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Project Evaluation

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Module 5: Project Evaluation


Minimum
Attractive
Rate of
Return

Project
Evaluation
Methods

Present
Worth
Method

Future
Worth
Method

Annual
Worth
Method

Internal
Rate of
Return
Method

External
Rate of
Return
Method

Payback
Period
Method

BenefitCost
Analysis

Learning Objectives
1.
2.
3.
4.

Evaluate the economic viability of projects using the Equivalent Worth Methods
Evaluate the economic viability of projects using the Rate of Return Methods
Calculate the payback period of projects
Perform Benefit-Cost analysis

CHE40: ENGINEERING ECONOMY

Minimum Attractive Rate of Return


Considerations

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
CHE40: ENGINEERING ECONOMY

Project Evaluation Methods


Equivalent
Worth
Methods

Rate of Return
Methods

Present
Worth
Method

Internal Rate
of Return
Method

Future Worth
Method

External Rate
of Return
Method

Payback
Period Method

Benefit-Cost
Analysis

Annual Worth
Method
CHE40: ENGINEERING ECONOMY

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 firms MARR is 10% per year, what is the
present worth of the project? Is it a sound investment opportunity?

CHE40: ENGINEERING ECONOMY

Present Worth Method


Capitalized Cost
used when the period of needed service is indefinitely long

= +
1
=

* PW RC calculated from AW RC

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?

CHE40: ENGINEERING ECONOMY

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

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

CHE40: ENGINEERING ECONOMY

Salvage Value

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

Project Evaluation Methods


Equivalent
Worth
Methods

Rate of Return
Methods

Present
Worth
Method

Internal Rate
of Return
Method

Future Worth
Method

External Rate
of Return
Method

Payback
Period Method

Benefit-Cost
Analysis

Annual Worth
Method
CHE40: ENGINEERING ECONOMY

10

Internal Rate of Return Method


also called the investors 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: >

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 Taylors internal rate of return on this investment?

CHE40: ENGINEERING ECONOMY

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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: >

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

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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

13

Project Evaluation Methods


Equivalent
Worth
Methods

Rate of Return
Methods

Present
Worth
Method

Internal Rate
of Return
Method

Future Worth
Method

External Rate
of Return
Method

Payback
Period Method

Benefit-Cost
Analysis

Annual Worth
Method
CHE40: ENGINEERING ECONOMY

14

Benefit-Cost Analysis
Conventional B/C Ratio

Modified B/C Ratio

&
=

measure of desirability: B/C > 1

Benefits, B

advantages
experienced by
the owner

Disbenefits,
D

disadvantages to
the owner

Costs, C

anticipated
expenditure less
any salvage
values

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 .

CHE40: ENGINEERING ECONOMY

15

Module 5: Project Evaluation


Minimum
Attractive
Rate of
Return

Project
Evaluation
Methods

Present
Worth
Method

Future
Worth
Method

Annual
Worth
Method

Internal
Rate of
Return
Method

External
Rate of
Return
Method

Payback
Period
Method

BenefitCost
Analysis

Learning Objectives
1.
2.
3.
4.

Evaluate the economic viability of projects using the Equivalent Worth Methods
Evaluate the economic viability of projects using the Rate of Return Methods
Calculate the payback period of projects
Perform Benefit-Cost analysis

CHE40: ENGINEERING ECONOMY

16

Project Evaluation
Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

17