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Benefit-cost Analysis
Incremental Analysis
Depreciation
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1. ENGINEERING ECONOMICS ANALYSIS
Definition
The economic analysis of costs, revenues and benefits occurring over time is called
engineering economic analysis
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1. ENGINEERING ECONOMICS ANALYSIS
In calculations
Receipts (Cash in): +ive sign
Expense (Cash out): -ive sign
Interest / Discount Used to move money through time for comparisons
Interest/ Discount rate(i) When interest is expressed as a percentage of the original
amount per unit time
Where,
P = Value or amount of money at a time designated as the
Present or time 0
F = Compound amount (the future value of money after n periods
of time at i interest)
i = Interest rate or Discount rate (%)
n = Return period
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2. TIME VALUE OF MONEY
Rs. 1,000 today will not be the same as Rs. 1,000 ten years from now
Receiving a dollar today is always worth more to you than receiving a dollar tomorrow.
REASONS:
2. Inflation:
The money received today, has more purchasing power than the money to be received in
future.
3. Consumption:
Individuals generally prefer current consumption to future consumption.
4. Investment opportunities:
An investor can profitably employ a rupee received today, to give him a higher value to be
received tomorrow or after a certain period of time.
you can use money to make more money!
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2. TIME VALUE OF MONEY
1. Expense or Receipts
2. When it occurs (by the end of year or so)
3. Magnitude
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2. TIME VALUE OF MONEY
Period = 4 Years
1 2 3 4
10,000
Total return = 3000 x 4 = 12,000 (Wrong)
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2. TIME VALUE OF MONEY
Compute
Interest
Interest rate
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2. TIME VALUE OF MONEY
Example-3: Suppose you loan a friend $5,000 for five years at the rate 8% per
year. How much your friend Pay you in period of 5 years?
1. By Simple interest F = P ( 1 + i . n)
= 5000 ( 1+ 0.08 . 5)
= $ 7,000
Comments
The amount earned by Compound interest is $ 347 more than that of by Simple
interest
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2. TIME VALUE OF MONEY
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2. TIME VALUE OF MONEY
or (F/P, i %, n)
or (P/F, i %, n)
or (P/A , i %, n)
or (F/A , i %, n)
Interest rate = 6%
?
Return period = 3 years
0
Future value = ?
1 2 3
12,000
F = 12,000 x ( 1 + 0.06 ) 3
F = $ 14,292
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2. TIME VALUE OF MONEY
1 2 3
?
P = 900 / ( 1 + 0.10 ) 3
P = $ 676.18
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2. TIME VALUE OF MONEY
Present value = ?
Formula
F = $ 262.43
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2. TIME VALUE OF MONEY
Present value = ?
Formula
F = $ 262.24
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3. NET PRESENT VALUE (NPV)
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3. NET PRESENT VALUE (NPV)
To convert a series of cost and benefits over a period of time in a one Equivalent
time value
If the net present worth = 0 then, The project earns exactly i% return
Its is also called Present Worth (PW), Present Value (PV), Discounted Cash Flow
(DCF)
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3. NET PRESENT VALUE (NPV)
Example:5 A friend needs $500 now, and will pay you back $570 in a year. Is
that a good investment when you can get 10% elsewhere?
This investment adds $18 to the value of than a 10% investment, in today's money
market, therefore accepted
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3. NET PRESENT VALUE (NPV)
EXAMPLE-6: Project investment = $ 10,000
2,500 4,000 5,000 3,000 1,000
Savings (Year - 1) = $ 2,500 0
Savings (Year - 2) = $ 4,000 2 3 4
1 5
Savings (Year - 3) = $ 5,000 10,000
Savings (Year - 4) = $ 3,000
Savings (Year - 5) = $ 1,000
Discount rate = 6%
Solution: We have to discount it to Time “0”
Select Single Payment Series
NPV = -1,25,000 + 17,000 (P/A, i%, n) – 15,000 (P/A, i%, n) + 25,000 (P/F, 8%, n)
NPV = - 125000 + (17000 x 7.5361) – (15000 x 7.5361) + (25000 x 0.3971)
NPV = -100,000 < 0
Minimum Attractive Rate of Return (MARR): It is a minimum rate the company will
accept on the money it invests
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3. NET PRESENT VALUE (NPV)
Select the alternative with PW value that is numerically largest, that is, less negative
or more positive.
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3. NET PRESENT VALUE (NPV)
Life, years 5 5 5
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Interest(i) = 10% 0
E.g.
0 0
1 2 3
1 2
Project-1 Project-2
1st cycle for proj-1 2nd cycle for proj-1 3rd cycle for proj-1 1st cycle for proj-2 2nd cycle for proj-2
2 yrs 2 yrs 2 yrs 3 yrs 3 yrs
0 0
1 2 3 4 5 6 1 2 3 4 5 6
Project-1 Project-2
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3. NET PRESENT VALUE (NPV)
1 2 3 4 5 6 1 2 3 4 5 6 7 8 9
15,000 3,500 18,000
3,100
Location-A
Location-B
LCM = ? Years
= 18 years
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3. NET PRESENT VALUE (NPV)
Example:9: Two lease options are available
1 2 3 4 5 6 7 8 10 11 12 13 14 15 16 17 18
18,000 9
18,000
3,100
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6. DEPRECIATION
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6. DEPRECIATION
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6. DEPRECIATION
Example-15
A company buys machinery for $20,000. The machinery has a salvage value of
$3,000 and an estimated useful life of 5 years.
Find a) Annual Depreciation, b) Book value after Year-1 & Year-3
Book value: Capital investment after total amount of depreciation to date have been subtracted
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6. DEPRECIATION
Accelerated method
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6. DEPRECIATION
Example-16:
A fiber optic testing device is to be DDB depreciated. It has capital cost of $25,000
and an estimated salvage of $2,500 after 12 years
Calculate the depreciation and book value for years 1 and 4
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