NEW VISION OF ENGINEERING ECONOMY

COURSE (VISION)

MODULE 3

LECTURE 1-2 Cairo, 13 July 2005

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Module 3 Contents

• Introduction• Investments Evaluation • The Cost Benefit Model • Applications of the Cost – Benefit Model • Dealing with Uncertainties • Replacement Analysis • CASE STUDIES: Evaluation of Energy

and Environmental Projects

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Greek Project Team TEAM MEMBER CONTRIBUTION SPECIALISATION

/ LAB

EMILIA KONDILI Material Development, Survey, Website, Project Management, Evaluation, Seminar

Optimisation of Production Systems (http://ikaros.teipir.gr/mecheng/OPS)

J. K. KALDELLIS Material Development, Survey, Website, Project Management, Evaluation, Seminar

Soft Energy Applcations and Environmental Protection Lab, www.sealab.gr

K. KAVADIAS Material Development, Training “

C. CHALVATZIS Material Development, Training

“

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Greek Project Team

Technological Educational Institute of Piraeus

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Greek Project Team

Technological Educational Institute of Piraeus

Τεχνολογικό Εκπαιδευτικό Ίδρυμα Πειραιά V 1.00 Σχολή Τεχνολογικών Εφαρμογών Τμήμα Μηχανολογίας Αριστοποίηση Παραγωγικών Συστημάτων

Welcome to the Optimization of Pruduction System modules Website

Optimization of Production Systems Mechanical Engineering Department Faculty of Engineering Created by V.S. | Πρώτη Έκδοση 26.11.2004 | Τελευταία Ενημέρωση 26.03.2005 Technological Educational I nstitute of Piraeus

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Optimisation of Production Systems Lab (1/2)

• Dr. Emilia Kondili, Chemical Engineer • Educational and Research Interests in the field

of Optimization of Energy and Environmental Production Systems

• Modules being provided : Production Management, Project Management, Engineering Economics, Operations Research, Waste Management

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Optimisation of Production Systems Lab (2/2)

Research Interests / Activities Optimisation of Production Systems with

the use of Operations Research (Mathematical Programming) Tools.

Production Management Implementation of optimization tools in

energy and environmental systems. Water Resources Management with the

Use of Optimisation Tools

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SEALAB Presentation (1/3)

Energy Related Courses:• Introduction to RES• Lab of RES• Applications of RES• Energy Engineering &

Management of Natural Resources• Design & Optimisation of Energy

Systems

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SEALAB Presentation (2/3)

Environment Related Courses:• Environment & Industrial Development• Basic Principles of Ecology• Air Pollution-Pollution Prevention

Technologies• Environmental Measurements

Technology• Waste Management Systems

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SEALAB Presentation (3/3) Research Interests/Activities:• Wind and Solar Energy Applications• Feasibility studies on Energy

Investments • Hybrid Energy Systems • Energy Storage Systems• Energy Saving• Cogeneration Systems• RES based Desalination• Environmental Impact of Power Stations

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Module 3 Learning Outcomes• Investments Evaluation Criteria • Comparison and Suitability of Evaluation

Criteria • Development of a General Cost Benefit

Model • Applicability of the Cost-Benefit Model

for the Evaluation of a Wide Range of Energy and Environmental Projects of Special Interest to our trainees

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Investment Evaluation

Objective: • To evaluate the profitability of an

investment, or • To compare mutually exclusive

alternatives and select the most economical, or

• To compare alternative and not mutually exclusive investments and rank them according to their profitability.

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Evaluation Criteria

• Payback Period • Net Present Value • Internal Rate of Return• Benefit / Cost Ratio (Lecture 2)

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Payback Period • PBP = Depreciable Fixed Investment/

Average Annual Cash Flow• It expresses the minimum length of time

necessary to recover the original fixed capital investment in the form of cash flow from the project

• No weighting of earlier vs. later cash flows, no consideration of project earnings after the initial investment has been recovered, no consideration of time value of money.

• Suitable only for rough calculations

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Payback Period (including interest)

• PBP including interest = (Depreciable Fixed Investment + interest on total capital investment during estimated service life)/ (Average Annual Profit + average annual depreciation)

• This method increases the PBP found with no interest.

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Evaluation Criteria – Net Present Value

• If projects are mutually exclusive, choose the one with the highest NPV

• If multiple projects are feasible, rank according to NPV and select the top ones first

01

])1/([ IiFNPVn

j

jj

The NPV is computed as the Present Value of all Revenues – the Present Value of all Costs

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Net Present Value - Practical issues

• The interest reflects the minimum accepted rate of return of the investment

• Determine the expected cash flows for the project, that may be different for each year

• NPV Rule: NPV > 0 indicates that the investment has an annual rate of return greater that the minimum acceptable.

Reject the project if its NPV < 0

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Net Present Value - Practical issues (2)

• It is easy to compute, it works with all cash flow patterns,

• It gives correct ranking in most project evaluations.

However • The size of NPV for a single investment

sometimes fails to indicate relative profitability

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Internal Rate of Return (IRR)

• The internal rate of return is the interest rate that makes the NPV = 0, ie. it is the break-even interest rate.

• It is a familiar and easy to understand concept

• It treats variable cash flows • It requires trial and error calculations

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Example IINVESTMENT A INVESTMENT

B

Initial Investment

75,000 105,000

Annual Revenue

16,000 22,000

Annual Cost 3,000 5,000

Residual Value

10,000 15,000

Life Time 10 10

NPV (I = 0,12) 16.627,95 21.548,67

IRR 0,18 0,17

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Example II

An energy intensive industrial unit, for energy conservation purposes, intends to install a Natural Gas based cogeneration unit. To that effect, two alternative proposals are examined, their data being presented in Table I. The investments must be depreciated within 10 years, but their economic life is 15 years. Taxation is 40% on the profits. Determine the annual energy conservation of each investment that will result in an IRR of 12%.

INVESTMENT 1 INVESTMENT 2

Initial Investment Cost (€)

900.000 1.300.000

Natural Gas Cost (€) 100.000 190.000

Maintenance Cost (€) 40.000 50.000