This action might not be possible to undo. Are you sure you want to continue?

• Describing Project Cash Flows • Initial Project Screening Method • Present Worth Analysis • Variations of Present Worth Analysis • Comparing Mutually Exclusive Alternatives

(c) 2001 Contemporary Engineering Economics 1

**Bank Loan vs. Investment Project
**

Bank Loan

Loan Bank Repayment Customer

Investment Project

Company

Investment Project Return

(c) 2001 Contemporary Engineering Economics

2

**Describing Project Cash Flows
**

Year (n) 0 1 2 … 8 Cash Inflows Cash Outflows (Benefits) (Costs) 0 215,500 215,500 … 215,500 $650,000 53,000 53,000 … 53,000 Net Cash Flows -$650,000 162,500 162,500 … 162,500

3

(c) 2001 Contemporary Engineering Economics

Payback Period

Principle: How fast can I recover my initial investment? Method: Based on cumulative cash flow (or accounting profit) Screening Guideline: If the payback period is less than or equal to some specified payback period, the project would be considered for further analysis. Weakness: Does not consider the time value of money

(c) 2001 Contemporary Engineering Economics 4

000 $35. (c) 2001 Contemporary Engineering Economics 5 .000 Cum.000 -$50.000 $95.000 $35.Example 7.000 $50.000 $45. Flow -$85.000 $45.000 $45.000 $50.000 $140.000+$20.000 -$5.3 Payback Period N 0 1 2 3 4 5 6 Cash Flow -$105.000 $175.000 Payback period should occurs somewhere between N = 2 and N = 3.

000 Annual cash flow $35.000 50.000 0 1 2 Years 3 4 5 6 $85.000 $25.000 $35.$45.000 $45.000 Cumulative cash flow ($) 150.000 $15.2 years Payback period (c) 2001 Contemporary Engineering Economics .000 100.000 0 1 2 3 Years (n) 4 5 6 6 3.000 -100.000 0 -50.

540(0.687 -7.329(0.15)= -1.000 35.524 -$45.000 45.15)= -10.000 35.163 -45.000 45.000 15.853 -$7.15)= -$12.413 -$70.163(0.000(0.329 76.Discounted Payback Period Calculation Period 0 1 2 3 4 5 6 Cash Flow -$85.778 7 .540 36.15)= -12.750(0.449 (c) 2001 Contemporary Engineering Economics Cumulative Cash Flow -$85.000 Cost of Funds (15%)* 0 -$85.000 -82.15)= 5.750 -$82.131 $36.000 25.15)=-6.687(0.750 -70.

Net Present Worth Measure Principle: Compute the equivalent net surplus at n = 0 for a given interest rate of i. Decision Rule: Accept the project if the net surplus is positive. Inflow 0 Outflow PW(i)inflow 1 2 3 4 5 Net surplus PW(i) > 0 0 PW(i)outflow (c) 2001 Contemporary Engineering Economics 8 .

4 ( P / F .7 0 ( P / F .000 PW (15%) = $78. 2 ) 00 4 +$55.400 0 1 $27.760 outflow $75.000 5 = $3. Accept 5 (c) 2001 Contemporary Engineering Economics 9 . 3) 6 = $78.15%.5 . 1) + $27.5 3 > 0.000 PW (15%) inflow = $24.15%.3 0 ( P / F .Tiger Machine Tool Company inflow $24.340 2 3 $55.5 3 − $75.Example 7.5 3 5 PW (15%) outflow = $75.15%.

296 -10.309 19.45* 18 *Break even interest rate PW(i) $32.110 -21.662 -14.076 0 -751 i(%) 20 22 24 26 28 30 32 34 36 38 40 PW(i) -$3.296 11.580 -18.500 27.673 -16.745 -23.302 10 (c) 2001 Contemporary Engineering Economics .360 -20.924 -8.169 15.743 23.670 8.077 2.270 5.Present Worth Amounts at Varying Interest Rates i (%) 0 2 4 6 8 10 12 14 16 17.539 -12.412 -5.

45% Accept Reject PW (i) ($ thousands) 10 5 10 15 20 25 30 35 40 i = MARR (%) (c) 2001 Contemporary Engineering Economics 11 .Present Worth Profile 40 30 20 Break even interest rate (or rate of return) $3553 0 -10 -20 -30 0 17.

000 Project life (c) 2001 Contemporary Engineering Economics 12 .340 2 3 $55.760 $75.400 0 1 $27.Future Worth Criterion • Given: Cash flows and MARR (i) • Find: The net equivalent worth at the end of project life $24.

760( F / P.2 + $27.15%1) ) . + $55. Accept (c) 2001 Contemporary Engineering Economics 13 .066 . FW(15% )= $119470 − $114. = $5.340( F / P. FW(15% ) ( .400( F / P.15% 0) .404 > 0.000 F / P. outflow = $75.15% . = $119470 .Future Worth Criterion FW(15% )inflow = $24.15% 3) = $114066 .

3) = $3.404 (P/F.404 Net future worth. 15%.850 -$9.788 3 -$43.553 (c) 2001 Contemporary Engineering Economics 14 .340 -$43.250 +$24.Project Balance Concept N Beginning Balance Interest Payment Project Balance -$75.850 2 -$61.000 0 1 -$75.760 +$5.788 -$6.000 -$11. FW(15%) PW(15%) = $5.568 +$55.278 +$27.400 -$61.000 -$75.

850 0 -20.Project Balance Diagram 60.000 -$75.000 0 1 Year(n) 2 3 15 (c) 2001 Contemporary Engineering Economics .000 -60.000 -120.000 -40.000 40. or project surplus) Project balance ($) $5.000 Terminal project balance (net future worth.788 -$61.000 20.404 Discounted payback period -$43.000 -80.000 -100.

i.Capitalized Equivalent Worth Principle: PW for a project with an annual receipt of A over infinite service life Equation: CE(i) = A(P/A. A 0 P = CE(i) (c) 2001 Contemporary Engineering Economics 16 ∞) = A/i .

( ) = $ 1 38 5 5 .000 $1.1 0 = $ 1 00 0 01 + 0.Given: i = 10%.3 8 5 5 . 17 (c) 2001 Contemporary Engineering Economics .0 0 0 C E(1 0 % ) = + ( P / F.1 0 0.000 0 10 P = CE (10%) = ? $ 1. 0) 0.0 0 0 $ 1.1 0 %1. N = ∞ Find: P or CE (10%) $2.

Example 7.$120.9 Mr. and will he ever make a profit? (c) 2001 Contemporary Engineering Economics 18 .000 investment a wise one? How long does he have to wait to recover his initial investment.000 • Expected service life of 50 years Was Bracewell's $800.000 • Power generating capacity of 6 million kwhs • Estimated annual power sales after taxes . Bracewell’s Investment Problem • Built a hydroelectric plant using his personal savings of $800.

Brcewell’s Hydro Project (c) 2001 Contemporary Engineering Economics 19 .Mr.

+ $100K(F/P. 50) = $1.Equivalent Worth at Plant Operation • Equivalent lump sum investment V1 = $50K(F/P.101K • Equivalent lump sum benefits V2 = $120(P/A. . Good Investment (c) 2001 Contemporary Engineering Economics 20 . 9) + $50K(F/P. 8%. 8%. 1) + $60K = $1. 8%.460K • Equivalent net worth FW(8%) = V1 . . 8) + . 8%.V2 = $367K > 0.

000 Economics (c) 2001 Contemporary Engineering ∞ 21 . 8) + . 8%. + $100K(F/P. 8%.08 = $1. . .V2 = $399K > 0 Difference = $32. 8%. ∞ ) = $120/0.500K • Equivalent net worth FW(8%) = V1 . 9) + $50K(F/P. 8%.With an Infinite Project Life • Equivalent lump sum investment V1 = $50K(F/P.101K • Equivalent lump sum benefits assuming N = V2 = $120(P/A. 1) + $60K = $1.

000 Renovation cost = $500.Problem 7.27 .000.000 every 15 years Planning horizon = infinite period Interest rate = 5% (c) 2001 Contemporary Engineering Economics 22 .Bridge Construction Construction cost = $2.000 Annual Maintenance cost = $50.

000 $500.000 $2.000 $500.0 $50.000 (c) 2001 Contemporary Engineering Economics 23 .000 15 30 45 60 $500.000.000 $500.

000(P/F.05 = $1.000/0.000(A/F.000 • Maintenance Costs P2 = $50. 5%. 60) . = {$500.000 • Renovation Costs P3 = $500.05 = $463. 5%. 5%. 5%.000(P/F.000(P/F.423 (c) 2001 Contemporary Engineering Economics 24 . 5%.000. 15)}/0.000(P/F. 15) + $500.Solution: • Construction Cost P1 = $2. 45) + $500.463.000. 30) + $500.423 • Total Present Worth P = P1 + P2 + P3 = $3.

893% • Capitalized equivalent worth P3 = $500.07893 = $463.423 (c) 2001 Contemporary Engineering Economics 25 .000 • Effective interest rate for a 15-year cycle i = (1 + 0.000 $500.05)15 .000 45 60 $500.000 30 $500.1 = 107.Alternate way to calculate P3 • Concept: Find the effective interest rate per payment period 0 15 $500.000/1.

Comparing Mutually Exclusive Projects Mutually Exclusive Projects Alternative vs. Project Do-Nothing Alternative (c) 2001 Contemporary Engineering Economics 26 .

Revenue Projects Projects whose revenues depend on the choice of alternatives Service Projects Projects whose revenues do not depend on the choice of alternative (c) 2001 Contemporary Engineering Economics 27 .

Analysis Period The time span over which the economic effects of an investment will be evaluated (study period or planning horizon). Required Service Period The time span over which the service of an equipment (or investment) will be needed. (c) 2001 Contemporary Engineering Economics 28 .

(c) 2001 Contemporary Engineering Economics 29 .Comparing Mutually Exclusive Projects • Principle: Projects must be compared over an equal time span. the analysis period should be the same as the required service period. • Rule of Thumb: If the required service period is given.

How to Choose An Analysis Period Analysis = Required period service period Case 1 Analysis period equals project lives Analysis period is shorter than project lives Analysis period is longer than project lives Analysis period is longest Case 2 Finite Case 3 Case 4 Required service period of project life in the group Project repeatability likely Analysis period is lowest common multiple of project lives Analysis period equals one of the project lives 30 Infinite Project repeatability unlikely (c) 2001 Contemporary Engineering Economics .

000 B (c) 2001 Contemporary Engineering Economics 31 .Case 1: Analysis Period Equals Project Lives Compute the PW for each project over its life $600 $450 0 $2.400 $2.110 $1.000 A PW (10%)A= $283 PW (10%)B= $579 $4.075 $500 $1.

000 This portion of investment will earn 10% return on investment.110 $2. $500 $2. Modified Project A $4.000 $600 $450 3.400 Project A $1.000 PW(10%)B = $579 32 (c) 2001 Contemporary Engineering Economics .000 PW(10%)A = $283 $3.075 $1.$600 $450 Comparing projects requiring different levels of investment – Assume that the unused funds will be invested at MARR.993 $500 Project B $1.

• Compute the PW for each project over the required service period. (c) 2001 Contemporary Engineering Economics 33 .Case 2: Analysis Period Shorter than Project Lives • Estimate the salvage value at the end of required service period.

Comparison of unequal-lived service projects when the required service period is shorter than the individual project life (c) 2001 Contemporary Engineering Economics 34 .

• Compute the PW for each project over the required service period.Case 3: Analysis Period Longer than Project Lives • Come up with replacement projects that match or exceed the required service period. (c) 2001 Contemporary Engineering Economics 35 .

Comparison for Service Projects with Unequal Lives when the required service period is longer than the individual project life (c) 2001 Contemporary Engineering Economics 36 .

(c) 2001 Contemporary Engineering Economics 37 . • Project Repeatability Likely Use the lowest common multiple of project lives.Case 4: Analysis Period is Not Specified • Project Repeatability Unlikely Use common service (revenue) period.

208.210 Assume no revenues (c) 2001 Contemporary Engineering Economics 38 .470 PW(15%)lease = $2.180.Project Repeatability Unlikely PW(15%)drill = $2.

534 (c) 2001 Contemporary Engineering Economics 39 .4) = 12 years PW(15%)B=-$48.657 Model A: 3 Years Model B: 4 years LCM (3.Project Repeatability Likely PW(15%)A=-$53.

• Two measures of investment. the net future worth and the capitalized equivalent worth. (c) 2001 Contemporary Engineering Economics 40 . • The MARR or minimum attractive rate of return is the interest rate at which a firm can always earn or borrow money. • MARR is generally dictated by management and is the rate at which NPW analysis should be conducted. are variations to the NPW criterion.Summary • Present worth is an equivalence method of analysis in which a project’s cash flows are discounted to a lump sum amount at present time.

when one of several alternatives that meet the same need is selected. • Revenue projects are those for which the income generated depends on the choice of project.• The term mutually exclusive means that. (c) 2001 Contemporary Engineering Economics 41 . • The required service period is the time span over which the service of an equipment (or investment) will be needed. regardless of which project is selected. the others will be rejected. • The analysis period (study period) is the time span over which the economic effects of an investment will be evaluated. • Service projects are those for which income remains the same.

• The analysis period should be chosen to cover the required service period. the analysis period to use in a comparison of mutually exclusive projects may be chosen by an individual analyst. • When not specified by management or company policy. (c) 2001 Contemporary Engineering Economics 42 .

Sign up to vote on this title

UsefulNot useful- Chapter 01
- Chapter 03
- Chapter 05
- Present worth analysis
- Time Value
- Time Value of Money
- Chapter%2006%20Solution
- Fmch05[1] Time Value Revised
- Investment Appraisal Method
- Index
- Appendix i i
- 02-1-1-Slides-Calculus-14-032
- Chapter_3
- Chapter 6
- Chapter 3
- Time Value of Money
- TIME VALUE OF MONEY
- Chap 001
- Annuity
- Scarcity and Choice
- 7 Fallacies of Economics
- DBS 1 FM 2
- Beat the Bullshit - 5 Big Business Topics EXPLAINED 2013
- Equivalent Uniform Annual Cost - A New Approach to Roof Life Cycle Analysis
- Mathematics of Finance
- ME Chapter 1 Fundamentals
- Time Value of Money
- 1 Jurnal.docx
- chapt3-1
- Sample Questions of Capital Budgeting
- cee3_ch_07