lecture 5 engineering economics engr 3300 department of mechanical engineering inter american...
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![Page 1: Lecture 5 Engineering Economics ENGR 3300 Department of Mechanical Engineering Inter American University of Puerto Rico Bayamon Campus Dr. Omar E. Meza](https://reader031.vdocuments.us/reader031/viewer/2022032517/56649c995503460f949564bf/html5/thumbnails/1.jpg)
Lecture
5
Engineering Economics ENGR 3300
Department of Mechanical EngineeringInter American University of Puerto Rico
Bayamon CampusDr. Omar E. Meza Castillo
[email protected]://www.facultad/bayamon.inter.edu/omeza
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Lecture
5 Present Worth Analysis
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Bank Loan vs. Investment Project
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Project Cash Flow
Representation of project’s future earnings, along with the capital expenditures and annual expenses (such as wages, raw materials, operating costs, maintenance costs and income taxes) at different time periods is called a Project Cash Flow.
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Identifying Project Cash Flows
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Initial Project Screening Methods
One of the primary concerns of most businesspeople is whether and when the money invested in a project can be recovered. The payback method screens projects on the basis of how long it takes for net receipts to equal investment outlays.
This calculation can take one of two forms: either ignore time-value-of-money considerations or include then. The former case is usually designated the conventional payback method, the latter case the discounted payback method.
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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
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Lecture 5EN
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takes to Pay Back 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
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Convectional Payback Period Consider the cash flows given in the
example of Computer Process Control System. Determine the payback period.
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Convectional Payback Period with Salvage Value Example
5.3
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Lecture 5EN
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-50,000
0
50,000
100,000
150,000
0 1 2 3 4 5 6
Years (n)
3.2 years Payback period
$85,000
$15,000$25,000
$35,000$45,000 $45,00
0 $35,000
0
1 2 3 4 5 6YearsA
nnual ca
sh fl
ow
Cum
ula
tive c
ash
flow
($
)
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Comments If the cash flow occur continuously
throughout the year, the payback period calculation needs adjustment.
A negative balance of $10,000 remains at t he start of year 4. If $45,000 is expected to be received as a more or less continuous flow during year 4, the total investment will be recovered two tenths ($10,000/$45,000) of the way through the four year. Thus, in this situation, the payback period is 3.2 years.
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Benefits and Flaws of Payback Screening
Investment Cash Flows for Two Competing Projects
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Is the number of years required to recover the investment from discounted cash flows.
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Present-Worth Analysis
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Present-Worth Analysis
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Present-Worth Analysis
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Present-Worth Analysis
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.
2 3 4 50 1
Inflow
Outflow
0
PW(i)inflow
PW(i)outflow
Net surplus
PW(i) > 0
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Net Present Worth: Uniform Flows
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Net Present Worth: Uniform Flows
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Net Present Worth: Uneven Flows
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Net Present Worth: Uneven Flows
PW P F P F
P F
PW
PW
( $24, ( / , ) $27, ( / , )
$55, ( / , )
$78,
( $75,
( $78, $75,
$3, ,
15%) 400 15%,1 340 15%,2
760 15%,3
553
15%) 000
15%) 553 000
553 0
inflow
outflow
Accept
$75,000
$24,400 $27,340$55,760
01 2 3
outflow
inflow
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Varying Interest Rates
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Future-Worth Analysis Net present worth measures the surplus in
an investment project at time 0. Net future worth (NFW) measures this surplus at a time other than 0.
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Net Future Worth: At the End of the Project
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Net Future Worth: At the End of the Project
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Net Future Worth: At the End of the Project
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Project Balance Concept
N 0 1 2 3
BeginningBalance
Interest
Payment
Project Balance
-$75,000
-$75,000
-$75,000
-$11,250
+$24,400
-$61,850
-$61,850
-$9,278
+$27,340
-$43,788
-$43,788
-$6,568
+$55,760
+$5,404
Net future worth, FW(15%)
PW(15%) = $5,404 (P/F, 15%, 3) = $3,553
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Project Balance Diagram
60,000
40,000
20,000
0
-20,000
-40,000
-60,000
-80,000
-100,000
-120,000
0 1 2 3
-$75,000-$61,850
-$43,788
$5,404
Year(n)
Terminal project balance(net future worth, or
project surplus)
Discounted payback period
Pro
ject
bala
nce
($
)
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Capitalized-Equivalent Worth
Principle: PW for a project with an annual receipt of A over infinite service life
Equation: CE(i) = A(P/A, i, ) = A/i
P = CE(i)
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Capitalized-Equivalent Worth
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Capitalized-Equivalent Worth
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Homework 3 www.bc.inter.edu/facultad/omeza