Engineering Economics

Content:

Introduction 3 Overview .3 Methodology ...4 Results and recommendations 5 Case Study 1 ..5 Case Study 2 ..6 References ..6 Appendix A ..7 Appendix B ..8 Appendix C ..9

Introduction:
This is an engineering economics analysis of a co-generation project. With hydro costs spiraling out of control, companys decision is to build their own facilities to produce enough power, to satisfy their own needs and some surplus to sell to other users. The facility would be a steam generator to drive the turbines with natural gas fuel, considering that consumption of the company is around 1 MW (megawatt) per week. The power plant was estimated to have a life for 20 years. In additional, toward the purchase of hydrogenation equipment the company would qualify for tax credits. This analyst will estimate the most that company should pay for the installation for such power plant to yield capital project return of 35%. IRR feature in excel should be used.

Overview:
The decision is made to install and use their own facility to satisfy their own needs for electrical energy for 20 years with following reference data of the assignment (See Appendix C) 1. $100Million paid last year in power.
2. Natural gas cost estimated $59Million per year. 3. Maintenance approximate cost $1 million per year (six new employees hired). 4. Sales to other consumers, cash inflow for The Co expected $5Million per year. 5. Ontario governments tax credit toward equipment purchase $10Million. 6. Capital project return 35%(MARR=35%)

7. Power plant life 20 years and must be dismantled at a time $20 Million.; 8. Overhaul in year 11must be performed $20 Million. I decided to show the case if company continue to pay to Hydro for the energy consumed, if they do not install their own producing energy facility. It was interesting to me to see what the Present Value is in this case: (Series Present Worth factor is used), (P/A, 0.35, 20) =100000000*(1+0.35)^20/0.35(1+0.35)^20=285007841.4 or approximately 285 million Present Worth. There is cash flow diagram to visualize this case: See Appendix A

Methodology:

1. First is defined what is the cash flow within the project, producing electrical

energy for 20 years. Bellow all in and out cash flows are brought to one pattern of cash flow. Every year the steel company consumes energy for $100Million .If the produce their energy this amount is inflow for them, plus $5Million from sales of energy. Accordingly the costs (outflows) for their energy are, $59Million for naturalgas, $1Million for maintenance, totally $60Million per year. Two times outflow considered in year 11and year 20, $20Million each. Total inflow per year: $100Million+$5Million=$105Million Total outflow per year (All except year 11 and 20): $59Millin+ $1Million=$60Million Outflow per year (year 11 and 20 only): $59Millin+$1Million+ $20Million=$80Million In an Outflow loaded on Excel. See Appendix B (Cash Flow Diagram See Appendix A)
2. The theory of the method used in the project is as follows:

Present worth of disbursements=present worth of receipts*(P/A, i*, N) or (P/A, i*, N) = Present worth of disbursements/ Present worth of receipts
3. As the assignment reference suggests methods used in this work are doing the problem

using the IRR feature in Excel. The principle of IRR method is analogous. This is when the project just breaks even. We will invest in any project that has IRR equal or exceeding the MARR. (The MARR of my project is accepted as35% according to reference) Next is shown excel calculation of NPV (Net Present Value) .Calculations include only positive cash flow without first payment or negative cash flow(formulae above could be used). For the purpose calculations 35% interest is used.
NPV(without first cost or how much we are willing to pay) $127,467,111.24 4. Tax credits consideration: It results from the fact that in taxed company the first cost

immediately gives rise to future tax savings as defined by the host countrys tax rules. In this particular case since we already know amount of 10 million tax deduction. The future cost(FV) translated as present worth( Present Worth Factor ) is used, because taxes are paid after one year ( end of the tax year).Therefore: P=$10000000(P/F, 0.35, 1) =$7407407.40

P first cost (used in the table) = $127467111.24 - $7407407.40=$120059703.80

Results and recommendations:

The case studies presented in diagrams and text show a classical project. This is a typical example repeated two times with different diagrams and charts, and provides us with a good sense what is happening within the project. The installation cost is negligible and is considered to take no significant time for the project. Case 1 and 2 have IRR higher than the MARR. Both cases could be used to answer what is the most that Dofasco should pay max for the equipment. The number that is in this analysis is $120000000, ($120Million) Cash flow Diagram (See Appendix A)

Case Study 1:
The interest rate at which curve cross the horizontal axis where Present Worth is zero (PW=0) is by definition the IRR. In this case I visualize with the included graph Fig.1 situation shown in Methodology part as Excel calculation. Theoretically could be explained as receipts are my annuities for 20 years equal to disbursements (which are my onetime first payment). It declares my effort to find out how much to pay for the equipment, tax credits subtracted, solely in order to solve the problem. P=$120059703.8 first cost used (See Appendix B)

IRR is 37%>MARR35%

Fig.1

Case Study 2:
This is the same case only difference is amount of the first payment(price of the equipment).The case is with less first payment than case study 1 which give as higher IRR=45% and bigger Present Worth .This case gives better and more stable project in long term regarding eventual future concussion. This case is another version to compare and see more clearly the situation in my view. Fig 2 visualizes the case. P=$120059703.8 first cost used (See Appendix B).

IRR is 45%>MARR35%

Fig.2

References:

Global Engineering Economics, Fourth Edition Fraser, Jewkes, Bernhardt, Tajima Engineering Economics EIT Review Cash Flow Evaluation Miller

Microsoft Office Excel, IRR, NPV Functions

Appendix A

PW (Do Nothing) =$100000000*(P/A, 0.35, 20) = $285007841.4

Cash Flow Diagram (Do nothing) $ 100M $ 100M $100M $ 100M $100M

$100M $100M $100M $100M

$100M

1 2 3 4 5 6 Cash7Flow Diagram 8 9 10 15 16 17 18 19 20 $45M $45M $45M $45M $45M $45M $45M $25M $45M $45M $25M

11

12

13

14

$45M $45M $45M

1 15

2 16

3 4 17 18 19

5 20

10

11

12

13

14

First cost (Equipment price)

$120Million

Table Shows how Fig 1 and 2 are made NPV($) as function of Interest Rate (interest rate)i $152,511,699.43 15% $91,861,708.20 20% $52,081,253.37 25% $24,198,179.42 30% $3,559,928.94 35% -$12,470,796.32 40% -$25,542,142.42 45% -$36,833,437.86 50% -$47,386,869.10 55% -$58,423,723.77 60%

Appendix B

Case Study 1: Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 In 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 Out -120059703.8 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -80000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -80000000 Cash Flow -120059703.8 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 25000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 25000000 Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Case Study 2 In 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 10500000 0 Out -107407407.4 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -80000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -60000000 -80000000 Cash Flow -107407407.4 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 25000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 45000000 25000000

IRR

37%

IRR

45%

Appendix C
CO-GENERATION CATCHING ON media, In a move mirroring recent operational initiatives at Medical Centre, Countryss largest steelmaker announced intention to study the introduction of hydro co-generation equipment at its sity operations. The spokesman H,s reported that Company, Countrys largest user of hydro, consumed just over $100 million in power last year. We have to consider our options with hydro costs spiralling out of control, he said. It estimates that it would be able to produce enough power to satisfy its own needs as well sell some surplus power to energy hungry users in the Sity area including rival Telco. While sketchy on specific costs, Smith indicated that operating the plant would involve hiring six new employees and natural gas would be the fuel of choice for generating steam to drive the turbines. Natural gas costs were estimated at $59 million a year while operating and maintenance manpower along with general power plant maintenance would cost approximately $1 million a year. In addition to satisfying The companys voracious appetite for power (it consumes some 1 megawatts per week), Smith indicated that energy sales could generate some $5 million dollars per year for The Company. In a related story, the Government today announced that tax credits would be available to companies considering the introduction of hydro generation equipment. The officials were confident that it might qualify for up to $10M in credits towards the purchase of equipment. The Company, as a matter of policy, demands that all capital projects return 35%. The power plant was estimated to have a life of 20 years and must be dismantled at a cost of $20M at that time. In addition, an overhaul must be performed sometime in year 11 to promote efficient operations at a cost of $20M. As The company starts down the road of inviting vendors in to provide project cost estimates, what is the most that The Co should pay for the installation of such a power plant to yield 35%? Make the decision based on:

1. Doing the problem long hand including a time diagram 2. Doing the problem using the IRR feature in Excel