Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Project Evaluation

1

CHE40: ENGINEERING ECONOMY 2

Benefit-Cost

Analysis

Payback Period

Method

External Rate of Return

Method

Internal Rate of Return

Method

Annual Worth

Method

Future Worth

Method

Present Worth

Method

Project Evaluation Methods

Minimum Attractive

Rate of Return

Learning Objectives

1. Evaluate the economic viability of projects using the Equivalent Worth Methods2. Evaluate the economic viability of projects using the Rate of Return Methods3. Calculate the payback period of projects4. Perform Benefit-Cost analysis

Module 5: Project Evaluation

CHE40: ENGINEERING ECONOMY 3

• amount of money available for investment, source and cost of funds

• number of good projects available for investment and their purpose

• amount of perceived risk associated with investment opportunities available

• type of organization involved

Considerations

Minimum Attractive Rate of Return

CHE40: ENGINEERING ECONOMY 4

Project Evaluation Methods

Equivalent Worth

Methods

Present Worth

Method

Future Worth Method

Annual Worth Method

Rate of Return Methods

Internal Rate of Return Method

External Rate of Return Method

Payback Period Method

Benefit-Cost Analysis

CHE40: ENGINEERING ECONOMY 5

Present Worth Method

• measures how much money a firm could afford to pay for the investment in excess of its cost

• assumes that cash generated by the alternative is available for other uses that earn interest at a rate equal to the MARR

• desirability measure: PW > 0

A project your firm is considering for implementation has these estimated costs and revenues: an investment cost of $50,000; maintenance costs that start at $5,000 at EOY 1 and increase by $1,000 for each of the next 4 years; savings of $20,000 per year from EOY 1 to EOY 10; and finally a resale value of $35,000 at EOY 10. If the project has a 10-year old life and the firm’s MARR is 10% per year, what is the present worth of the project? Is it a sound investment opportunity?

CHE40: ENGINEERING ECONOMY 6

Present Worth Method

• used when the period of needed service is indefinitely long

* PW RC calculated from AW RC

Capitalized Cost

What is the capitalized cost, when the interest rate is 10% per year, of $10,000 now, $1,500 per year, starting in year 1 and continuing forever and $10,000 in year five, repeating every 5 years?

𝐶𝐶 = 𝑃𝑊 𝑁𝑅𝐶 + 𝑃𝑊 𝑅𝐶

𝑃𝑊 𝑅𝐶 = 𝐴1

𝑖

CHE40: ENGINEERING ECONOMY 7

Future Worth Method

• based on the equivalent worth of all cash inflows and outflows at the end of the planning horizon at an interest rate that is generally the MARR

• desirability measure: PW > 0

A small company purchased now for $23,000 will lose $1,200 each year the first 4 years. An additional $8,000 invested in the company during the 4th year will result in a profit of $5,500 each year from the 5th year through the 15th year. At the end of 15 years, the company can be sold for $33,000. Calculate the future worth if MARR is 12%.

CHE40: ENGINEERING ECONOMY 8

Annual Worth Method

• equal series of dollar amounts for a stated study period that is equivalent to the cash inflows and outflows at an interest rate that is generally the MARR

• desirability measure: PW > 0

• R Annual Revenues E Annual Expenses

• CR Capital Recovery Amount: shows the loss in value of the asset and interest on invested capital

• I Initial Capital Investment S Salvage Value

𝐴𝑊 = 𝑅 − 𝐸 − 𝐶𝑅

𝐶𝑅 = 𝐼 𝐴 𝑃 , 𝑖%,𝑁 − 𝑆 ( 𝐴 𝐹 , 𝑖%,𝑁

CHE40: ENGINEERING ECONOMY 9

Annual Worth Method

Your company is considering the introduction of a new product line. The initial investment required for this project is $500,000, and annual maintenance costs are anticipated to be $35,000. Annual operating costs will be directly proportional to the level of production at $7.50 per unit, and each unit of product can be sold for $50. If the MARR is 15% and the project has a life of 5 years, what is the minimum annual production level for which this project is economically viable?

CHE40: ENGINEERING ECONOMY 10

Project Evaluation Methods

Equivalent Worth

Methods

Present Worth

Method

Future Worth Method

Annual Worth Method

Rate of Return Methods

Internal Rate of Return Method

External Rate of Return Method

Payback Period Method

Benefit-Cost Analysis

CHE40: ENGINEERING ECONOMY 11

Internal Rate of Return Method

• also called the investor’s method, the discounted cash flow method, and the profitability index

• equates the equivalent worth of the cash inflows to the equivalent worth of the cash outflows

• desirability measure: 𝑖′ > 𝑀𝐴𝑅𝑅

In July of 2009, Taylor purchased 2,000 shares of XYZ common stock for $75,000. He then sold 1,000 shares of XYZ in July 2010 for $39 per share. The remaining 1,000 shares were finally sold for $50 per share in July 2011. What was Taylor’s internal rate of return on this investment?

CHE40: ENGINEERING ECONOMY 12

External Rate of Return Method

• takes into account the interest rate ( ) external to a project at which net cash flows can be reinvested

• desirability measure: 𝑖∗ > 𝑀𝐴𝑅𝑅

The prospective exploration for oil in the outer continental shelf by a small, independent drilling company has produced a rather curious pattern of cash flows, as follows:

EOY 0 -$520,000EOY 1-10 +$200,000EOY 10 -$1,500,000

The $1,500,000 expense at the end of year 10 will be incurred by the company in dismantling the drilling rig. The company expects to earn at least 20% per earn on invested capital. Use the ERR method to determine the viability of this investment. The external reinvestment rate is 15%.

CHE40: ENGINEERING ECONOMY 13

Payback Period Method

• determines the amount of time that the company will be able to recover its initial investment

• indicates a projects liquidity rather than its profitability

Simple Payback Period Discounted Payback Period

ignores the time value of money takes the time value of money into account

A plasma arc furnace has an internal combustion temperature of 7,000C and is being considered for the incineration of medical wastes at a local hospital. The initial investment is $300,000 and annual revenues are expected to be $175,000 over the six-year life of the furnace. Annual expenses will be $100,000 at the end of year one and will increase by $5,000 each year thereafter. The resale value of the furnace after six years is $20,000. Determine the simple payback period and the discounted payback period of the furnace. Use an interest rate of 10%.

CHE40: ENGINEERING ECONOMY 14

Project Evaluation Methods

Equivalent Worth

Methods

Present Worth

Method

Future Worth Method

Annual Worth Method

Rate of Return Methods

Internal Rate of Return Method

External Rate of Return Method

Payback Period Method

Benefit-Cost Analysis

CHE40: ENGINEERING ECONOMY 15

Benefit-Cost Analysis

Conventional B/C Ratio Modified B/C Ratio

𝐵 𝐶 =𝐵 − 𝐷

𝐶 𝐵 𝐶 =

𝐵 − 𝐷 −𝑀&𝑂 𝑐𝑜𝑠𝑡𝑠

𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

A wastewater treatment plant is expected to require an initial investment of $500,000 and annual maintenance expenses of $80,000. The benefits to the public are valued at $100,000 per year. This project can be assumed to have a 30-year life. If MARR is 10% per year, determine whether the project is economically attractive .

Benefits, B advantages experienced by

the owner

Disbenefits, D

disadvantages tothe owner

Costs, C anticipatedexpenditure less

any salvage values

• measure of desirability: B/C > 1

CHE40: ENGINEERING ECONOMY 16

Benefit-Cost

Analysis

Payback Period

Method

External Rate of Return

Method

Internal Rate of Return

Method

Annual Worth

Method

Future Worth

Method

Present Worth

Method

Project Evaluation Methods

Minimum Attractive

Rate of Return

Learning Objectives

1. Evaluate the economic viability of projects using the Equivalent Worth Methods2. Evaluate the economic viability of projects using the Rate of Return Methods3. Calculate the payback period of projects4. Perform Benefit-Cost analysis

Module 5: Project Evaluation

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Project Evaluation

17