IEN255 Chapter 4 - Present Worth Analysis

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IEN255 Chapter 4 - Present Worth Analysis

• Do the product or not?
• 3 main issues
• How much additional investment in plant
  equipment to mfg the product?
• How long to recover initial investment
• Can we make a profit a X price?

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Measures of investment worth

• Payback period
• Cash flow equivalence
• present worth
• future worth
• annual worth (chap 5)
• rate of return (chap 6)
• (tax concerns later)

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Loan vs Project cash flow

• Figure 4.1

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Example 4.1

• Purchase cost 300,000
• 5000 x 40 x 3 6000 productive hours
• 6,000/60 10,000 hours of paid time per year
• Avoided cost 10,000 hours x 25 /hour
  250,000/year
• So, net benefits (250000 - 175000) 75000
  per year
• Fig 4.2

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Payback period

• How long does it take to recoup investment?
• Most common measure
• Used for initial screening

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Example 4.2
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Example 4.3
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Payback period - Pros and Cons

• Pro
• simple
• minimize further analysis (screen all projects)
• Cons
• no time value of money
• no consideration of length of investment

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Two competing projects

• Table 4.1

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Present worth analysis

• MARR minimum acceptable rate of return
• MARR is a management decision
• estimate
• service life
• cash flows (in and out) (if An positive net cash
  inflow and An is negative if net cash outflow)
• determine net cash flows
• find present worth of each net cash flow

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Good or bad?

• If PW(i) gt 0, accept
• If PW(i) 0, indifferent
• If PW(i) lt 0, reject

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Example 4.5
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Investment pool (borrowed funds)

• place to get funds for projects within a company
• In pool gt 75000(F/P, 15, 3) 114,066
• Project 119,470 - 114,066 5404
• Bring back to present 3553
• fig 4.5

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Variations (future worth)

• NFW net future worth
• If FW(i) gt 0, accept
• If FW(i) 0, indifferent
• If FW(i) lt 0, reject

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Example 4.6
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Capitalized equivalent method

• Perpetual service life
• capitalized cost
• PW(I) A(P/A,I,N??) A/i (4.3)
• Projects life is extremely long

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Mutually exclusive alternatives

• buying vs leasing
• is a single alternative mutually exclusive? (do
  nothing)
• revenue vs service projects
• analysis period
• figure 4.11

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Analysis period equals project lives

• table solution on pg 212

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Analysis period differs from project lives

• life is longer than analysis period
• figure 4.12
• solution pg 215

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Projects life is shorter than analysis period

• what to do at tend?
• replacement projects
• fig 4.13

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Analysis period coincides with longest project
life

• fig 4.14

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Lowest common multiple of project lives

• figure 4.15

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Note table 4.3
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IEN255 Summer99 Chapter 3, 4 5 HW2

• Homework Assignment
• Chapter 3
• s 3.66 3.73 3.78
• Chapter 4
• s 4.1 4.3 4.7 4.22 4.26 4.34 4.39 4.48
• Due together (Tues June 29)
• Chapter 5 - will not be collected problems will
  be done in class, others will be posted.
• s 5.15.6 5.11 5.17 5.20 5.28 5.32
  5.34 5.38 5.42