflows

228 ©2017 Batangas State University

Example. An investment of P270,000 can be made in a

229 ©2017 Batangas State University

Step 2: Analyze what method will be used

Future worth Method = FW inflows – FW outflows

Annual Cost (excluding depreciation) =P91,800

FW= FW of cash inflows – FW of cash outflows

FW = 𝑃1,548,583.5940 - P1,577,380.0780 = -P28,796.4841