5-1

Part 2

Evaluation of Business and

Engineering Assets

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 5-2

Chapter 5 Analysis of Independent Projects

Identifying Cash Inflows and Outflows

5.1
(a) Cash inflows: (1) savings in labour, $45,000 per year, (2) salvage value,
$3,000 at year 5.

(b) Cash outflows: (1) capital expenditure = $30,000 at year 0, (2) operating
costs = $5,000 per year.

(c) Estimating project cash flows:

n Inflow Outflow Net flow

0 $30,000 -$30,000
1 $45,000 5,000 40,000
2 45,000 5,000 40,000
3 45,000 5,000 40,000
4 45,000 5,000 40,000
5 45,000+3,000 5,000 43,000

Payback Period
5.2
(a) Payback period: one year (discrete cash flows)

(b) Discounted payback period = 0.86 years, assuming continuous payments:

n Net Cash Flow Cost of Funds (15%) Cumulative Cash Flow

0 $30,000 $30,000
1 +$40,000 $30,000(0.15) = $4,500 +$5,500

5.3
(a) Payback period assuming end-of-year cash flows:

Project A B C D
Payback period No payback 2 years 3 years 1 years

(b) It may be viewed as a combination of two separate projects, where the first
investment is recovered at the end of year 1 and the investment that made
in year 2 and 3 will be recovered at the end of year 6.

(c) Discount payback period assuming end-of-year cash flows:

Project A B C D
Payback period No payback 2 years 4 years 1 years

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 5-3

NPW Criterion
5.4
(a)
PW (10%) A $1,500 $3, 000( P / F ,10%,3) $754
PW (10%) B $1,200 $600( P / F ,10%1) $800( P / F ,10%,2)
$1,500( P / F ,10%,3) $1,134
PW (10%) C $1,600 $1,800( P / F ,10%1) $800( P / F ,10%,2)
$2,500( P / F ,10%,3) $697
PW (10%) D $3,100 $800( P / F ,10%1) $1,900( P / F ,10%,2)
$2,300( P / F ,10%,3) $926

(b) Not provided. (Can easily obtain the graphs using Excel or other software)
*
5.5

(a)
PW (9%) $200,000 $24,000( P / A,9%,35) $35,000( P / F ,9%,35)
$55,317.71 0

(b)
PW (6%) $200,000 $24,000( P / A,6%,35) $35,000( P / F ,6%,35)
$152,511.60

(c)
PW (i) $200,000 $24,000( P / A, i,35) $35,000( P / F , i,35) 0
i 11.80%

Therefore, the answer is (d).

5.6 *

Given: Estimated remaining service life = 25 years, current rental income =

$150,000 per year, O&M costs = $45,000 for the first year increasing by
$3,000 thereafter, salvage value $50, 000 , and MARR 12% .
Let A0 be the maximum investment required to break even.

* An asterisk next to a problem number indicates that the solution is available to

students on the Companion Website.

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 5-4

PW (12%) A0 [$150, 000( F / A,12%, 25) $15, 000( F / A,12%, 20)

$16,500( F / A,12%,15) $18,150( F / A,12%,10)
$19,965( F / A,12%,5) $50, 000]( P / F ,12%, 25)
$45, 000( P / A,12%, 25) $3, 000( P / G,12%, 25)
0

Solving for A0 yields

A0 $793,113

5.7
P $42, 000 [[$32, 400 [$33, 400 [$32,500 {$32,500
$33, 000( P / F ,12%,1)}( P / F ,15%,1)]( P / F ,13%,1)]
( P / F ,11%,1)]]( P / F ,10%,1)
$77, 417

5.8 Units are in thousand

PW (15%) $500 $3,200( P / F ,15%,1) $4,000( P / F ,15%,2)

($4,000 $2,000 $2,800)( P / A,15%,8)( P / F ,15%2)
$1,200( P / F ,15%,10)
$4,847.23

5.9 *

PW (18%) $3,000,000 [$1,550,000 $350,000 $150,000]( P / A,18%,10)

$200,000( P / F ,18%,10)
$1,757,018

Future Worth and Project Balance

5.10

(a)
PW (15%) A $12,500 $5,400( P / F ,15%,1) $14,400( P / F ,15%,2)
$7,200( P / F ,15%,3) $7,818
PW (15%) B $11,500 $3,000( P / F ,15%,1) $21,000( P / F ,15%,2)
$13,000( P / F ,15%,3) $10,318
PW (15%) C $12,500 $7,000( P / F ,15%,1) $2,000( P / F ,15%,2)
$4,000( P / F ,15%,3) $7,531
PW (15%) A $13, 000 $5,500( P / F ,15%,1) $5,500( P / F ,15%, 2)
$8,500( P / F ,15%,3) $1,530

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(b)
FW (15%) A $7,818( F / P,15%,3) $11,890
FW (15%) B $10,318( F / P,15%,3) $15,694
FW (15%) C $7,531( F / P,15%,3) $11,454
FW (15%) D $1,530( F / P,15%,3) $2,327

All the projects are acceptable.

5.11
(a) The original cash flows of the project are as follows.

n An Project Balance
0 $1,000 $1,000
1 $100 $1,100
2 $520 $800
3 $460 $500
4 $600 0

(b)
PB(i ) 3 $800(1 i) $460 $500

i 20%

(c) Yes, the project is acceptable.

5.12 *

PW (15%) $1, 000, 000( P / F ,15%,1) $750, 000( P / F ,15%, 2)

$562,500( P / F ,15%,3) $421,875( P / F ,15%, 4)
$2, 047, 734

5.13
(a) First find the interest rate that is used in calculating the project balances.
We can set up the following project balance equations:

PB (i )1 $10, 000(1 i ) A1 $11, 000

PB (i ) 2 $11, 000(1 i ) A2 $8, 200
PB (i )3 $8, 200(1 i ) $8, 000 $1,840
PB (i ) 4 $1,840(1 i ) A4 $3, 792
PB (i )5 $3, 792(1 i ) A5 $7,550

From PB(i )3 , we can solve for i : i 20% .

Substituting i into other PB(i )n yields

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 5-6

n An PB(i )n
0 $10,000 $10,000
1 1,000 11,000
2 5,000 8,200
3 8,000 1,840
4 6,000 3,792
5 3,000 7,550

(b) Conventional payback period 3 years

5.14
(a) From the project balance diagram, note that PW ( 24%)1 0 for Project
1 and PW (23%) 2 0 for Project 2.

PW (24%)1 $1,000 $400( P / F ,15%,1) $800( P / F ,15%,2)

X ( P / F ,15%,3) 0
PW (23%) 2 $1,000 $300( P / F ,15%,1) Y ( P / F ,15%,2)
$800( P / F ,15%,3) 0
X = $299.58, Y = $493.49

(b) Since PW ( 24%)1 0 , FW ( 24%)1 0 .

(c) = $593.49, = $499.56, = 17.91%

5.15
(a) The original cash flows of the project are as follows:

n An Project Balance
0 $3,000 $3,000
1 $600 $2,700
2 $1,470 $1,500
3 $1,650 0
4 $300 $300
5 $600 $270

(b)
PB(i) 2 $2,700(1 i) $1,470 $1,500

i 10%

PW (10%) $270( P / F ,10%,5) $167.65

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5.16 i 10%
(a)
Project Balance as a Function of Time
Year A B C D
0 ($2,500) ($3,000) ($5,500) ($4,000)
1 ($2,450) ($1,300) ($4,050) $600
2 ($2,395) $70 ($2,455) ($2,340)
3 ($2,335) $1,577 ($701) ($5,074)
4 ($2,268) $2,235 $4,229 ($4,581)
5 ($2,195) $2,958 $9,652 ($4,040)
6 ($2,114) $4,754 ($2,443)
7 ($2,026) $312
8 ($1,928)

A
PB 12000
10000 B
8000 C
6000 D
4000
2000
0
-2000 1 2 3 4 5 6 7 8 9 n
-4000
-6000
-8000

(b)
Project A B C D
PB2 $2,395 $70 $2,455 $2,340

Project B because it is the only one with a positive balance at the end of
year 2.

5.17
(a)
FW (12%) A $1,800( F / P,12%,5) $500( F / P,12%,4)
$700
$700.18
FW (12%) B $5,200( F / P,12%,5) $2,500( F / P,12%,4)
$3,000
$5,141.91
FW (12%) C $3,800( F / P,12%,5) $4,000( F / P,12%,4)
$12,000
$18,160.7

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FW (12%) D $4,000( F / P,12%,5) $500( F / P,12%,4)

$1,250
$6,040.45
FW (12%) E $6,500( F / P,12%,3) $1, 000( F / P,12%, 2)
$3, 600( P / F ,12%,1) $2, 400
$1, 445.63

(b) Accept all projects except E.

5.18
(a) You may plot the future worth for each project as a function of interest rate,
using Excel software.

(b)
n A B C D E
0 $1,800.00 $5,200.00 $3,800.00 $4,000.00 $6,500.00
1 $2,516.00 $3,324.00 $4,256.00 $3,980.00 $6,280.00
2 $1,917.92 $7,722.88 $4,766.72 $2,457.60 $3,433.60
3 $848.07 $3,649.63 $1,338.73 $247.49 $1,445.63
4 $1,250.16 $1,912.42 $5,500.63 $4,277.19
5 $700.18 $5,141.91 $18,160.70 $6,040.45

(c) Note that PB (12%) N FW (12%)

5.19 *

From the project balance table shown below, it will take about eight years.

n Cash flow Balance

0 $20,000.00 $20,000.00
1 $5,000.00 $18,000.00
2 $5,000.00 $15,700.00
3 $5,000.00 $13,055.00
4 $5,000.00 $10,013.25
5 $5,000.00 $6,515.24
6 $5,000.00 $2,492.52
7 $5,000.00 $2,133.60
8 $5,000.00 $7,453.64
9 $5,000.00 $13,571.68
10 $5,000.00 $20,607.44

5.20
Equivalent investment made or required at n = 0:

PW (20%)investment $10M( F / A, 20%, 4) $30M $83.68M

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Anticipated future benefits with $83.68M investment:

PW (20%)revenue $100M( P / A, 20%,10) $419.25M

Potential asking price = $83.68M + $419.25M = $502.93M

Comments: The absolute minimum asking price is $83.68M because that is

how much you have invested in the project. However, if you go with this
absolute minimum, you are giving up the future benefits that the R&D project
would generate. Certainly, you have no way of knowing that Merck would
pay this price, but at least you know where you stand at the time of
negotiation.

5.21
(a)
PW (10%) A $404.40
PW (10%) B $191.59
PW (10%)C $0.53

(b)
FW (10%) A $404.40( F / P,10%,6) $716.42
FW (10%) B $191.59( F / P,10%,5) $308.56
FW (10%)C $0.53( F / P,10%,3) $0.7

(c)
PW (i) A $400 $150( P / A,10%, 2)
$350( P / F ,10%,3)
200 P / F ,15%,1 P / F ,10%,3

$368.07

PW i B $182.52

PW i C $0.53

5.22
(a) Since the projects terminal project balance is equivalent to its future
worth, we can easily find the equivalent present worth for each project by

PW (10%) A $105( P / F ,10%,5)

$65.20
PW (10%)C $1, 000( P / F , 20%,5)
$401.80

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 5-10

(b)
PB(10%)0 A0 $1, 000
PB (10%)1 PB (10%)0 (1 0.10) A1 $1, 000
PB (10%) 2 PB (10%)1 (1 0.10) A2 $900
PB(10%)3 PB (10%) 2 (1 0.10) A3 $690
PB (10%) 4 PB (10%)3 (1 0.10) A4 $359
PB (10%)5 PB (10%) 4 (1 0.10) A5 $105

From the project balance equations above, we derive

A0 $1, 000, A1 $100, A2 $200, A3 $300, A4 $400, and A5 $500 .

(c)
FW (20%) PB(20%)5 $1, 000

(d)
PW (i ) B FW (i ) B ( P / F , i, N )
$198 /(1 i )5
$79.57

Solving for i yields i 20%

5.23
(a)
PW (0%) A 0
PW (18%) B $575( P / F ,18%,5) $251.34
PW (12%)C 0

(b) Assume that A2 $500.

PW (12%)0 $1, 000

PW (12%)1 $1, 000(1.12) A1 $530
PW (12%) 2 $530(1.12) $500 X

Solving for X yields X = $93.60.

(c) The net cash flows for each project are as follows:

Net Cash Flow

n A B C
0 $1,000 $1,000 $1,000
1 $300 $500 $590
2 $280 $500 $500
3 $260 $300 -$106

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4 $240 $300 $147

5 $220 $300 $100

(d)
FW (0%) A 0
FW (18%) B $575
FW (12%)C 0

Capitalized Equivalent Worth

5.24 *
(a)
PW (13%) $50,000( P / A,13%,5) $70,000( P / A,13%,5)( P / F ,13%,5)
($90,000 / 0.13)( P / F ,13%,10) $513,435.45

(b)
A
PW (13%)
i
A $513, 435.45(0.13) $66, 746.61

5.25 *
Find the equivalent annual series for the first cycle:

A $100 [$60( F / A,14%,3) $20]( A / F ,14%,5)

$65.75

Capitalized equivalent amount:

$65.75
CE $469.64
0.14

5.26 Given: r = 6% compounded monthly, maintenance cost = $30,000 per year

0.06 12
ia (1 ) 1 6.17%
12

$30,000
CE (6.17%) $486,223.66
0.0617

5.27 Given: Construction cost = $5,000,000, renovation cost = $1,000,000 every

15 years, annual O & M costs = $100,000 and i 5% per year

(a)

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 5-12

P1 $5, 000, 000

$1, 000, 000( A / F ,5%,15)
P2
0.05
$926,846
P3 $100, 000 / 0.05
$2, 000, 000
CE (5%) P1 P2 P3
$7,926,846

(b)
P1 $5, 000, 000
$1, 000, 000( A / F ,5%, 20)
P2
0.05
$604,852
P3 $100, 000 / 0.05
$2, 000, 000
CE (5%) P1 P2 P3
$7, 604,852

(c)
A 10-year cycle with 10% of interest:

P1 $5, 000, 000

$1, 000, 000( A / F ,10%,15)
P2
0.10
$314, 738
P3 $100, 000 / 0.10
$1, 000, 000
CE (10%) $6,314, 738

A 20-year cycle with 10% of interest:

P1 $5, 000, 000

$1, 000, 000( A / F ,10%, 20)
P2
0.10
$174,596
P3 $100, 000 / 0.10
$1, 000, 000
CE (10%) $6,174,596
As interest rate increases, CE value decreases.

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 5-13

5.28 *

Given: Cost to design and build $650, 000 , rework cost $100, 000
every 10 years, a new type of gear $50, 000 at the end of fifth year,
annual operating costs $30, 000 for the first 15 years and $35, 000
thereafter

$100, 000( A / F ,8%,10)

CE (8%) $650, 000
0.08
$50, 000( P / F ,8%,5)
$30, 000( P / A,8%,15)
$35, 000
( P / F ,8%,15)
0.08
$1,165, 019

Annual Equivalent Worth Calculation

5.29
AE (10%) $5, 000( A / P,10%, 6)
[$2, 000( P / F ,10%,1)
$2,500( P / F ,10%, 6)]( A / P,10%, 6)
$1,103.50

5.30
AE (12%) $20,000( A / P,12%,6) $5,000
$3,000( P / G,12%,5)( P / F ,12%,1)( A / P,12%,6)
$4,303.13

5.31
AE (10%) [$3, 000 $3, 000( P / A,10%, 2)
$3, 000( P / A,10%, 4)( P / F ,10%, 2)
$1, 000( P / G,10%, 4)( P / F ,10%, 2)]( A / P,10%, 6)
$751.01

5.32 *

AE (13%) [$8, 000 $2, 000( P / A,13%, 6)

$1, 000( P / G,13%, 6) $4, 000( P / F ,13%, 2)
$2, 000( P / F ,13%, 4) $1, 000( P / F ,13%, 6)]( A / P,13%, 6)
$934.92

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5.33 *

AE (8%) $5, 000( A / P,8%, 6) $2, 000

[($500 $1, 000( P / A,8%, 2))( P / F ,8%, 2)
$500( P / F ,8%,5)]( A / P,8%, 6)
$421.37

5.34
AE (10%) A $2,500( A / P,10%,5) $400
$100( A / G,10%,5)
$78.47 (Reject)
AE (10%) B $4,500( A / P,10%,5) $500
[$2,500( P / F ,10%,1) $1,500( P / F ,10%, 2)
$500( P / F ,10%,3)]( A / P,10%,5)
$338.57 (Accept)
AE (10%)C [$8, 000 $2, 000( P / F ,10%,1)
$2, 000( P / F ,10%,5)]( A / P,10%,5)
$162.77 (Accept)
AE (10%) D [$12, 000 $2, 000( P / F ,10%,1)
$4, 000( P / F ,10%,5)]( A / P,10%,5)
$1,868.31 (Accept)

5.35 *

AE (12%) [$500, 000 $600, 000( P / F ,12%,1) $400, 000( P / F ,12%, 2)

$300, 000( P / F ,12%,3) $200, 000( P / F ,12%, 4)]( A / P,12%, 4)
$228,894

5.36
AE (13%) A $7,500( A / P,13%,3) $15,500( A / F ,13%,3)
$1,373.10 (Accept)
AE (13%) B $4, 000( A / P,13%,3) $1,500
$300( A / G,13%,3)
$81.53 (Accept)
AE (13%)C $5, 000( A / P,13%,3) $4, 000
$1, 000( A / G,13%,3)
$963.62 (Accept)
AE (13%) D $6, 600( A / P,13%,3) $3,800
$1, 004.70 (Accept)

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5.37 Since the project has the same cash flow cycle during the project life, you
just can consider the first cycle.
AE (10%) [$800 $900( P / F ,10%,1) $700( P / F ,10%, 2)
$500( P / F ,10%,3)]( A / P,10%,3)
$390.98

Accept the project.

5.38
$10, 000
CE (i ) $10, 000( P / A,8%,10) ( P / F ,8%,10)
0.06
$77,199 $67,101
$144,300

The amount of additional funds should be $44,300.

Capital (Recovery) Cost/Annual Equivalent Cost

5.39 *

Given: I $55, 000, S $6, 000, N 10 years, i 12%

(a)

CR(12%) ($55, 000 $6, 000)( A / P,12%,10)

$6, 000(0.12)
$9,392

(b)

AE (12%)Operating Revenue $5, 000 $2,500( A / G,12%,10)

$13,962
(c)

AE (12%) $13,962 $9,392

$4,570

This is a good investment.

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5.40 *

CR(12%) ($45, 000 $9, 000)( A / P,12%, 4) (.12)($9, 000)

$11, 067
AE (12%)O&M $15, 000 $2, 000( A / G,12%,5)
$18,549
AEC (12%) $11, 067 $18,549
$29, 616

5.41 Given: P $250, 000, S $40, 000, N 5 years, i 18%

CR (18%) ($250, 000 $40, 000)( A / P,18%,5)

$40, 000(0.18)
$74,353
5.42

n Option 1 Option 2
0 $600$8,000
1 0 $2,160
2 0 $2,320
3 0 $2,480
4 +$100 $2,540

AEC (8%)Option 1 $8, 600( A / P,8%, 4) $100( A / F ,8%, 4)

$2,574.33
AEC (8%)Option 2 $2,160 $160( A / G,8%, 4)
$2,384.63
Select Option 2.

5.43 Given i 6% , N =12 years,

Conventional System:

AEC (6%)Conventional $471 $576 $1, 047

IONETIC System:

AEC (6%)IONETICS $185 $1, 200( A / P, 6%,12) $328.13

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5.44
(a)
AE (13%) $4,000( A / P,13%,4) $1,000
( X $1,000)( P / F ,13%, 2)( A / P,13%, 4)
0
AE (13%) $608.06 0.26328 X 0
X $2,309.55

(b)
AE (15%) $5,500( A / P,15%, 4) $1, 400
$526.46 0

Accept Project B.

5.45
Option 1: Purchase-annual installment option:

A $45, 000( A / P, 7%,5) $10,975

AEC (10%)1 $5, 000( A / P,10%,5) $10,975
$12, 294

Option 2: Cash payment option:

AEC (10%) 2 $46, 000( A / P,10%,5)

$12,135

Option 2 is a better choice.

5.46 The total investment consists of the sum of the initial equipment cost and the
installation cost, which is $135, 000 . Let R denote the break-even annual revenue.

AE (10%) $135, 000( A / P,10%,10) $30, 000

$5, 000 $10, 000 R
0

Solving for R yields

R $46,971

5.47
Capital cost:

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CR (15%) ($105, 000 $6, 000)( A / P,15%,5) $6, 000(0.15)

$30, 432

Annual operating costs: $45, 000

AEC (15%) $30, 432 $45, 000 $75, 432

Unit-Cost Profit Calculation

5.48 *

Capital recovery cost

CR(10%) ($20, 000 $10, 000)( A / P,10%, 2) $10, 000(0.10)

$6, 762

$30, 000 $40, 000
AE (10%) Revenue [ ]( A / P,10%, 2)
1.1 1.12
$34, 762
AE (10%) Net Savings =$34, 762 $6, 762
$28, 000

C (6, 000) C (8, 000)
AE (10%)Savings [ ]( A / P,10%, 2)
1.1 1.12
$6,952C
$28, 000 6,952C
C $4.02 per hour

5.49 Given data: Total cost of building: $1, 000 4 8 $32, 000, Salvage value =
$3,200, Annual taxes, insurance, maintenance = $1,920, Other operating cost =
$1,600, Number of engineers assigned = 3

Equivalent annual cost of operating the new building:

AEC (12%) ($32, 000 $3, 200)( A / P,12%, 25) (0.12)($3, 200)
$1,920 $1, 600
$7,576.00

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 5-19

Required annual increase in productivity per engineer:

$7,576 / 3 $2,525.33 per engineer

5.50

Equivalent annual cost of owning and operating the vehicle:

AEC (6%) [$4, 680( P / F , 6%,1) $3, 624( P / F , 6%, 2)

$3, 421( P / F , 6%,3)]( A / P, 6%,3)
$3,933

Annualized cost of owning and operating the vehicle as a function of mileage.

C (14,500) C (13, 000) C (11,500)

AEC (6%) [ ]( A / P, 6%,3)
1.06 1.062 1.063
13, 058C

So

13,058C $3,933
C $0.3012 per kilometer

5.51
Option 1: Pay employee $0.38 per km (Annual cost: $8360)
Option 2: Provide a car to employee:

CR (10%) ($25, 000 $8, 000)( A / P,10%,3) (0.10)($8, 000)

$7, 636
AEC (10%)operating cost $900 ($0.22)(22, 000) $5, 740
AEC (10%) total cost $7, 636 $5, 740 $13,376
Operating cost per km $13,376 / 22, 000 $0.61

Option 1 is a better choice.

5.52
Capital costs:

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CR(7%) ($30, 000 $2, 000)( A / P, 7%,12) (0.07)($2, 000)

$3, 665.

Annual battery replacement cost:

AEC (7%) [$3, 000( P / F , 7%,3) ( P / F , 7%, 6)

( P / F , 7%,9)]( A / P, 7%,12)
$765.41
Annual recharging cost:

AEC (7%) ($0.015)(20, 000) $300

Total annual costs:

AEC (7%) $3, 665 $765.41 $300 $700

$5, 430.41
Costs per kilometre:

cost/km $5, 430.41 / 20,000 $0.2715

5.53 *

Minimum operating hours:

AEC (9%) ($30, 000 $2, 000)( A / P,9%,15)

(0.09)($2, 000) $500
$4,153.65

Let T denote the annual operating hours. Then the total kilowatt-hours generated
would be 40T . Since the value of the energy generated is considered to
be $0.08 per kilowatt-hour, the annual energy cost is

$0.08 40T $4,153.65

Solving for T yields

T 1, 298 hours

Annual worth of the generator at full load operation:

AE (9%) ($0.08)(100, 000) $4,153.65 $3,846.35

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Discounted payback period at full load of operation:

n Investment Revenue Maintenance Net

cost Cash flow
0 $30,000 $30,000
1 $8,000 $500 7,500

15 +$2,000 8,000 500 9,500

$30, 000 $7,500( P / A,9%, n)

Solving for n yields

n 5.185 years

5.54
Capital recovery cost:

CR (6%) ($150, 000 $3, 000)( A / P, 6%,12) (0.06)($3, 000)

$17, 714

Annual operating costs:

AEC (6%)O&M $50, 000 $10, 000 $3, 000

$63, 000

Total annual system costs:

AEC (6%) $17, 714 $63, 000 $80, 714

Number of rides required per year:

Number of rides $80, 714 /($0.10) 807,140 rides

5.55 Given: Investment cost $7 million, plant capacity 200, 000 kg/hour, plant
operating hours 3, 600 hours per year, O&M cost $4 million per year, useful
life 15 years, salvage value $900,000, and MARR = 15%.

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(a)
PW (15%) $7, 000, 000 ( R $4, 000, 000)( P / A,15%, 6)
3.7844 R $22,137,900
0

Solving for R yields

R $5,849, 700 per year

(b) Minimum processing fee per kg (after-tax):

$5,849, 700
$0.0081 per kg
(200, 000)(3, 600)

Comments: The minimum processing fee per kg should be higher before-tax basis.

5.56 Given: Investment $3 million, plant capacity 160 m3/day, useful plant
life 20 years, salvage value negligible, O&M cost $250, 000 per year,
MARR 10% compounded annually (or effective monthly rate of 0.7974%)

AEC (10%) $3, 000, 000( A / P,10%, 20) $250, 000

$602,379

Monthly water bill for each household:

$602,379( A / F , 0.7974%,12)
$162.83
295
5.57
Annual total operating hours:

(0.70)(8, 760) 6,132 hours per year

The amount of electricity generated annually:

50, 000 6,132 306, 600, 000 kilowatt-hours

Equivalent annual cost:

AEC (14%) $85, 000, 000( A / P,14%, 25) $6, 000, 000
$18,367,364

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Cost per kilowatt-hour:

$18,367,364 / 306, 600, 000 $0.06 per kilowatt-hour

5.58 Let X denote the average number of round-trip passengers per year.

Capital costs:

CR (15%) ($12, 000, 000 $2, 000, 000)( A / P,15%,15)

(0.15)($2, 000, 000)
$2, 010,171

Annual crew costs: $225,000

Annual fuel costs for round trips:

($1.80)(4,500)(2)(3)(52) $2,527, 200

Annual landing fees:

($250)(3)(52)(2) $78, 000

Annual maintenance, insurance, and catering costs:

$237,500 $166, 000 $75 X $403,500 $75 X

Total equivalent annual costs:

AEC (15%) $2, 010,171 $225, 000 $2,527, 200

$78, 000 $403,500 $75 X
$3, 400 X

Solving for X yields

X 1,577 Passengers per year

Or

1,577 /(52)(3) 10.11 11 passengers per round trip

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Concept of Rate of Return

Note: Symbol conventionThe symbol i* represents the break-even interest rate that
makes the NPW of the project equal to zero. The symbol IRR represents the internal rate of
return of the investment. For a simple (or pure) investment, IRR = i*. For a nonsimple
investment, generally i* is not equal to IRR.

5.59
$14,500 $267( P / A, i, 72)
i 0.8148% per month
r 0.8148% 12 9.7776%
ia (1 0.008148)12 1 10.23%

5.60
$2.5 $1.2( P / A, i,10)
i 46.98%

5.61 *

$104, 200, 000 $30, 000( F / P, i,54)

3, 473.33 (1 i )54
i 16.30%

Investment Classification and Calculation of i*

5.62
(a) Simple investment: Project A (Note: Project C is a simple borrowing.)

(b) Nonsimple investment: Project B and Project D

(c)
Project A:

PW (i ) $18, 000 $30, 000( P / A, i,3) $10, 000( P / G, i,3)

0
i* 126.54%

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 5-25

Project B:

PW (i ) $30, 000 $32, 000( P / A, i, 2) $22, 000( P / F , i,3)

0
i* 45.34%

Project C:

PW (i ) $34,578 $18, 000( P / A, i,3)

0
i 26.08% Borrowing rate of return
*

(d) Project D has no rate of return.

5.63 The equivalent annual cash flow for the first cash flow cycle ($400, $800, $500,
$500) will be

AE (i ) $500 [$100( P / F , i,1) $300( P, F , i, 2)]( A / P, i, 4)

Then, the present worth of the infinite cash flow series is expressed as

AE (i )
PW (i ) $1, 000
i
[$100( P / F , i,1) $300( P, F , i, 2)]( A / P, i, 4)
$1, 000
i
0

i* 54.05%

5.64
(a) Classification of investment projects:

Simple projects: A, B, and E

Nonsimple projects: C and D
However, if you use the cumulative cash flow sign test, all are simple projects.

(b)
$60 $150
$100 0
1 i (1 i) 2

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 5-26

1
Let X , then,
(1 i )

$100 $60 X $150 X 2 0

X 1 0.6406, X 2 1.0406

i* 56.09%

(c) Find i* by plotting the NPW as a function of interest rate:

Project i*
A 56.09%
B 47.94%
C 8.32%
D 178.8%
E 24.21%

5.65
(a) Classification of investment projects:

Simple projects: A, B, and D

Nonsimple projects: C

(b)
Project A: i* 9.63%
Project B: i 27.6%
*

Project C: i 276.72%
*

Project D: i 86.69%
*

(c) Use the PW plot command provided in Cash Flow Analyzer, or you may use the
Excels Chart Wizard.

5.66
(a)
$50, 000 ($25, 000 $9, 000)( P / A, i,8) $10, 000( P / F , i,8) 0
Solving for i yields i* 28.45%

(b) With the geometric expense series

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 5-27

$50, 000 $25, 000( P / A, i,8) $9, 000( P / A1 , 7%, i,8)

$10, 000( P / F , i,8) 0

Solving for i yields i 24.48%

* *

(c) To maintain i 28.45%

*

PW (i ) $50, 000 $25, 000( P / A1 , g , 28.45%,8)

$9, 000( P / A1 , 7%, 28.45%,8) $10, 000( P / A, 28.45%,8)
0

Solving for g yields

g 2.7035%

5.67 *

(a) Rate of return calculation:

Project A: i 32.10%
*

Project B: i 25.53%
*

(b) i* 44.95%

PW Plot

$50,000.00
$40,000.00
$30,000.00
PW ($)

$20,000.00 A
$10,000.00 B
$0.00
($10,000.00) 0 5 10 15 20 25 30 35 40 45 50
($20,000.00)
Interest Rate (%)

5.68
(a) IRR = 69.81%

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94, 000 144, 000 72, 000

PW (i ) 120, 000 0
(1 i ) (1 i ) 2 (1 i )3
i* 69.81%

(b) Use the PW plot command provided in Cash Flow Analyzer, or you may use the
Excels Chart Wizard.

(c) Since IRR(69.81%) > MARR (15%), accept the project!

IRR Analysis

5.69 *

The present worth of the project cash flow is

PW (i ) $10 M $1.8M ( P / A, i,8) $1M ( P / F , i,8) 0

Since IRR 10.18% > MARR, accept the project

5.70 The present worth of the project cash flow is

PW (i ) $5, 000 $4,840( P / F , i, 2) $1,331( P / F , i,3) 0

Since IRR 10% = MARR, the project breaks even.

5.71
(a) Since IRR = 10% and PW(10%) = 0, we have,

PW (10%) $2, 000 $800( P / F ,10%,1) $900( P / F ,10%, 2)

X ( P / F ,10%,3) 0

X = $704

(b) Since IRR > 8%, the project is acceptable.

5.72 *

Let X be the annual rent per apartment unit. Then net cash flow table is:

N Capital Revenue Maintenance Manager Net Cash Flow

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Investment

0 (12,500,000) -12,500,000

1 50 X -250,000 -80,000 50X - 330,000

2 50 X -300,000 -80,000 50X - 380,000

3 50 X -350,000 -80,000 50X - 430,000

4 50 X -400,000 -80,000 50X - 480,000

5 14,000,000 50 X -450,000 -80,000 50X - 13,470,000

PW (15%) 12,500, 000 (50 X 330, 000)( P / A,15%,5)

50, 000( P / G ,15%,5) 12,940, 000( P / F ,15%,5)
0
X * $41,373 per year or $3,448 per month

5.73 *

Let X be the annual savings in labour, then

PW (10%) $25, 000 ( X $3, 000)( P / A,10%, 6)

$5, 000( P / F ,10%, 6) 0

X = $8,092.15

5.74
Net cash flow table:

n Land Building Equipment Revenue Expenses Net Cash Flow

0 ($1.50) ($3) ($4.50)
1 ($4) ($4.00)
2 $3.50 ($1.40) $2.10
3 $3.68 ($1.47) $2.21
4 $3.86 ($1.54) $2.32
5 $4.05 ($1.62) $2.43
6 $4.25 ($1.70) $2.55
7 $4.47 ($1.79) $2.68
8 $4.69 ($1.88) $2.81
9 $4.92 ($1.97) $2.95
10 $5.17 ($2.07) $3.10

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 5-30

11 $5.43 ($2.17) $3.26

12 $5.43 ($2.17) $3.26
13 $5.43 ($2.17) $3.26
14 $2 $1.40 $0.50 $5.43 ($2.17) $7.16

Rate of return calculation:

PW (i ) $4.5 $4( P / F , i,1) $2.1( P / F , i, 2)

$7.16( P / F , i,14) 0

i* 24.85%

Since this is a simple investment, IRR = 24.85%. At MARR = 15%, the project is
economically attractive.

5.75
(a)
PW (i ) $20 $8( P / F , i,1) $17( P / F , i, 2) $19( P / F , i,3)
$18( P / F , i, 4) $10( P / F , i,5) $3( P / F , i, 6)
0

This is a simple investment. Therefore, IRR i 60.52% .

*

Since IRR > MARR (18%), the product is worth marketing.

(b) IRR = 67.03%

(c) IRR = 48.07%

Short Case Studies

ST 5.1
(a) Analysis period of 40 years:

Without the mothballing cost:

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 5-31

PW (i ) $1,500, 000 $138, 000( P / A1 , 0.05%, i, 40)

0
i* 8.94%

With the mothballing cost of $0.75 billion:

PW (i ) $1,500, 000 $138, 000( P / A1 , 0.05%, i, 40)

$750, 000( P / F , i, 40)
i 8.77%
*

For a 40-year analysis period, the drop of IRR with the mothballing cost is
only 1.9%, which is relatively insignificant.

(b) Analysis period of 25 years (unit: thousand $):

Without the mothballing cost:

PW (i ) $1,500, 000 ($207, 000 $69, 000)( P / A1 , 0.05%, i, 25)

0
i* 7.84%

With the mothballing cost of $0.75 billion:

PW (i ) $1,500, 000 ($207, 000 $69, 000)( P / A1 , 0.05%, i, 25)

$750, 000( P / F , i, 25)
0
i* 6.80%

For a 25-year analysis period, the drop of IRR with the mothballing
cost is about 13.27%, which is relatively significant.

ST 5.2 Assuming that the cost of your drainage pipe has experienced a 4%
annual inflation rate, I could estimate the cost of the pipe 20 years ago
as follow:

$4, 208( P / F , 4%, 20) $4, 208(1.04) 20 $1,920.48

If the pipe had a 50-year service life with a zero salvage value when it was placed in
service 20 years ago, the annual capital recovery cost to the owner would be as
follows: (I assumed the owners interest rate would be 5% per year. In other words,
the owner could invest his $1,920.48 at 5% annual interest, if he did not purchase the

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pipe.)

CR (5%) $1,920, 48( A / P,5%,50)

$105.20 per year

You can view this number as the annual amount he would expect to recover from his
investment considering the cost of money. With only a 20-years usage, he still has
30 more years to go. So the unrecovered investment at the current point is

$105.20( P / A,5%,30) $1, 617.15.

The owner could claim this number, but the citys interest rate could be different from
the owners, so there is some room for negotiation.

Assumed interest rate Claim cost

0% $1,152.24
3% $1,462.98
4% $1,545.89
5% $1,617.15

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Appendix 5A
Investment Classification and Calculation of i *

5A.1

(a) Cash flow sign rules:

Projects Number of Sign Changes Possible Number of i*

A 1 0, 1
B 1 0, 1
C 1 0, 1
D 1 0, 1
E 2 0, 1, 2
F 1 0, 1

(b) Use the PW plot command provided in Cash Flow Analyzer, or you may use the
Excels Chart Wizard.

(c)
Project A: i* 228.42%
Project B: i* 500%
Project C: i* 23.27%
Project D: i* 70.99%
Project E: i* 265.41%
Project F: i* 258.91%

Mixed Investments

5A.2
(a)

Project 1: i* 20%
Project 2: i 18%
*

Project 3: i 1 32.45%, i 2 92.45%

* *

(b) Investment classification:

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Project 1: simple and pure investment, IRR 20%

Project 2: simple and pure investment, IRR 18%
Project 3: nonsimple and mixed investment, IRR RIC 31.07% , using
MARR 12%.

PB(31.07%,12%)0 $1, 000

PB (31.07%,12%)1 $1, 000(1 0.3107) $1, 400 $89.30
PB(31.07%,12%)2 $89.30(1 0.12) 100 $0

(c) If MARR = 12%, all the projects are acceptable.

5A.3

(a)

$100 $24
$100 0
1 i (1 i ) 2

1
Let X , then,
(1 i )

$100 $100 X $24 X 2 0

X 1 0.8333, X 2 5
i 20%
*

(b)

Simple projects: A,B, and D

Nonsimple projects: C and E

(c) Apply the cash flow sign rule:

Projects Number of Possible Number of Actual i

*

Sign Changes i*
A 1 0, 1 20%
B 1 0, 1 28.58%
C 2 0, 1, 2 14.63%,210.27%
D 1 0, 1 15.24%
E 2 0, 1, 2 12.63%,41.42%

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(d)
Project B: IRRB 28.59%
Project C: IRRC 15.70%
Project D: IRRD 15.24%
Project E: IRRE 11.24%

Note that since Projects C and E are mixed investments, we need to find the RIC for
both C and E by using external interest rate of 10%.

(e) Apply the net investment test: Project C = pure investment, Project D = pure
borrowing

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Project Balances
n
Project C ( i 14.63% ) Project D ( i 12.63% )
* *

0 $5.0 $200
1 $5.8 $320
2 $36.4 $148
3 0 $665
4 $539
5 0

5A.4

(a)

Project 1: i 612.695%
*

Project 2: i
*
1 14.64%, i*2 210.28%
Project 3: i* 100%

(b) Apply the net investment test:

Project 1:

PB(612.695%)0 $1, 600

PB (612.695%)1 $1, 600(1 6.12695) $10, 000 $1, 403.2
PB(612.695%) 2 $1, 403.2(1 6.12695) $10, 000 0

(,,0), a pure investment

Project 2:

PB (14.64%)0 $5, 000

PB (14.64%)1 $5, 000(1 0.1464) $10, 000 $4, 268
PB(14.64%) 2 $4, 268(1 0.1464) $30, 000 $34,892.80
PB (14.64%)3 $34,892.8(1 0.1464) $40, 000 0

(-,+,0), a mixed investment

Project 3:

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PB (100%)0 $1, 000

PB (100%)1 $1, 000(1 1) $4, 000 $2, 000
PB(100%) 2 $2, 000(1 1) $4, 000 0

(-,+,0), a mixed investment

(c)
Project 1: IRR1 612.695%, PW (12%) $15,300
Project 2: IRR2 RIC 2.04%, PW (12%) $623 0
Project 3: IRR3 RIC 57.14%, PW (12%) $617 0

(d) Only Project 1 is acceptable.

5A.5
(a) Simple investments: A and B (simple as well as pure)

(b) Mixed investments: C

(c) Project A: IRRA 23.24% , Project B: IRRB 21.11% , Project C:

IRRC 12.24% at an external rate of 12%

(d) All three projects are acceptable.

5A.6

(a) There are two sign changes in cash flow, indicating multiple i s.
*

i*1 20%, i*2 40%

Apply the net investment test:

PB(20%)0 $100
PB(20%)1 $100(1.2) $260 $140
PB(20%) 2 $140(1.2) $168 0

(-,+,0), a mixed investment

(b) At an external interest rate of 12%, RIC = IRR = 10% < 12%.

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(c) The project is not acceptable.

5A.7

(a) i*1 15.99%, i*2 0%

(b) Since all projects pass the net investment test, all projects are pure investments.

(c) All projects are acceptable at MARR = 10%.

5A.8

(a) Project A: i*1 10%, i*2 100% , Project B: i*1 350.33%, i*2 80.83%

(b) Pure investment: C, mixed investments: A, B, D, and E

(c) Project A: IRRA 13.57% , Project B: IRRB 342.16% , Project C:

IRRC 18% , Project D: IRRD 31.07% , Project E: IRRE 19.66%

(d) All projects are acceptable at MARR = 12%.

5A.9

(a) Use the PW plot command provided in Cash Flow Analyzer.

From the plot, we get i*1 14.64%, i*2 210.27%

(b) Apply the net investment test:

PB(14.64%)0 $5, 000

PB(14.64%)1 $5, 000(1 0.1464) $10, 000 $4, 268
PB(14.64%)2 $4, 268(1 0.1464) $30, 000 $34,892.80
PB(14.64%)3 $34,892.8(1 0.1464) $40, 000 0

(-,+,+,0): The project is a mixed investment.

(c) Since RIC = IRR = 33.92% > 18%, the project is acceptable.

5A.10

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(a) Apply the net investment test using i* 10%

PB(10%)0 $100, 000

PB(10%)1 $100, 000(1.1) $310, 000 $200, 000
PB(10%) 2 $200, 000(1.1) $220, 000 0

(-,+,0), a mixed investment

(b) RIC = IRR = 6.29% <8%. So the project is not acceptable.

5A.11 (c)

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.