Engineering Economics Final

In a developing country, two alternatives are being considered for delivering water from a mountainous area to an arid area. A pipeline can be installed at a cost of $125 million;
major replacements every 15 years will cost $10 million. Annual O&M costs are estimated to be $5 million. Alternately, a canal can be constructed at a cost of $200 million; annual
O&M costs are estimated to be $1 million; upgrades of the canal will be required every 10 years at a cost of $5 million. Using a 5% MARR and a capitalized cost analysis, which
alternative should be chosen?
Pipeline

CC = $125,000,000 + [$10,000,000(A|F 5%, 15)+ $5,000,000]/0.05 = $234,268,000.00

 =125000000+ (PMT (5% , 15,,-10000000)+5000000)/0.05

= $234,268,457.52

Canal

CC = $200,000,000 + [$5,000,000(A|F 5%,10)

+ $1,000,000]/0.05 = $227,950,000.00

CC = 200000000+ (PMT (5%, 10,-5000000)+1000000)/.05

CC = $227,950,457.50

A contractor has been awarded the contract to construct a six-miles-long tunnel in the mountains. During the five-year construction period, the contractor will need water from a nearby stream.
He will construct a pipeline to convey the water to the main construction yard.

An analysis of costs for various pipe sizes is as follows:

Pipe Size
2 3 4 6
Installed cost of pipeline $22,000 $23,000 $25,000 $30,000
and pump.
Cost per hour for $1.20 $0.65 $0.50 $0.40
pumping

The pipe and pump will have a salvage value at the end of five years equal to the cost to remove. The pump will operate 2000 hours per year. The lowest interest rate at which the contractor is
willing to invest money is 7% (The minimum required interest rate for invested money is called the minimum attractive rate of return, or MARR.) Select the alternative with the least present
worth of cost.

SOLUTION:

We can compute the present worth of cost for each alternative. For each pipe size, the Present worth of cost is equal to the installed cost of the pipeline and pump plus the present worth of five
years of pumping costs.

MARR for corresponding pipes: PW for corresponding pipes

2" = 1.20(2000)(4.1002) = 9840.48 2" = 22000 + 9840.48 = 31840.48
3" = 0.65(2000)(4.1002) = 5330.26 3" = 23000 + 5330.26 = 28330.26
4" = 0.50(2000)(4.1002) = 4100.20 4" = 25000 + 4100.20 = 29100.20
6" = 0.40(2000)(4.1002) = 3280.16 6" = 30000 + 3280.16 = 33280.16

A Canadian company is considering adding a new product line that needed $80,000 of class 43 equipments (cca rate = 30%) and initial working capital of $55000. the product would have
production cost of $79,000 per year and revenue is $167000 per year. the product would be manufactured for 5 years and then discontinued. The working capital would then be fully recovered
(at the end of the last year) and the equipment sold $5000. Find the equilibrium uniform annual worth with MARR=10% and a tax rate of 29% (copied from page 408)

Solution:

t=0.29
d=CCA rate=0.30
i=MARR=0.10
(0.29)(0.30)
= 1 (+) = 1 ( ) = 0.7825
0.10+0.30
0.10
(1+ ) (0.29)(0.30)(1+ )
2 2
= 1 (+)(1+) = 1 ((0.10+0.30)(1+0.10) ) = 0.7924
55000
( ) = 80000 ( , 10%, 5) () + (167000 79000)(1 0.29) + 5000 ( , 10%, 5) () 5
( ) = 80000(0.26380)(0.7924) + 56800 + 5000(0.16380)(0.7825) 11000 = 29718.06
( ) = 29718.06

What is the total after-tax annual cost of a machine producing bolts with a first cost of $45,000 and operating and maintenance costs of $0.22 per unit per day? It will be sold for $4,500 at the
end of five years. Production volumes are 750 units per day. 250 days per year. The CCA rate is 30%, the after-tax MARR is 20%. And the corporate income tax in 2012 is 40%. (Consider the
Canadian Taxation System for your calculations. The formulation of the CTF and CSF factors is provided in chapter 8.8.3 and example 8.7 of the textbook.)
Solution:

Calculation of after tax Annual Cost:

0 1 2 3 4 5
Initial Investment
(P) $45,000
Operating &
Maintenance
Costs
(0.22/day) $41,250.00 $41,250.00 $41,250.00 $41,250.00 $41,250.00

Depreciation $13,500.00 $9,450.00 $6,615.00 $4,630.50 $3,241.35

Total Expense $54,750.00 $50,700.00 $47,865.00 $45,880.50 $44,491.35

Tax Savings on
depreciation $21,900.00 $20,280.00 $19,146.00 $18,352.20 $17,796.54

Net Salvage Value $5,725.26

After tax Annual

Cost $45,000 $32,850.00 $30,420.00 $28,719.00 $27,528.30 $20,969.55

Depreciation: Salvage Value:

Year Beginning Balance Depreciation Ending Balance Particulars Amount

1 $45,000.00 $13,500.00 $31,500.00 Selling Price $4,500.00

2 $31,500.00 $9,450.00 $22,050.00 Written Down Value $7,563.15

3 $22,050.00 $6,615.00 $15,435.00 Capital Loss $3,063.15

4 $15,435.00 $4,630.50 $10,804.50 Tax Savings on Capital Loss $1,225.26

5 $10,804.50 $3,241.35 $7,563.15
Net Salvage Value $5,725.26

Year 1 Year 2
Op. & Main costs = 0.22(750)(250) = Op. & Main costs = remains constant
Depreciation= 45000(0.3) = Depreciation= (45000 13500)(0.3) =
Total expense=41250 + 13500 = Total expense=41250 + 9450 =
Tax savings on dprction= 54750(0.4) = Tax savings on dprction=50700(0.4) =
Net salvage value= Net salvage value=
After tax annual cost=54750 21900 = After tax annual cost=50700 20280 =

A plant is considering the replacement of a piece of equipment in its materials handling system with a new piece. If the companys cost of capital is 10%. Should the present asset be kept or
replaced? State your recommendation. {TIP: calculate the EAC (Equivalent annual cost) of each of the two options } the following data are provided:

Present asset Replacement alternative

Present salvage value: $10.000 Capital cost: $200.000
Economic life: 1 Year Economic Life: 8 years
Next Years operating and maintenance costs: $51,000 Operating and maintenance costs:
Salvage value in one year: $5,000 o Years 1-2: $15,000 per year
o Years 3-4: $20,000 per year
o Years 5-6: $25,000 per year
o Years 7-8: $30,000 per year
Salvage value in 8 years: 25,000
Note: all calculations are approximated to the nearest $100
Option A= keep the old piece of equipment for one more year
Option B= buy the new piece and sell the old piece of equipment

Solution:
Present Asset: Option A

Particulars 0 1

Capital Cost $10,000.00

Operating & Maintenance Costs $51,000.00

Salvage Value $5,000.00

Cash Flows $10,000.00 $46,000.00

PVF @ 10% 1.000 0.909

Present Value $10,000.00 $41,814.00

Net Present Value $51, 814.00

Equivalent Annual Cost = Net Present Value/At,r
$51,814
= = $27,142.00
1.909

Replacement Alternative: Option B

Particulars 0 1 2 3 4 5 6 7 8

Capital Cost $200,000

Operating &
Maintenance
Costs $15,000 $15,000 $20,000 $20,000 $25,000 $25,000 $30,000 $30,000
Salvage
Value $25,000

Cash Flows $200,000 $15,000 $15,000 $20,000 $20,000 $25,000 $25,000 $30,000 $5,000
1 1 1
= (1+0.1)2
= (1+0.1)3
=
(1+0.1)
PVF @ 10% 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

Present
Value $200,000 $13,636.36 $12,396.69 $15,026.30 $13,660.27 $15,523.03 $14,111.85 $15,394.74 $2,332.54
Net Present Value: $302, 081.78

$302,081.78
= = = $47,685.13
6.335

To conclude, the present asset (option a) shall be kept because the equivalent annual cost is less if the present asset is retained.

A forecasted increase in metal prices has encouraged the Delta Resource Company to consider the expansion of the capacity in one of its mine operations in Northern Ontario. For this purpose,
the following after tax cash flow estimates have been made:

Existing capacity: positive after tax annual cash flows of $12.5 millions over the remaining 10- year mine life.

Expanded Capacity: $ 21.5 million capital expenditure now (time 0), followed by positive annual cash flows of $20 million over the remaining 8-year mine life.

(I) Determine the distribution of after-tax cash flows, as well as the rate of return associated with the considered incremental investment for expanding the production capacity.

(II) If the companys cost of capital is 30% and it is considering selling the mine, what should its minimum acceptable selling price be? What capacity option did you choose (existing or expanded)?
Explain your answer.

(III) What would your choice be (existing or expanded capacity if the ABC Resources companys cost of capital is 20%?) Explain your answer.

Solution:

(I) Rate of Return:

$20
= = = 93.02%
$21.5

(II) Calculation of Present Value Under Both Options:

Existing Capacity: Expanded Capacity:

Cash Flows Present Value Cash Flows Present Value
Year ($millions) PVF @ 30% ($millions) Year ($millions) PVF @ 30% ($millions)

0 $(21.50) 1.000 $21.50

1 $12.50 0.769 $9.62 1 $20.00 0.769 $15.38

2 $12.50 0.592 $7.40 2 $20.00 0.592 $11.83

3 $12.50 0.455 $5.69 3 $20.00 0.455 $9.10

4 $12.50 0.350 $4.38 4 $20.00 0.350 $7.00

5 $12.50 0.269 $3.37 5 $20.00 0.269 $5.39

6 $12.50 0.207 $2.59 6 $20.00 0.207 $4.14

7 $12.50 0.159 $1.99 7 $20.00 0.159 $3.19

8 $12.50 0.123 $1.53 8 $20.00 0.123 $2.45

 9 $12.50 0.094 $1.18 9 $20.00 0.094 $1.89

10 $12.50 0.073 $0.91 10 $20.00 0.073 $1.45

Present Value of Cash Flows $38.64 million Present Value of Cash Flows $40.33

Company will select expanded option because the present value of cash flows under this option is higher than present value of cash flows under existing option. The minimum selling price will
be $40.33.

Sample calculations for part (II):

Existing Capacity Expanded Capacity year 1

Year 1 Year 2 Year 1 Year 2
1 1 1 1
= 1+0.3 = 0.769 = (1+0.3)2 = 0.591 = 1+0.3 = 0.769 = (1+0.3)2 = 0.592
PV=12.5(0.769)=9.62 PV=12.5(0.592)=7.4 PV=20(0.769)=15.38 PV=20(0.592)=11.83

= =

(III) Calculation of Present Value Under Both Options:

Existing Capacity: Expanded Capacity:

Present Present
Cash Flows PVF @ Value Cash Flows PVF @ Value
Year ($millions) 20% ($millions) Year ($millions) 20% ($millions)

0 $(21.50) 1.000 $21.50

1 $12.50 0.833 $10.42 1 $20.00 0.833 $16.67

2 $12.50 0.694 $8.68 2 $20.00 0.694 $13.89

3 $12.50 0.579 $7.23 3 $20.00 0.579 $11.57

4 $12.50 0.482 $6.03 4 $20.00 0.482 $9.65

5 $12.50 0.402 $5.02 5 $20.00 0.402 $8.04

6 $12.50 0.335 $4.19 6 $20.00 0.335 $6.70

7 $12.50 0.279 $3.49 7 $20.00 0.279 $5.58

8 $12.50 0.233 $2.91 8 $20.00 0.233 $4.65

9 $12.50 0.194 $2.42 9 $20.00 0.194 $3.88

10 $12.50 0.162 $2.02 10 $20.00 0.162 $3.23

Present Value of Cash Flows $52.41 Present Value of Cash Flows $62.35

Company will select expanded option because the present value of cash flows under this option is higher than present value of cash flows under existing option. The minimum selling price will
be $62.35.

Sample calculations for part (III):

Existing Capacity Expanded Capacity year 1

Year 1 Year 2 Year 1 Year 2
1 1 1 1
= 1+0.2 = 0.833 = (1+0.2)2 = 0.694 = 1+0.2 = 0.833 = (1+0.2)2 = 0.694
PV=12.5(0.833)=10.42 PV=12.5(0.694)=8.68 PV=20(0.833)=16.67 PV=20(0.694)=13.89

= =

An industrial drill costs $60.000 to purchase and $10,000 to install seven years ago. The market value now is $33.000 and this will decline by 12% of current value each year for the next 3 years.
Operating and maintenance costs are estimated to be $3400 this year, and are expected to increase by $500 per year. How much should the EAC (Equivalent annual cost) of a new drill be over
its economic life to justify replacing the old one sometime in the next three years? The MARR is 10%.

Solution:

0 1 2 3

Capital Cost $33,000.00

Operating & Maintenance
Costs $3,900.00 $4,400.00 $4,900.00
 Total Cost $33,000.00 $3,900.00 $4,400.00 $4,900.00

PVF @ 10% 1.000 0.909 0.826 0.751

Present Value $33,000.00 $3,545.45 $3,636.36 $3,681.44

= $43,863.26

$43,863.26
= = $12,579.62 Note: The depreciation is not considered because the tax rate was not given.
3.487