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Engineering Economics ENGR 3300

Engineering Economics ENGR 3300. Department of Mechanical Engineering Inter American University of Puerto Rico Bayamon Campus Dr. Omar E. Meza Castillo omeza@bayamon.inter.edu http://www.facultad/ b ayamon.inter.edu/ omeza. Present Worth Analysis. Bank Loan vs. Investment Project.

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Engineering Economics ENGR 3300

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  1. Engineering Economics ENGR 3300 Department of Mechanical Engineering Inter American University of Puerto Rico Bayamon Campus Dr. Omar E. Meza Castillo omeza@bayamon.inter.edu http://www.facultad/bayamon.inter.edu/omeza

  2. Present Worth Analysis

  3. Bank Loan vs. Investment Project

  4. 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.

  5. Identifying Project Cash Flows

  6. 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.

  7. 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

  8. Payback Period: The time it 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

  9. Convectional Payback Period • Consider the cash flows given in the example of Computer Process Control System. Determine the payback period.

  10. Convectional Payback Period with Salvage Value Example 5.3

  11. $45,000 $45,000 $35,000 $35,000 $25,000 $15,000 Annual cash flow 0 1 2 3 4 5 6 Years $85,000 150,000 3.2 years Payback period 100,000 50,000 Cumulative cash flow ($) 0 -50,000 -100,000 0 1 2 4 5 6 3 Years (n)

  12. 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.

  13. Benefits and Flaws of Payback Screening Investment Cash Flows for Two Competing Projects

  14. Discounted Payback Period • Is the number of years required to recover the investment from discounted cash flows.

  15. Present-Worth Analysis

  16. Present-Worth Analysis

  17. Present-Worth Analysis

  18. PW(i) > 0 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. Inflow 0 1 2 3 4 5 Outflow Net surplus PW(i) inflow 0 PW(i) outflow

  19. Net Present Worth: Uniform Flows

  20. Net Present Worth: Uniform Flows

  21. Net Present Worth: Uneven Flows

  22. Net Present Worth: Uneven Flows inflow $55,760 $27,340 $24,400 0 3 1 2 outflow $75,000

  23. Present Worth Amounts at Varying Interest Rates

  24. 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.

  25. Net Future Worth: At the End of the Project

  26. Net Future Worth: At the End of the Project

  27. Net Future Worth: At the End of the Project

  28. Project Balance Concept N 0 1 2 3 Beginning Balance Interest Payment Project Balance -$75,000 -$11,250 +$24,400 -$61,850 -$61,850 -$9,278 +$27,340 -$43,788 -$43,788 -$6,568 +$55,760 +$5,404 -$75,000 -$75,000 Net future worth, FW(15%) PW(15%) = $5,404 (P/F, 15%, 3) = $3,553

  29. Project Balance Diagram 60,000 40,000 20,000 0 -20,000 -40,000 -60,000 -80,000 -100,000 -120,000 Terminal project balance (net future worth, or project surplus) $5,404 Discounted payback period Project balance ($) -$43,788 -$61,850 -$75,000 0 1 2 3 Year(n)

  30. 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)

  31. Capitalized-Equivalent Worth

  32. Capitalized-Equivalent Worth

  33. Homework 3  www.bc.inter.edu/facultad/omeza

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