06 Evaluating Business and Eng'g Assets

Evaluating Business and Engineering Assets
MLDC, MatE 180
Wednesday, August 17, 11
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Mutually Exclusive Project: any one of several alternatives will fulll the same need, selecting one alternative means that the others will be excluded Example: buying versus leasing an automobile for business use
Mutually Exclusive Project: any one of several alternatives will fulll the same need, selecting one alternative means that the others will be excluded Example: buying versus leasing an automobile for business use Independent Project: the decision on any one project has no effect on the decision made on another more than one viable project may be selected Example: purchase of a milling machine, ofce furniture, and a forklift truck
Service Projects: Revenues do not depend on the choice of the project Example: Combustion turbine plant or fuel-cell power plant for electricity generation
Service Projects: Revenues do not depend on the choice of the project Example: Combustion turbine plant or fuel-cell power plant for electricity generation
Revenue Projects: Revenues depend on the choice of alternative Example: TV manufacturer is marketing two types of HD monitor
Project Classification
1. Material and Process Selection
1. Material and Process Selection 2. Equipment Replacement
1. Material and Process Selection 2. Equipment Replacement 3. New Product and Product Expansion
1. Material and Process Selection 2. Equipment Replacement 3. New Product and Product Expansion 4. Cost Reduction
1. Material and Process Selection 2. Equipment Replacement 3. New Product and Product Expansion 4. Cost Reduction 5. Service Improvement
Can existing plant be used to achieve new production levels?
Can existing plant be used to achieve new production levels? Does the rm have the knowledge and skill to undertake this new investment?
Can existing plant be used to achieve new production levels? Does the rm have the knowledge and skill to undertake this new investment? Does the new proposal requires recruitment of new technical personnel?
How Project Cash Flow is Described?
First, there is the investment, which is usually made in a lump sum at the beginning of the project.
First, there is the investment, which is usually made in a lump sum at the beginning of the project. Second, a stream of cash benets that are expected to result from this investment over a period of time.
First, there is the investment, which is usually made in a lump sum at the beginning of the project. Second, a stream of cash benets that are expected to result from this investment over a period of time.
The essential characteristics of most transactions is the funds are committed today in the expectation of earning a return in the future.
Future return takes the form of interest plus repayment of the principal
LOAN
Future return takes the form of prots generated by productive use of the assets which includes capital expenditures and annual expenses
PROJECT CASH FLOWS
Payback Method
One of the primary concerns of most businesspeople is whether when the money invested in a project can be recovered.
Payback method screens the project on the basis of how long it takes for net receipts to equal investment outlay.
Payback Method
Important!! Payback method is not an end in the screening process but rather a method of screening out certain unacceptable investment alternatives before progressing to an analysis of potentially acceptable ones.
Payback Period
Payback Period
Payback Period is the time required to recover the investment made in a project.
Payback Period
Payback Period is the time required to recover the investment made in a project. If a company considers only payback period as screening method, only projects with shorter payback period will be considered
Payback Period
Payback Period is the time required to recover the investment made in a project. If a company considers only payback period as screening method, only projects with shorter payback period will be considered
Payback Period
Payback Period is the time required to recover the investment made in a project. If a company considers only payback period as screening method, only projects with shorter payback period will be considered What do Payback Period really tell us?
Payback Period
Payback Period is the time required to recover the investment made in a project. If a company considers only payback period as screening method, only projects with shorter payback period will be considered What do Payback Period really tell us? Assures investors that invested asset is restored within a short time frame
Payback Period - Unif orm Annual Benefit

Consider the cash ow given below. Determine the payback period for this project.
Given: Initial Cost = $300,000 Annual Net Benets = $75,000 Find: Payback Period
Soln:
Initial Cost Uniform Annual Benefit 300, 000 Payback Period = 75, 000 Payback Period = 4 yrs. Payback Period =
Payback Period - Unev en Cash Flow

A company plans to invest funds to purchase a new machine. The projected after-tax cash ows are as follows:
When cash ows vary from each period, the payback period must be determined by adding the expected proceeds for each year until the sum is equal to or greater than zero.
Payback Period - Unev en Cash Flow

A company plans to invest funds to purchase a new machine. The projected after-tax cash ows are as follows:
C JE E R
E T
!! D
When cash ows vary from each period, the payback period must be determined by adding the expected proceeds for each year until the sum is equal to or greater than zero.
Benefits and Flaws of Payback Screening
Advantages:
Simple Less information search Can eliminate alternatives
Disadvantages:
Failure to measure protability Fails to recognize the time value of money Cannot foresee the advantages of project with longer economic life
Benefits and Flaws of Payback Screening
Using payback period as sole criteria may well lead to an undue emphasis on liquidity at the expense of protability.
Discounted Payback P eriod

It is the number of years/period to recover the investment from discounted cash ows.
Discounted Payback P eriod

It is the number of years/period to recover the investment from discounted cash ows.
Discounted payback period still does not show the complete picture of the project protability.
Net Present Worth Cri terion

1. Determine the interest rate (MARR) the rm wishes to earn on its investments.

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project.

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project. 3. Estimate the cash inow for each period over the economic life.

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project. 3. Estimate the cash inow for each period over the economic life. 4. Estimate the cash outow over the each economic period

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project. 3. Estimate the cash inow for each period over the economic life. 4. Estimate the cash outow over the each economic period 5. Determine the net cash ows

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project. 3. Estimate the cash inow for each period over the economic life. 4. Estimate the cash outow over the each economic period 5. Determine the net cash ows (net cash ows = cash inow - cash outow)

1. Determine the interest rate (MARR) the rm wishes to earn on its investments. 2. Estimate the economic life of a project. 3. Estimate the cash inow for each period over the economic life. 4. Estimate the cash outow over the each economic period 5. Determine the net cash ows (net cash ows = cash inow - cash outow) 6. Find the Present worth of each cash ow at the MARR.

7. Decision rule: If PW(i) > 0, accept the investment If PW (i) = 0, remain indifferent If PW (i) < 0, reject the investment
Net Present Worth - U neven Flows

Tiger Machine Tool Company is considering the proposed acquisition of a new metal cutting machine. The required initial investment of 75,000PhP and the projected cash benets over the projects 3-year life are as follows.
End of Year Cash Flow 0 1 2 3 -$75,000 24,400 27, 340 55,760
You are tasked to evaluate the economic merit of the acquisition. The rms MARR is known to be 15%.
Net Present Worth - U neven Flows

Tiger Machine Tool Company is considering the proposed acquisition of a new metal cutting machine. The required initial investment of 75,000PhP and the projected cash benets over the projects 3-year life are as follows.
End of Year Cash Flow 0 1 2 3 -$75,000 24,400 27, 340 55,760
You are tasked to evaluate the economic merit of the acquisition. The rms MARR is known to be 15%.
PW (15%) = $3553.46
Variation to PW Analy sis

Future Worth Analysis, [FW (i)] measures the surplus in an investment at time period other than zero Decision Rule If PW(i) > 0, accept the investment If PW (i) = 0, remain indifferent If PW (i) < 0, reject the investment
Example
1. A pressure vessel was purchased for $16000, kept for 5 years, and sold for $3000. Annual operating and maintenance costs were $4000. Using a 12% MARR, what was the present worth of the investment? 2. Improved tooling for numerical control machinery will cost 10,000, last for 6 years, and have no salvage value at that time. Due to this investment, net income will increase by 2,525 during each of the rst 3 years and by 3,840 during each of the remaining 3 years. Using a 15% MARR, what is the present worth for the investment?

Capitalized Equivalent Method, [CW (i)]

Capitalized Equivalent Method, [CW (i)] Useful when the life of a proposed project is perpetual or the planning horizon is extremely long

Capitalized Equivalent Method, [CW (i)] Useful when the life of a proposed project is perpetual or the planning horizon is extremely long Examples are public projects like bridges, waterway constructions, irrigation systems, and hydrodams for electricity

Capitalized Equivalent Method, [CW (i)] Useful when the life of a proposed project is perpetual or the planning horizon is extremely long Examples are public projects like bridges, waterway constructions, irrigation systems, and hydrodams for electricity Capitalized Cost represents the amount of money that must be invested today to yield a certain return A at the end of each and every period forever

Capitalized Equivalent Method, [CW (i)] Useful when the life of a proposed project is perpetual or the planning horizon is extremely long Examples are public projects like bridges, waterway constructions, irrigation systems, and hydrodams for electricity Capitalized Cost represents the amount of money that must be invested today to yield a certain return A at the end of each and every period forever (1 + i )N 1 1
lim ( P A , i, N ) = lim i (1 + 1)
N N
P , i, N = A PW (i) = A A i
= i
Example
An engineering school has just completed a new engineering complex worth $50M. A campaign, targeting alumni, is planned to raise funds for future maintenance costs, which are estimated to be $2M per year. Any unforeseen costs above $2M would be obtained by raising tuition. Assuming that the school can create a trust-fund that earns 8% interest annually, how much has to be raised now to cover the perpetual string of $2M annual costs?
Example
An engineering school has just completed a new engineering complex worth $50M. A campaign, targeting alumni, is planned to raise funds for future maintenance costs, which are estimated to be $2M per year. Any unforeseen costs above $2M would be obtained by raising tuition. Assuming that the school can create a trust-fund that earns 8% interest annually, how much has to be raised now to cover the perpetual string of $2M annual costs?
A CE (i) = i $2, 000, 000 CE (8%) = 0.08 CE (8%) = $25, 000, 000

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Evaluating Business and Engineering Assets

MLDC, MatE 180

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Wednesday, August 17, 11

Can existing plant be used to achieve new production levels?

Wednesday, August 17, 11

Wednesday, August 17, 11

How Project Cash Flow is Described?

Wednesday, August 17, 11

How Project Cash Flow is Described?

Wednesday, August 17, 11

How Project Cash Flow is Described?

Wednesday, August 17, 11

How Project Cash Flow is Described?

How Project Cash Flow is Described?

PROJECT CASH FLOWS

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Wednesday, August 17, 11

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Wednesday, August 17, 11

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Wednesday, August 17, 11

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Wednesday, August 17, 11

Payback Period - Unif orm Annual Benefit

Wednesday, August 17, 11

Payback Period - Unev en Cash Flow

Payback Period - Unev en Cash Flow

Benefits and Flaws of Payback Screening

Wednesday, August 17, 11

Benefits and Flaws of Payback Screening

Discounted Payback P eriod

Wednesday, August 17, 11

Discounted Payback P eriod

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

Wednesday, August 17, 11

Net Present Worth Cri terion

06 Evaluating Business and Eng'g Assets

06 Evaluating Business and Eng'g Assets