Question 1:

The astral company is considering investment in a project with first cost of

$60,000 that should be available now together with amounts of $40,000 and
$20,000 that required by the end of 1st and 2nd years respectively. The annual net
receipt of $20,000 by the end of 3rd year. the annual net receipts of the project , after
the first one ,are expected to increase uniformly by $10,000 every year till the end
of the 7th year , then remain constant till the end of 11th year . After this it decreases
at the rate of 20% every year till the end of the 15th year (i.e. the net receipt of a year
is equal to 80% of that of the previous year). The minimum attractive rate of return
of the astral company is 18%, and the prevailing interest rate, is=12% interest in all
cases is compounded continuously.
(a) Sketch the project cash flow diagram.
(b) From the view point of the astral company evaluate the following items for the
project:
(i) Present – worth, pw.
(ii) Payout period.
(c) When the same project is considered by golden star company ,with minimum
attractive rate of return of 25% the ene ineers of that company found that the
project has a present – worth of -$17,457.35 (a negative value). Do you
believe that? if you do determine the approximate value of the internal rate
,IRR,of the project ; if you don't explain why?
(d) Do you recommend any of the two companies: the astral Co or golden star Co.
to invest in this project? Why? Give at least three reasons.

Solution :
(a): the cash flow diagram of the project as shown below :

15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0

(b)
i) From the view point of astral company the present worth pw,is given as
Pw(18)=-60000-40000[p/f 18,1 ]-20000[p/f18,2]+[20000+1000[A/G 18,5 ]]
[p/A18,5]
[p/f 18,2]+60000[p/A18,4] [p/f 18,7]+48000[p/f 18,12]+

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 38400[p/f 18,13] +30720[p/f 18,14]
+24576[p/f 18,15]
Pw(18)=-60000[0.83527]-20000[0.69768]+[20000+1000[1.64496][3.00902]
[0.169768]+60000[2060245]
[.28585]+48000[.11533]+38400[.09633]+30720[0.08046]+24576[0.06721]=$273
64.236

ii) From the cash flow diagram the payout period pois given as
n=6 years
total cost=60000+40000+20000=$120000

(c)
For golden star company with MARR 25%
The present worth of the project pw(25)is calculate as:
Pw(25)=-60000-40000[p/f 25,1 ]-20000[p/f25,2]+[20000+1000[A/G 25,5 ]]
[p/A25,5]
[p/f 25,2]+60000[p/A25,4] [p/f 25,7]+48000[p/f 25,12]+
38400[p/f 25,13]+30720[p/f 125,14]
+24576[p/f 25,15]
Pw(25)=$-41911.27512
We don’t belive that because that interst rat is high and produce more cost in the
beginning in first project

Pw(18)=27364.236
Pw(25)=-41911.27512
Using the linear interpolation we get
i*-18 =0.0-27364.236
25-18 -41911.27512
i*=22.5%

d) I recommend the project for astral company only

for this reasons
i)IIR>MARR
ii)pw(18)>0.0
ii)result pay out period n=6 years:

Q (3):
The present worth of a certain investment proposal is given as:
PW (i) = -$1500 + $570(p/A i/n) – $ 500(A/G i/4)(p A i/4)(p/F i/4) + [$500 + 100$
(A/G i/4)](F/A i/4)(p/F i/12)
1. Sketch the cash flow diagram of this proposal
2.Determine the present –worth ,PW(i), at the following Interest Rates :
(i) i = 0.0%
(ii) i → ∞
(iii) i = 15%

Solution:
1)

2
2)
(i) i=0.0% ,that means time has no impact on value of money and the different payment
through all the period can be assumed to be happening at the present time.
PW (0) = -$1500 + 5*$570 - $3000 + 2*$1300 = $950

(ii) i→∞ ,that means all the future payments are expected to be zero know .
PW (∞) = Fj0 = -$1500

(iii) PW(15) = -$1500 + $570(P/A 15 ,5) - $500(A/G 15 ,4)(P/A 15 ,4) (P/F

15 ,4 A/G 15 ,4 F/A 15 ,4 P/F 15 ,12
) + [$500+$100( )]( )( )
(P/A i ,n) = (1+i)ⁿ-1
i(1+i)ⁿ
P/A i ,n
( ) = ((1.15)^5)-1 = 3.3525
0.15(1.15)^5
A/G i ,n
( ) = {1/i-n/((1+i)ⁿ-1))}
(A/G 15 ,4) = {1/0.15-4/(1.15^4)-1)} = 1.32626
(P/A 15 ,4) = (1.15^4)-1 = 2.85497
0.15(1.15)^4
P/F i ,n
( )= 1/(1+i)ⁿ
(P/F i ,n) = 1/1.15^4=0.57175
(F/A i ,n) = (1+i)ⁿ-1
i
(F/A 15, 4) = (1.15^4) -1 = 4.9937
0.15
(P/F 15, 12) = 1/1.15^12 = 0.18691
PW (15) = -$1500 + $570(3.35215) - $500(1.32626)(2.85498)(0.57175) +[$500+
$100(1.32626)](4.99337)(0.18691) = -$81.220
The old problem solution was -$81.288
The percentage error = revised result – old result = 0.083%
old result
Q.1:

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 The Astral company is considering investment in a project with first cost of $
60,000 that should be available now, together with amounts of $40,000 and $20,000
that required by the end of and 2nd years, respectively .The project results in a first
net receipts of $20,000 by the end of 3rd year .The annual net receipts of the
project, after the first one ,are expected to increase uniformly by $10,000 every year
till the end of the 7th year ,then remain constant till the end of 11th year .After this it
decreases at rate of 20% every year till the end of the 15th year (i.e the net receipt of
a year is equal to 80% of the previous year ).The minimum attractive rate of return
of Astral company is 18% ,and the prevailing interest rate ,is =12%.Interest in all
cases is compounded continuously .
a) Sketch the project cash flow diagram.

MARR=18% compound continuously.

b) From the viewpoint of the Astral Company evaluate the following items for the
project:
1. Present –Worth ,PW

P1(18) is the net present deposits for the investment

P1(18)= - (60,000 + 40,000[P/F 18,1] + 20,000[P/F 18 ,2])
= - $107,365.2243
P1(18)= - (60,000 + 40,000(0.8352) + 20,000(0.6977))
P2(18) is the net present – worth from the receipts at 3rd till 7th year
P2(18)={A0 +G[A/G 18, 5]}[P/A 18 5][P/A 18 ,2]
P2(18)= {20,000 +10,000[1.64496]}[3.00902][0.6977]
= $76,522.0173
P3(18) is the net present – worth from the receipts at 8t till the 10th year
P/A 18 ,3 P/F 18 ,7
P3(18)=A3[ ][ ]
But
A3=A0 + G(n-1)
= 20,000 +10,000(4)
= $60,000
P3(18)=60,000[2.1157][0.2837]
=$36,013.4454
P4(18) is the net present – worth from the receipts at 11th till the 15th year

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 P4(18)= 60,000{ [P/F 18, j+1]}[P/F 18, 10]

=60,000 { }. [0.1653]

=$21,642.2487
The total Present – Worth is

Pw(18)=-P1 + P2 + P3 + P4
= $26,812.4871

2. The payout period

From the figure above

Time The net amount $

0 -60,000
1 -100,000
2 -120,000

3 -100,000
4 -70,000

5 -30,000

6 20,000

From the table n is between 5,6

Using linear interpolation

= 5.6 yr.

c) When the same project is considered by Golden Star Company, with minimum rate of
return 0f 25% ,The engineers of that company found that the project has present –
worth of -$17,457.35 .Do you believe that? If you do, determine the approximate
value of the internal rate, IRR, of the project .If you don’t explain why?
Pw =(25=

=-103,282.6444 + (20,000+10,000(1.51306)(2.51208)(0.60653) +
(60,000(1.8720)(0.0821)
=-$40,519.026
The present worth is larger than the given value but it is possible

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 The IRR is given by
Pw(18)=26,812.4871
Pw(25)=- 40,519.026
Pw(IRR)=0

IRR=25 +

IRR= 20.7875%
 The calculation is not absolutely right but it gives a sign for the
investment opportunity ,since MARR>IRR

d) Do you recommend any of the two companies: Astral Co. or Golden Star Co. to
invest in this project? .Why? Give at least three reasons.
I recommend the project for the Astral Co because of
1. MARR>IRR.

2. Pw(18)>0 .

3. The payout period is reasonable.

Comment on the revised solution:

 We have detected an error in the solution, when the first receipt is considered
$30,000 rather than $20,000 and gradient is $5,000 rather than $10,000.

 We have proved the equation for non-uniform gradient ,which used in 12th to
15th year:

P10 =F1 +……..

=F1

=F1

= F1

 Although, the given calculation is not absolutely right in section c above ,

the decision was the same as given . This is due to the similarity in the sign
of the solutions.

PROBLEM
An engineering project with an initial cost of $55,000 yield a net annual receipt
of $10.000 for 10 year is considered for investment when the minimum attractive
rate of return MARR is 15%

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 a)Determine the payout period and the internal rate of return of this project.
b) Sketch the present-worth PW (i) versus interest rate , i , for the project
c) Do you recommend investment in this project? Why?

Solution:
From the definition of the (PAY OUT) period :
(PAY OUT) period of the project = 6 years .
To find the value of IRR I * That sets the present-worth
0=PW(i) = -55,000+10,000 ( P / A i ,10 )
55,000
(P/ A 12 ,10
) =  5.5
10,000
From tables we found :
( P / A 13,10 ) = 5.4262
( P / A 12 ,10 ) = 5.6502
By interpolation:
 5.6502  5.5 
I * = 10% +  * 1%
 5.6502  5.4236 
>>> I * = 10.67 % Which is internal rate of return

b)

C) we don’t recommend investment in this project because the value of interest rate
calculated above is less than the value of MARR .

Example (1.6):
Part (a):
When the selling price of a certain commodity is 15 KD , 30,000 units are
demanded . Taking this as the initial condition in all cases and assuming an
elasticity of demand:

7
 (1)E D = 1.0
(2)E D =5.0
Determine the quantity demand for each of the following selling prices P=16, 17,
18, 19
and 20 KD and sketch the demand curve.
b) If the unit production cost of the commodity is 13.5. Determine the point of
diminishing returns for the selling price in this case.
c) What is the selling price in the present case? Why?

Solution:
(1)E D =1.0
|Q| |P|
a) E D = /
Qh Ph
|P|
|  Q|=E D Q h
Ph
P 1 =15 and Q 1 =3,0000 units
|P|
|  Q|= (1) (3,0000)
Ph
Q 2 =Q L =Q h -|  Q|=3,0000-|  Q|
(i)P 2 =16 KD
|  P|=|16-15|=1 KD
(3,0000)(1)
|  Q|= =1,875 units
(16)
Q 2 =3,0000-1875=28,125 units
(ii) P 2 =17 KD
|  P|=2 KD
(3,0000)(2)
|  Q|= =3,529.4118 units
(17)
Q 2 =3,0000-3,529.4118=26,470.588units

(iii) P 2 =18 KD
|  P|=3 KD
(3,0000)(3)
|  Q|= =5,000 units
(18)
Q 2 =3,0000-5,000=25,000 units

(iv)P 2 =19 KD
|  P|=4 KD
(3,0000)( 4)
|  Q|= =6,315.7895 units
(19)
Q 2 =30000-6,315.7895=23,684.210 units

(v)P 2 =20 KD
|  P|=5 KD

8
 (3,0000)(5)
|  Q|= =7,500units
(20)

Q 2 =30000-7,500=22,500 units

Part (b):
Total Profit= Quantity demanded * Profit per unit
To determine the point of diminishing returns the following table is constructed:

Selling price Profit Per unit Quantity Demanded Total Profit

(KD) (KD/unit) (units) (KD)
15 1.5 30,000 45,000
16 2.5 28,125 70,312.5
17 3.5 26,470.6 92,647.1
18 4.5 25,000 112,500
19 5.5 23,684.2 130,53.1
20 6.5 22,500 146,250

The maximum profit is 146,250 KD and it has occurred at at a selling price of 20

KD

Part(c):
At the worst selling price Q 2 drops to zero
|P|
30,000-(3,0000) =0.0
Ph
|P|
(3,0000) =30,000
Ph
P h =P L + |  P|=15 + |  P|

(30,000) |  P |
=30,000
15 | Ph |
(30,000)|  P| = 450,000+30,000|  P|
450,000 = 0.0
Which is impossible and this means that the worse price is an imaginary number ,
therefore it is assumed that the worse selling price is 13.5 KD

(2)E D =5.0
|Q| |P|
a) E D = /
Qh Ph
|P|
|  Q|=E D Q h
Ph
P 1 =15 and Q 1 =3,0000 units
|P| |P|
|  Q|= (5) (3,0000) =150,000
Ph Ph
Q 2 =Q L =Q h -|  Q|=3,0000-|  Q|
(i)P 2 =16 KD

9
|  P|=|16-15|=1 KD
(150,000)(1)
|  Q|= =9,375 units
(16)
Q 2 =3,0000-9,375=20,625 units
(ii) P 2 =17 KD
|  P|=2 KD
(150,0000)( 2)
|  Q|= =17,647.0588 units
(17)
Q 2 =3,0000-17,647.0588 =12,352.94 units

(iii) P 2 =18 KD
|  P|=3 KD
(150,0000)(3)
|  Q|= =25,000 units
(18)
Q 2 =3,0000-25,000 =5,000 units

(iv)P 2 =19 KD
|  P|=4 KD
(150,0000)( 4)
|  Q|= =31,578.95 units
(19)
Q 2 =30000-31,578.95= -1,578.95 units

(v)P 2 =20 KD
|  P|=5 KD

(150,0000)(5)
|  Q|= =37,500 units
( 20)

Q 2 =30000-37,500= -7,500 units

* Note:
Negative values for the quantity of demand (Q 2 ) are not acceptable that is why
they’ll be considered to be zero when calculating the total profit.

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Q. 3
The present-worth of a certain investment proposal is given as:
PW(i) = −$1500 + $570(P/A i,5) − $500(A/G i,4)(P/F i,4)
+[$500 + $100(A/G i,4)](F/A i,4)(P/F i,12)
a) Sketch the cash-flow diagram of this proposal.
b) Determine the present-worth PW(i) , at the following interest rates:
(i) i = 0.0%
(ii) i → ∞
(iii) i = 15%

Solution:-
a)

b)

i) PW(0) = −$1500 + (5)($570) − $3000 + (2)($1300) = $950

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 ii) PW(∞) = Fj0 = −$1500

iii) PW(15) = −$1500 + $570 (P/A 15,5) − $500 (A/G 15,4)(P/A 15,4)(P/E 15,4)
+[$500 + $100(A/G 15,4)](F/A 15,4)(P/F 15,12)

= −$1500 + $570 (3.35215) − $500 (1.32626)(2.85498)(0.57175)

+[$500 + $100(1.32626)](4.99337)(0.18691)

= − $81.288

Exam 9.2
The Morphy Corporation is now considering two plans for constructing one of its
New petrochemical plants. The two plans will result in the same income per year at
all times. The "X" is to build a half-size plant now at a first cost ,P x ,of 2.5$
millions and a comparable operating cost of 700,000$ per year for the 3 years. This
operating cost includes charges for renting other facility so as to me et the required
demand. At the end of the third year an additional costing of 1.4$ millions will be
installed to double capacity. Costs thereafter are 460,000 per year.
Plan "Y" is to build a full-scale plant now at a cost of 3.75$ millions with operating
costs C y of 520,000$ per year for the first 2 years and [C y +30,000$] per year
thereafter.
(I) If money can be invested at a nominal rate of 15% compounded
continuously and a period of 12 year ahead is the base for a comparison,
which plan do you recommend for the Morphy Corporation?
(II) What would be the first cost , P y ,of the plan "Y" for the two plans to
break-even?
(III) Determine the annual operating cost ,C y of plan "Y" which results in a
break-even.
Plan X:

12
 (TEA) x ={2.5  10 6 +1.4  10 6 + 7  10 5 +4.6  10 5
 P / F 15 , 3   P / A 15 , 3 
0.63763 2.23915
   
 P / A 15 , 9   P / F 15 , 3  }  A / P 15 , 12 
 4.57727  0.63763 0.19388
     
=[2.5  10 6 +892,682+1,567,405+1,342,558.1](0.19388) =1,221,956.8$

Plan Y:

={3.75  10 6 +5.20  10 5  10 5
 P / A 15 , 2   P / A 15 , 10 
(TEA) y 1.60153 +5.5
 
4.80041
 
 P / F 15 , 2   A/ P 15 , 12

0.74082
} 0.19388
 
=[3.75  10 6 +832,795.6+1,955,931.9](0.19388)=1,267,728.50$

Since (TEA) x  (TEA) y  Recommend Plan "X"

Section (II): Assume the first cost of plan Y is P y . For the 2 plans to break-even ,
we have (TEA) y =(TEA) x or:
 A / P 15 , 12 
[P y +2,788,727.5] 0.19388
 
=(TEA) x =1,221,956.80$
P =1,221,956.80 / 0.19388 – 2,788,727.50 = 3,513,917.50$
y

Section (III): Assume the annual operating cost of plan Y is C y . For the 2 plans to
break-even , we have : (TEA) y =(TEA) x or :
[3.75  10 6 +C
 P / A 15 , 2   P / A 15 , 10   P / F 15 , 2   A/ P 15 , 12

y 1.60153 +(C y +30,000) 4.80041 0.74082 ] 0.19388
     
=(TEA) x
Or
[3.75  10 6 +106,687.19+(5.15777) C y ](0.19388) =1,221,,956.80

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5.15777 C y =1,221,956.80 / 0.19388 – [3.75  10 6 +106,687.19]
 C y = 474,227.77$

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