Professional Documents
Culture Documents
Engineering Economics Present Worth Analysis
Engineering Economics Present Worth Analysis
Engineering Economics
Present-Worth Analysis
http://www.stellman-greene.com 1
Applied Software Project Management
Recap
PART 1 UNDERSTANDING MONEY AND ITS MANAGEMENT
Chapter 1 Engineering Economic Decisions
Chapter 2 Time Value of Money
Chapter 3 Understanding Money Management
Chapter 4 Equivalence Calculations under Inflation
www.hoasen.edu.vn 2
Applied Software Project Management
Road Map
Chapter 5 Present-Worth Analysis
Loan versus Project Cash Flows
Initial Project Screening Methods
Present-Worth Analysis
Methods to Compare Mutually Exclusive Alternatives
3
Applied Software Project Management
Loan versus Project Cash Flows
4
Applied Software Project Management
Loan versus Project Cash Flows
Similarity between loan cash flow and project cash flow
future → use the same equivalence techniques to
measure economic worth
Bank Loan
Loan
Bank Customer
Repayment
Investment Project
Investment
Company Project
Return
5
Applied Software Project Management
Road Map
Chapter 5 Present-Worth Analysis
Loan versus Project Cash Flows
Initial Project Screening Methods
Present-Worth Analysis
Methods to Compare Mutually Exclusive Alternatives
6
Applied Software Project Management
Initial Project Screening Methods
7
Applied Software Project Management
Benefits & Flaws of Payback Screening
Benefits:
– Simplicity: one of its most appealing qualities.
– focusing on that time at which the firm expects to
recover the initial investment.
– Eliminate some alternatives: reducing a firm's need to
make further analysis efforts on those alternatives
Flaws:
– fails to measure profitability
8
Applied Software Project Management
Benefits & Flaws of Payback Screening
n Project 1 Project 2
0 -10,000 -10,000
1 1,000 9,000
2 9,000 1,000
3 1,000 1,000
Payback Period 2 years 2 years
9
Applied Software Project Management
Discounted-Payback Period
Take into account the time value of money, i.e. the cost
of funds (interest) used to support the project
10
Applied Software Project Management
Road Map
Chapter 5 Present-Worth Analysis
Loan versus Project Cash Flows
Initial Project Screening Methods
Present-Worth Analysis
Methods to Compare Mutually Exclusive Alternatives
11
Applied Software Project Management
Net-Present-Worth Criterion
12
Applied Software Project Management
Net-Present-Worth Criterion
Step 6: Find the present worth of each net cash flow at the MARR. Add up
these present-worth figures; their sum is defined as the project's PW:
N
An
PW(i)
n 0 (1 i) n
N
PW(i) A n (P/F, i, N)
n 0
13
Applied Software Project Management
Net-Present-Worth Criterion
Step 7: a positive PW means that the equivalent worth of the inflows is
greater than the equivalent worth of the outflows, so the project makes
a profit.
If PW(i) > 0, accept the investment.
If PW(i) = 0, remain indifferent.
If PW(i) < 0, reject the investment.
14
Applied Software Project Management
Net-Present-Worth Criterion
Above rule for evaluation of a single project
Below guidelines for evaluating and comparing more than one project:
Comparing More Than One Alternative
1. To select the best alternative
– Select the one with the highest PW (all the alternative have the
same service lives)
– Comparison of alternatives with unequal service lives requires
special assumptions, as will be detailed in next Section.
2. Comparison of mutually exclusive alternatives with the same revenues
is performed on a cost-only basis.
– accept the project that results in the smallest PW of costs,
– or the least negative PW (because you are minimizing costs, rather
than maximizing profits).
15
Applied Software Project Management
Net-Present-Worth Criterion
Tiger Machine Tool Company is considering the acquisition of a new metal
cutting machine. The required initial investment of $75,000 and the
projected cash benefits over a three-year project life are as follows:
You have been asked by the president of the company to evaluate the
economic merit of the acquisition. The firm's MARR is known to be
15%.
Given: Cash flows as tabulated; MARR = 15% per year.
Find: PW.
16
Applied Software Project Management
Net-Present-Worth Criterion
To bring each flow to its equivalent at time zero as shown the table:
1 2 3
outflow
75,000
17
Applied Software Project Management
Guidelines for Selecting a MARR
18
Applied Software Project Management
Meaning of Net Present Worth
19
Applied Software Project Management
Meaning of Net Present Worth
Consider previous example which required an investment of $75,000
If the firm did not invest in the project and instead left the $75,000 in
the investment pool for three years to grow to:
75,000(F/P,15%,3) = 114,066
If the firm invest in the project, the return cash flow would also earn
interest:
24,400(F/P,15%,2) + 27,340(F/P,15%,1) + 55,760(F/P,15%,0) =
119,470
The additional cash accumulation at the end of three years from
investing in the project:
119,470 – 114,066 = 5,404 → Net Future Worth of the Project
the equivalent present worth of this net cash surplus at time zero
$5,404(P/F, 15%. 3) = $3,553 same as in previous example
20
Applied Software Project Management
Capitalized-Equivalent Method
A special case of the PW criterion: when the life of a
proposed project is perpetual or the planning horizon is
extremely long
capitalized-equivalent [CE(i)] method for evaluating
such projects
PW(i) = A(P/A,i,N) with N → ∞
(1 i) N 1 A
PW(i) A lim (P/A, i, N) A lim
i(1 i) i
N N N
21
Applied Software Project Management
Road Map
Chapter 5 Present-Worth Analysis
Loan versus Project Cash Flows
Initial Project Screening Methods
Present-Worth Analysis
Methods to Compare Mutually Exclusive Alternatives
22
Methods to Compare Mutually
Applied Software Project Management
Exclusive Alternatives
Until now, considering situations involving only a single
project or projects that were independent of each other.
In both cases, the decision to reject or accept each
project individually, based on whether it met the MARR
requirements, evaluated using the PW.
In this section, evaluation techniques to consider multiple
projects that are mutually exclusive: the selection of
one alternative implies that the others will be excluded.
Consider two cases:
1. analysis period equals project lives and
2. analysis period differs from project lives.
23
Applied Software Project Management
Doing Nothing Is a Decision Option
24
Applied Software Project Management
Service Projects vs. Revenue Projects
25
Applied Software Project Management
Analysis Period Equals Project Lives
26
Applied Software Project Management
Analysis Period Equals Project Lives
27
Applied Software Project Management
Analysis Period Equals Project Lives
28
Applied Software Project Management
Analysis Period Equals Project Lives
PW = 54,600(P/F,12%,1) + 54,600(1+7%)(P/F,12%,2) +
54,600(1+7%)2(P/F,12%,3) + 54,600(1+7%)3(P/F,12%,4)
29
Applied Software Project Management
Analysis Period Equals Project Lives
1 (1 7%) 5 (1 12%) 5
POption1 54,600
12% 7%
POption1 222,936
30
Applied Software Project Management
Analysis Period Equals Project Lives
31
Applied Software Project Management
Analysis Period Differs from Project Lives
32
Present-Worth Comparison: Project
Applied Software Project Management
The more efficient model B costs $240,000 each, has a life of 12,000
hours before requiring any major overhaul, and costs $22,500 to
operate for 2,000 hours per year in order to complete the job within
two years. The estimated salvage value of model B at the end of six
years is $30,000. Once again, two units of model B will be required.
Since the lifetime of either model exceeds the required service period
of two years, WMC has to assume some things about the used
equipment at the end of that time. Therefore, the engineers at WMC
estimate that, after two years, the model A units could be sold for
$45,000 each and the model B units for $125,000 each.
33
Present-Worth Comparison: Project
Applied Software Project Management
34
Present-Worth Comparison: Project
Applied Software Project Management
35
Present-Worth Comparison: Project
Applied Software Project Management
Given: Cash flows for the two alternatives as shown in Figure 5.12,
analysis period of five years. and i = 15%.
Find: PW for each alternative: the preferred alternative.
37
Present-Worth Comparison: Project
Applied Software Project Management
39
Applied Software Project Management
Tutorial
www.hoasen.edu.vn 40