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If a depositor places Rs . 1000 in a bank account that pays 7% interest per year. After 10 years, Rs

1967.15 be the expected amount as a result of interest paid and compounded over 10 year period.

Thus 7%/year is the depositors time value of money

Business Concept

Business owners also have a time value of money. A business may have profits this year and the

owners must decide what to do with these profits like investing in expanding the profits, deposit in

bank account for interests, distributed to other owners of the business for expansion etc.

The merits of these alternatives rest on how the business views its time value (or cost) of money.

Time value money is the opportunity cost of capital for the business or discount or present worth

rate.

For electric utilities, the time value of money can be computed by examining the cost of investment

capital or simply cost of money.

The cost of money is the weighted average composite interest cost of bonds, the yield rate of new

investment, and the rate of return on common stock offerings by the utility. These components can

be combined into a term called discount or present worth rate

Time value of money contd..

For example, a utility could finance its new offerings as follows:

50% with bonds at an interest of 7%

10% with preferred stock and a dividend yield of 11%

40% with common equity offerings that are expected to achieve a 15% return

The composite cost of capital for new financing would be 10.6% per year

(0.5 x 0.7 + 0.1 x 0.11 + 0.4 x 0.15 = 0.106)

In economic analysis studies, this composite cost of the new capital

would be the discount rate or time value of money to the utility.

Some utilities use an after tax discount rate such as the following,

Discount rate = (1 t) x b x B + p x P + c x C

t = incremental income tax rate

b = bond or debt interest rate per year (% / year)

B = fraction that is debt financed

p = preferred stock dividend rate (% / year)

P = fraction that is preferred stock financed

c = common stock equity rate

C = fraction that is financed by common stock

Interest Factors

Single payment Interest Factors

Compound Interest Factor (CIF)

Present Value Factor (PCV)

Uniform Series Factors

Uniform Series (Present Worth) Factor

Capital Recovery Factor (CRF)

Compound Amount Factor (CAF)

Sinking Fund Factor (SFF)

Uniform Annual Equivalent of an Inflation Series

Compound Interest Factor

Given P, find F (at n years in the future)

= (1 + )2

=

As an example of single payment compounding, suppose that an investor has Rs.

1000 in hand, and if he deposits the same in bank for interest rate of 7% p.a.,

then after 10 years,

= (1 + 0.07)2 = 1.96715,

= = . 1967.15

In engineering economic analysis, the inverse of CIF finds extensive application

and is called Single-Payment Present Worth Factor or Present Value Factor. For

this factor, a future amount in year n of value F is known and the objective is to

find the value of amount at time zero, P.

The present value factor, is the inverse of the compound interest factor

Present Value Factor (PVF)

Given F (at n years in the future ) find P,

1

=

(1+)

1

= . =

As an example of single payment discounting, suppose that an investor wants to have Rs.

1000 in savings account 5 years from now and the bank is paying7% compound interest,

to calculate the single payment,

That is Rs. 712.99 has to be deposited for 5 years in order to have Rs. 1000, (the interest

rate is 7% p.a.)

Uniform Series Present Worth Factors

In economic analysis, there often exists uniform series of annual payments (annuity) that extend from today through n

years. To compute, the present worth for the uniform annual series of payments, a convenient formula can be derived as

illustrated,

The formula is computed by calculating the present worth of each one of the annual payments by discounting it back to

time zero, as shown below,

= + + + + -------- (1)

(1+) (1+)2 (1+)3 (1+)

(1 + ) = + + ++ ------- (2)

(1+)2 (1+)3 (1+)

=

(1+)

(1+) 1

= =

(1+)

As an example, an investor might want to know the equivalent payment, or one-time payment, that is the same as making

equal payments into a savings account on a regular basis. Suppose that Rs. 100 is saved on the last day of the year for 10

years in a savings account, that pays 6% interest. What is the present worth equivalent amount? The amount is,

= 7.36009 100 = . 736.01

Capital Recovery Factor

CRF, finds equivalent value of a future annuity given the present cash equivalent. This is noted in

equation below (1), where CRF is merely inverse of the uniform series present worth factor as

shown (1) and (2).

(1+)

= = CRF P

(1+) 1

1 (1+)

= =

(1+) 1

As an example of CRF calculation, assume that the interest rate is 10% for 30 years The CRF of

equation (2) can then be calculated. Thus Rs. 1 today is equivalent to 0.10608 rupees per year for

the next 30 years, assuming a discount rate of 10% per year. Given P, find R for n years

0.1(1.1)30

= 30, = 10%, = = 0.10608

(1.1)30 1

= . 1,00,000

= 0.10608 1,00,000 = . 10,608 . .

Compound Amount Factor (CAF)

The CAF calculates the future worth of a uniform series. The CAF helps to determine what future

amount an investor would have if equal amounts R were placed in a savings account at the end of

each year for N years. The CAF is the product of

= =

1+ 1 1+ 1

= (1 + ) =

1+

1+ 1

CAF = Compound Amount Factor =

The CAF helps one determine how much money can be saved by regularly putting equal amounts

into a savings account. Suppose that Rs. 100 is saved at the end of each year for 10 years in a

Savings account that pays 6%. On the same day the last payment is made, the saver will have

10

1 + 0.06 10 1

= (1 + 0.06) 10

100

0.06 1 + 0.06

= 13.18079 100 = . 1,318.08

Sinking Fund Factor (SFF)

The SFF is uniform series interest factor. In this case, a future payment is given and the objective is to

calculate the value of an annuity in order to accumulate a future cash equivalent.

The formula for the SFF can be calculated using the CAF or the results of CRF formula. A recurring annuity

has a present worth equal to P, the present cash equivalent times the CRF; P is equal to Present Value Factor

PVF times the future value, as shown in the equation (1). Thus sinking fund factor is merely equal to the

present-value factor times the capital recovery factor as shown in equation (2),

= = =

1 1+ 1

= = = = ----- (1)

1+ 1+ 1 1+ 1

= ----- (2)

1+ 1

The SFF tells the saver how much money must have put into a savings account each year (a sinking fund) in

order to have a given amount at the time the last payment is made. For example, a mortgage bonds with a face

value of Rs. 1000, must be redeemed in 20 years. How much money should be put into a savings account at the

end of each year to meet that bond commitment if the savings account pays 7%?

1 0.07 1 + 0.07 20

= 1000 = 0.02439 1000 = . 24.39

1 + 0.07 20 1 + 0.07 20 1

Economic Evaluation

A business enterprise participating in a free-market system attempts to maximize

its profit over a long-term period.

In most cases, this method of conducting business encourages competition and

assures that consumers and society receive the greatest benefits in terms of the

lowest acceptable price for standards of product quality.

An electric utility, however, is granted a monopoly franchise within a service

territory subject to the condition that its rates be regulated in a manner that

allows a fair and reasonable return on its investment

The electric utility must charge the lowest electric rates possible consistent with

providing an acceptable rate of return on its investment and an acceptable

quality of electric service

A business enterprise in a free-market system and an electric utility have

distinctly have different business objectives, and their economic evaluation

methods are markedly different.

Electric utility economic evaluation methods

For a competitive business enterprise, the widely used economic evaluation method is

discounted cash-flow rate-of-return method. In this method, all of the cash flows are examined

for each alternative through the time horizon of the evaluation (several different present worth

rates).

For each alternative, the cash flows are discounted at several different present-worth rates. That

discount rate which results in the future cash flows equalling the initial investment is called the

discounted cash-flow rate of return.

The project with the highest discounted cash-flow rate of return is considered the best choice. All

projects that have a discounted cash-flow rate of return that exceeds the cost of money are worth

while projects (ignoring investment risk).

For regulated utilities, the economic evaluation method most widely used is called the

minimum-revenue-requirement method. Because the utility is regulated, the rate of return on

any investment is determined based on the allowed regulated return on investment.

Another evaluation method, the investment-pay-back-method is used by both utility and free

market enterprises for scoping analysis.

The pay-back method is simply calculated as the number of years required for the net benefits to

equal the initial investment.

Economic evaluation contd.

The primary objective of the economic analysis of power projects is to determine the cost of

generation / transmission at their true resources cost to the economy as the financial cost of the

generation / transmission may not reflect the true cost of power to the economy on account of

distortion inherent in the market prices.

While working out the economics, cost of generation / transmission, both the costs and power

generated have to be valued at their true resources cost.

This process involves removal of taxes and duties from their costs as they are not the costs to the

society. Similarly subsidies are also not taken into account as they are only transfer payments.

Coal, fuel oil or other liquid fuel oils have to be valued at their resources cost which may be the

economic cost of production plus transportation cost and international prices in case of gas or

petroleum fuels. Apart from adjustment in the costs, the economic analysis also covers the impact of

the proposed project on the power system.

Efforts should be made to bring out the possible reduction in operating costs for the rest of the system

on account of addition of the proposed project.

Economic Comparison is usually best made on the basis of present worth economics and accounting

for all costs to ascertain total cost of ownership.

Contd,

The life cost of the system consists of

Capital cost or fixed cost (cost of land, building, machinery installation)

Working capital

operating cost (mostly cost of electrical loss and maintenance)

Interest

Insurance

The truly optimized project is one in which the total lifetime cost is

minimized (for example in case of overhead transmission lines conductor

selection, bundling, tension, effects of terrain, structure configuration and

design all have great potential for cost saving).

For an estimation of the specific energy cost / unit of electricity generated

(expressed in Rs/kWh), the following additional parameters have to be

specified:

The rate of discount (in per cent) as determined by the regulatory body

The systems total lifetime (in years)

The annual electricity production (in kWh)

Contd,

In first step, If these parameters are known, then the initial investment costs can

easily be transformed into annual costs.

In a second step, summed up to the current costs (O & M) to get the total

generation costs for the power plant. The first step is done by means of the

conversion factor (CF)

(1+)

= , = , =

(1+) 1

In the last step, total generation costs have to be divided by the annual electricity

production (provided this is constant)in order to receive specific energy cost,

which then can easily be compared to the respective cost figure of conventional

energy system (eg. Thermal, diesel generation).

To keep the calculation effort minimum, the cost comparison should always be

conducted in real terms, i.e. all costs should be measured in constant prices

prevailing at the beginning of the investment period, and the discount rate used

to determine the CF should be a real discount rate.

Benefit-Cost Analysis

It is method for determining the economic justification of a power project

Compute Benefit Cost ratio (B-C Ratio) - Benefits are defined to mean all

the advantages, less any disadvantages to the utility, consumers and public.

The time frame must be clearly specified to list out all cost and benefits for

each year over the life cycle

Comparison of various projects for final selection of an economical project

(Generation or Demand side projects)

The B.C. ratio must be more than one for a worthwhile scheme

,

. . =

The benefits and cost present, or equivalent annual amount are computed

using the rate of discount.

Many benefits which embrace valuable benefits also result in inexcapable

disadvantages.

Contd

Rural electrification in India is done in contrast to the view of private

enterprise which evaluates the investment on the basis of some

measures of profitability.

The forest clearance involving the forest areas of more than 5

hectares in hills or 20 hectares in plains for lines/hydro project is

taken on the basis of B-C analysis (as per forest conservation act

1980).

This method is appropriate for appraising of investments in multi

purpose hydro-projects.

The life cycle costs (LCC) can be expressed as follows:

LCC = CI + CP + CO + CG + CD

CI total cost of installation, CP Cost of planned corrective maintenance, CO operation costs, CG outage costs, CF

cost of modernization/refurbishment/extension, CD Cost of decommissioning, disposal

Example

Economic analysis on the basis of project life-cycle cost in real terms suggests that

small or micro hydro generation must be preferred over thermal power generation even

if is a few times costlier than the latter, in interest of overall grid economy. Improvement

in load carrying capacity due to peaking support gives a weightage factor of

approximately 1.3 in favor of hydro.

The hydro projects are proposed on the basis of 90% hydrological dependability. The

actual generation in the long term comes to 10% higher, thereby leading to a weightage

factor 1.1. an escalation of 6% annum in case of thermal over hydro, statistically gives a

weightage of 8.89 in favor of hydro having project life of 60 years or more. Double the

life of hydro projects than thermal leads to weightage of 2. Small projects have

environmentally higher weightage than thermal.

Life-cycle cost in case of new equipment proposed for installation may be called total

owing cost such a transformers, circuit breakers, computer etc. For example, in case of

transformers, there are two kinds of costs purchase price and cost of energy lost in

losses during the active life of the transformer. The total owning cost of a transformer is

the sum of purchase price and net present value of energy losses. The transformer or any

other equipment should be procured on the basis of lowest owning cost.

Cash flow statements

The basic principle of the cash flow is that revenue receipts (inflow)

and revenue expenditure (outflow) are counted for the financial year.

The gross operating surplus / deficit cash flow is calculated as a

difference between these and are compared.

Annual balance sheets are made as per the Electricity (Supply) Annual

Accounts Rules, 1985

Cash flow statements can be attained through

Break-Even Point

Payback method

Rate of Return on investment

Net Present Value Method

Internal Rate of return method

Break Even point

This method is used to determine minimum revenue requirement

analysis.

The tariffs in public power utilities are generally fixed to break even

costs (fixed and variable ), i.e. at break even point the fixed annual

cost of capital equalizes the revenue earned over the financial year

period as shown in figure.

The method is applied for economic analysis of power system

improvement schemes

Payback method

Payback period definition: The length of time required to recover the

initial investment is computed or It is the time in which the initial

cash outflow of an investment is expected to be recovered from the

cash inflows generated by the investment. It is one of the simplest

investment appraisal techniques.

This does not consider the time value of money and life of investment

after payback period.

But this measure is used as an indication of the amount of the

investments risk in small generation schemes, energy conservation

schemes and system improvement schemes.

Contd

The formula to calculate payback period of a project depends on whether

the cash flow per period from the project is even or uneven. In case they

are even, the formula to calculate payback period is:

=

When cash inflows are uneven, we need to calculate the cumulative net

cash flow for each period and then use the following formula for payback

period:

= +

Where A = last period with a negative cumulative cash flow

B = absolute of cash flow at the end of period A

C = total cash flow during the period after A

Example 1: Even Cash Flows

A electric utility company is planning to undertake a hydro project

after orographic survey requiring initial investment of Rs. 105 million

(inclusive of survey). The project is expected to generate Rs. 25

million per year for 7 years, (if favourable weather conditions exists

and it is persistent, capable of bulk power supply into the grid on the

par capacity) . Calculate the payback period of the project.

Solution

Payback Period = Initial Investment Annual Cash Flow

= Rs. 105M Rs. 25M = 4.2 years

Example 1: Un-Even Cash Flows

A electric utility company is planning to undertake another wind energy

harvesting project, requiring initial investment of Rs. 50 million and is expected to

generate Rs. 10 million in Year 1, Rs. 13 million in Year 2, Rs. 16 million in year 3,

Rs. 19 million in Year 4 and Rs. 22 million in Year 5 (varying revenues owing to

varying average wind flow conditions). Calculate the payback value of the project.

Cash flow in Rs. Millions Cumulative Remarks

= +

Year Cash flow Cash flow P Positive Where

N Negative

A = last period with a negative cumulative cash flow

0 -50 -50 N

B = absolute of cash flow at the end of period A

1 +10 -40 N

C = total cash flow during the period after A

2 +13 -27 N

+16 N = +

3=A -11 = B 11

= 3 + 19 = 3.58

4 +8 P

+19 = C

5 +22 +30 P

Contd

For example, a cogeneration plant in a sugar factory will give an idea

about pay back analysis. A typical example (1993) is given below:

Cogeneration project cost Rs. 44 Millions

Power feed to grid (in kW) 4750 kW

Power to grid in units considering 19 GWh

4000 hours per annum as the

season for sugar plant

Revenue from power (19 * Rs. Rs. 23.75 Millions

1.25 per unit)

Expenditure per annum (excluding Rs. 9.681 Millions

depreciation)

Net cash revenue Rs. 14.069 Millions

44

= =

14.069

= 3.127 3.15

Advantages and Dis-advantages

Advantages Of Pay Back Period Disadvantages Of Pay Back Period

1. Pay back period is simple and easy to 1. In the calculation of pay back period, time

understand and compute. value of money is not recognized.

2. Pay back period is universally used and easy 2. Pay back period gives high emphasis on

to understand. liquidity and ignores profitability.

3. Pay back period gives more importance on 3. Only cash flow before the pay back period is

liquidity for making decision about the considered. Cash flow occurred after

investment proposals. the PBP is not considered.

with a shortest PBP has less risk than with the

project with longest PBP.

is an added advantage of calculation of capital

expenditure.

Rate of Return on Investment (RORI)

The most popular method of measuring profitability/loss as a percentage

of an investment (capital base i.e. net fixed assets of power utility at the

beginning of a year along with additional internal resources that could be

generated during the year) is rate of return on investment.

The RORI of an investment is the average revenue divided by average

capital base.

The revenue and capital base (investment) measures are used in

conventional annual accounting statements.

Power utilities could break even if they could achieve zero percent ROR.

Minimum three percent of RORI on capital is desirable as per the Indian

Electricity (Supply) Act, 1948.

Rate of Return on Investment Formula

=

Net operating income is the departments revenue minus all expenses for which

the department (utility perspective) manager is responsible.

Average operating assets of the department represent the asset base of the

department

= 100

RORI is a very popular metric because of its versatility and simplicity. Essentially

RORI can be used as a rudimentary gauge of an investments profitability.

RORI can be very easy to calculate and to interpret and can apply to a wide

variety of kinds of investments.

Positive value of RORI indicates Gain or Profit, when RORI is negative, it reflects a

loss. This information is very useful in determining whether or not the choice of

investment made was a Appropriate.

Example RORI

An electric utility invests Rs. 100 Million on constructing a Thermal Power station.

It also invests, Rs. 10 Million on importing coal from Australia and purchase of Rs.

5 Million on in-house coal from Jharkhand (Jharia, Bokaro, Godda) per year. The

maintenance cost of the power station is 5 % of Investment cost (includes of raw

material procurement). The revenue for the power station over a period of 6

years after supplying 150 MW bulk power to grid/year is Rs. 250 Million. Estimate

the RORI after six years.

Solution:

Investment = Rs 100 M + (Rs. 10 M + Rs 5 M) *6 + 0.05 * (Rs 100 M + (Rs. 10 M + Rs

5 M) *6) = Rs. 199.5 M

RORI = ((Rs. 250 M Rs. 199.5) / Rs. 199. 5 ) * 100 = 25.31 %

Gain in investment.

Net Present Value (NPV)

Net Present Value of a utility project is the potential change in an investors

wealth caused by that project while time value of money is being

accounted for. It equals the present value of net cash inflows generated by

a project less the initial investment on the project.

It is one of the most reliable measures used in capital budgeting because it

accounts for time value of money by using discounted cash flows in the

calculation.

NPV calculations takes the following two inputs:

Projected net cash flows in successive periods from the project

A target rate of return i.e. the hurdle rate

Where, net cash flow equals total cash inflow during a period, including

salvage value if any, less cash outflows from the project during the period

Hurdle rate is the rate used to discount the net cash inflows. Weighted

average cost of capital (WACC) is the most commonly used hurdle rate.

Steps:

Step 1: The first step in the computation of the net present value of

an investment is to choose a rate of discount (this may be required

return) (step involved in the calculation of NPV is the estimation of

net cash flows from the project over its life)

Step 2: The second step is to compute the present value equivalents

of all cash flows (considering inflow as positive and outflows as

negative) associated with investment (on an after tax basis) and add

these present value equivalents to obtain the net present value of the

investment over period of time (step is to discount those cash flows

at the hurdle rate).

Formulas

The net cash flows may be even (i.e. equal cash flows in different periods) or uneven (i.e.

different cash flows in different periods). When they are even, present value can be

easily calculated by using the formula for present value of annuity. However, if they are

uneven, we need to calculate the present value of each individual net cash inflow

separately.

Once we have the total present value of all project cash flows, we subtract the initial

investment on the project from the total present value of inflows to arrive at net present

value.

Thus we have the following two formulas for the calculation of NPV:

When cash inflows are even:

1(1+)

=

where

R is the net cash inflow expected to be received in each period;

i is the required rate of return per period;

n are the number of periods during which the project is expected to operate and generate

cash inflows.

Formulas contd

When cash inflows are uneven:

1 2

= + +

(1+)1 (1+)2 (1+)

Where,

i is the target rate of return per period;

R1 is the net cash inflow during the first period;

R2 is the net cash inflow during the second period;

R3 is the net cash inflow during the third period, and so on ...

Decision Rule

In case of standalone projects, accept a project only if its NPV is positive,

reject it if its NPV is negative and stay indifferent between accepting or

rejecting if NPV is zero.

In case of mutually exclusive projects (i.e. competing projects), accept the

project with higher NPV.

Example:

Even Cash Inflows: Calculate the net present value of a wind hydro based project

which requires an initial investment of Rs. 243,000 and it is expected to generate a cash

inflow of Rs. 50,000 each month for 12 months. Assume that the salvage value of the

project is zero. The target rate of return is 12% per annum.

Solution

We have,

Initial Investment = Rs. 243,000

Net Cash Inflow per Period = Rs. 50,000

Number of Periods = 12

Discount Rate per Period = 12% 12 = 1%

Net Present Value

= Rs. 50,000 (1 (1 + 1%)-12) 1% Rs. 243,000

= Rs. 50,000 (1 1.01-12) 0.01 Rs. 243,000

Rs. 50,000 (1 0.887449) 0.01 Rs. 243,000

Rs. 50,000 0.112551 0.01 Rs. 243,000

Rs. 50,000 11.2551 Rs. 243,000

Rs. 562,754 Rs. 243,000

Rs. 319,754

Example

Uneven Cash Inflows: An initial investment of Rs. 8,320 thousand on plant

and machinery is expected to generate cash inflows of Rs. 3,411 thousand,

Rs. 4,070 thousand, Rs. 5,824 thousand and Rs. 2,065 thousand at the end

of first, second, third and fourth year respectively. At the end of the fourth

year, the machinery will be sold for Rs. 900 thousand. Calculate the net

present value of the investment if the discount rate is 18%. Round your

answer to nearest thousand.

Solution

PV Factors:

Year 1 = 1 (1 + 18%)^1 0.8475

Year 2 = 1 (1 + 18%)^2 0.7182

Year 3 = 1 (1 + 18%)^3 0.6086

Year 4 = 1 (1 + 18%)^4 0.5158

Example contd

Year 1 2 3 4

Net cash inflow Rs. 3,411 Rs. 4,070 Rs. 5,824 Rs. 2,065

Salvage value 0 0 0 Rs. 900

Total cash inflow Rs. 3,411 Rs. 4,070 Rs. 5,824 Rs. 2,965

x Present Value 0.8475 0.7182 0.6086 0.5158

Factor

Present Value of cash Rs. 2,890.68 Rs. 2,923.01 Rs. 3,544.67 Rs. 1,529.31

flows

Total PV of cash Rs. 10,888

# # #

inflows

- Initial Investment Rs. 8,320 # # #

Net Present Value Rs. 2,568 # # #

Strengths and Weaknesses of NPV

Strengths Weakness

NPV is after all an estimation. It is

Net present value accounts for time sensitive to changes in estimates for

value of money which makes it a future cash flows, salvage value and the

sounder approach than other cost of capital.

investment appraisal techniques Net present value does not take into

which do not discount future cash account the size of the project. For

example, say utility Project A (wind based)

flows such payback period and requires initial investment of Rs. 4 million

accounting rate of return. to generate NPV of Rs. 1 million while a

competing utility Project B (Solar based)

Net present value is even better requires Rs. 2 million investment to

than some other discounted cash generate an NPV of Rs. 0.8 million. If we

base our decision on NPV alone, we will

flows techniques such as IRR. In prefer Project A because it has higher

situations where IRR and NPV give NPV, but Project B has generated more

conflicting decisions, NPV decision shareholders wealth per dollar of initial

investment (Rs. 0.8 million/Rs. 2 million vs

should be preferred. Rs. 1 million/Rs. 4 million).

Internal Rate of Return (IRR)

The internal rate of return is defined as the unique rate of discount that causes the sum of the

present value of the cash flows, i.e. sum of cash inflow (+) and cash outflow (-) to be equal to zero

over the investments economic life of project life.

This definition can then be used to compute an investments internal rate of return.

The internal rate of return is found by a trial and error procedure (when the net present value is

found equal to zero, the rate of discount being used is the rate of return) if analysis is done with

the help of present value tables.

It can be defined as rate of discount at which sum of the present value of future net benefits

generated by the project during the life spans equal its initial investment. This means NPV of the

project is zero.

When a project has a more complex cash flow pattern, computer aided calculations are used, for

which standard spreadsheet softwares are available in market.

The internal rate of return is much superior for ranking investment compared to simple methods

(payback, balance sheet statements).

MINIMUM IRR of 3% to 4% above the borrowing interest rate is considered generally viable

commercially.

IRR of 11% to 12% with 16% return on equity on the thermal, hydro private sector power projects

respectively will come. This method is used for analysis of rural electrification projects in many

developing countries.

Contd

Internal rate of return or IRR is the minimum discount rate that electric power utility

management uses to identify what capital investments or future projects will yield an

acceptable return and be worth pursuing.

The IRR for a specific project is the rate that equates the net present value of future cash

flows from the project to zero. In other words, if we computed the present value of future

cash flows from a potential project using the internal rate as the discount rate and subtracted

out the original investment, our net present value of the project would be zero.

This sounds a little confusing at first, but its pretty simple. Think of it in terms of capital

investing like the companys management would. They want to calculate what

percentage return is required to break even on an investment adjusted for the time value of

money.

It can be thought of as the internal rate of return as the interest percentage that utility

company has to achieve in order to break even on its investment in new capital. Since

management wants to do better than break even, they consider this the minimum

acceptable return on an investment.

Formula

The IRR formula is calculated by equating the sum of the present value of future

cash flow less the initial investment to zero. Since we are dealing with an

unknown variable, this is a bit of an algebraic equation. Heres what it looks like:

1 2 3

+ + + = 0

(1+)1 (1+)2 (1+)3

As it can be seen, the only variable in this equation that management wont know

is the IRR. They will know how much capital is required to start the project and

they will have a reasonable estimate of the future income of the investment. This

means we will have to solve for the discount rate that will make the NPV equal to

zero.

Example

A private investor, is considering to purchase a year Revenue IRR Innvestment NPV

new wind turbine system for commissioning 1 20000 8% 18518.52 100000 5393.167

2 30000 8% 25720.16

and bulk power supply, but he is unsure if its 3 40000 8% 31753.29

the best use of his funds at this point in time. 4 40000 8% 29401.19

With the new Rs. 100,000 wind turbine unit, Total Revenue 105393.2

the investor will be able to inject power into

the grid based on the forecasted wind power year Revenue IRR Innvestment NPV

level, such that he will get a revenue of Rs. 1 20000 9% 18348.62 100000 2823.371

2 30000 9% 25250.4

20,000, Rs. 30,000, Rs. 40,000, and Rs. 40,000

3 40000 9% 30887.34

in subsequent assessment periods. Lets 4 40000 9% 28337.01

calculate investors minimum rate. Since its Total Revenue 102823.4

difficult to isolate the discount rate unless you

use an excel IRR calulator. You can start with an year Revenue IRR Innvestment NPV

approximate rate and adjust from there. Lets 1 20000 10% 18181.82 100000 348.3369

3 40000 10% 30052.59

4 40000 10% 27320.54

Total Revenue 100348.3

Analysis

Remember, IRR is the rate at which the net present value of the costs of an investment

equals the net present value of the expected future revenues of the investment. Utility

Management can use this return rate to compare other investments and decide what

capital projects should be funded and what ones should be scrapped.

Going back to our renewable wind based project example, assume investor could

purchase a wind turbine unit and install it in a wind favourable regime. He can purchase

two other wind turbine units from different manufacturers. Each unit has different

characteristics, and the unit which has highest Cp would definitely harvest more power

from existing favourable wind flow conditions. Hence, different magnitude of power

would be injected into grid and thereby different cash flow. The investor can calculate

the internal rate of return on each machine and compare them all. The one with the

highest IRR would be the best investment.

Since this is an investment calculation, the concept can also be applied to any other

investment. For instance, private owner can compare the return rates of investing the

companys money in the stock market or new unit. Now obviously the expected future

cash flows arent always equal to the actual cash received in the future, but this

represents a starting point for private utility management to base their purchase and

investment decisions on.

Life cycle costing

Life cycle costing is the accumulation of costs over a product's entire

life. The practice of obtaining over their life time, the best use of

physical asset at the lowest cost of entity.

Life cycle costing is different to traditional cost accounting system

which report cost object profitability on a calendar basis i.e. monthly,

quarterly and annually. In contrast life cycle costing involves tracing

cost and revenues on a product by product basis over several

calendar periods.

Contents of LCC

I. Meaning of Life Cycle Costing

II. Characteristics of Life Cycle Costing

III. Stages of Product Life Cycle Costing

IV. Benefits of Product Life Cycle Costing

V. Life Cycle Costing Process

I. Meaning of LCC

Life cycle costing is a system that tracks and accumulates the actual costs and revenues attributable to

cost object from its invention to its abandonment. Life cycle costing involves tracing cost and revenues

on a product by product base over several calendar periods.

The LCC of an asset is defined as:

The total cost throughout its life including planning, design, acquisition and support costs and any other

costs directly attributable to owning or using the asset.

Life Cycle Cost (LCC) of an item represents the total cost of its ownership, and includes all the cots that

will be incurred during the life of the item to acquire it, operate it, support it and finally dispose it. Life

Cycle Costing adds all the costs over their life period and enables an evaluation on a common basis for

the specified period (usually discounted costs are used).

This enables decisions on acquisition, maintenance, refurbishment or disposal to be made in the light

of full cost implications. In essence, Life Cycle Costing is a means of estimating all the costs involved in

procuring, operating, maintaining and ultimately disposing a product throughout its life.

Life cycle costing is different from traditional cost accounting system which reports cost object

profitability on a calendar basis (i.e. monthly, quarterly and annually) whereas life cycle costing

involves tracing costs and revenues of a cost object (i.e. product, project etc.) over several calendar

periods (i.e. projected life of the cost object).

Thus, product life cycle costing is an approach used to provide a long-term picture of product line

profitability, feedback on the effectiveness of the life cycle planning and cost data to clarify the

economic impact on alternative chosen in the design, engineering phase etc.

It is also considered as a way to enhance the control of manufacturing costs. It is important to track and

measure costs during each stage of a products life cycle.

II. Characteristics of LCC

Product life cycle costing involves tracing of costs and revenues of a

product over several calendar periods throughout its life cycle.

Product life cycle costing traces research and design and development

costs and total magnitude of these costs for each individual product

and compared with product revenue.

Each phase of the product life-cycle poses different threats and

opportunities that may require different strategic actions.

Product life cycle may be extended by finding new uses or users or by

increasing the consumption of the present users.

III. Stages of product LCC

Following are the main stages of Product Life Cycle:

(i) Market Research:

It will establish what product the customer wants, how much he is

prepared to pay for it and how much he will buy.

(ii) Specification:

It will give details such as required life, maximum permissible maintenance

costs, manufacturing costs, required delivery date, expected performance

of the product.

(iii) Design:

Proper drawings and process schedules are to be defined.

(iv) Prototype Manufacture:

From the drawings a small quantity of the product will be manufactured.

These prototypes will be used to develop the product.

Contd

(v) Development:

Testing and changing to meet requirements after the initial run. This period of testing

and changing is development. When a product is made for the first time, it rarely meets

the requirements of the specification and changes have to be made until it meets the

requirements.

(vi) Tooling:

Tooling up for production can mean building a production line; building jigs, buying the

necessary tools and equipments requiring a very large initial investment.

(vii) Manufacture:

The manufacture of a product involves the purchase of raw materials and components,

the use of labour and manufacturing expenses to make the product.

(viii) Selling

(ix) Distribution

(x) Product support

(xi) Decommissioning:

When a manufacturing product comes to an end, the plant used to build the product

must be sold or scrapped.

IV. Benefits of product LCC

Following are the main benefits of product life cycle costing:

It results in earlier action to generate revenue or lower costs than

otherwise might be considered. There are a number of factors that

need to be managed in order to maximise return in a product.

Better decision should follow from a more accurate and realistic

assessment of revenues and costs within a particular life cycle stage.

It can promote long term rewarding in contrast to short term

rewarding.

It provides an overall framework for considering total incremental

costs over the entire span of a product.

5. Life Cycle Costing Process

Life cycle costing is a three-staged process. The first stage is life cost planning stage which

includes planning LCC Analysis, Selecting and Developing LCC Model, applying LCC Model and

finally recording and reviewing the LCC Results. The Second Stage is Life Cost Analysis Preparation

Stage followed by third stage Implementation and Monitoring Life Cost Analysis

The three stages are:

LCC Analysis is a multi-disciplinary activity. An analyst, involved in life cycle costing, should be fully

familiar with unique cost elements involved in the life cycle of asset, sources of cost data to be

collected and financial principles to be applied.

He should also have clear understanding of methods of assessing the uncertainties associated

with cost estimation. Number of iteration may be required to perform to finally achieve the

result. All these iterations should be documented in detail to facilitate the interpretations of final

result.

Stage 1: LCC Analysis planning

The Life Cycle Costing process begins with development of a plan, which

addresses the purpose, and scope of the analysis.

The plan should:

Define the analysis objectives in terms of outputs required to assist a

management decision.

Typical objectives are:

Determination of the LCC for an asset in order to assist planning,

contracting, budgeting or similar needs.

Evaluation of the impact of alternative courses of action on the LCC of an iv. Identify alternative courses of action to be evaluated.

asset (such as design approaches, asset acquisition, support policies or The list of proposed alternatives may be refined as new

alternative technologies). options are identified or as existing options are found to

violate the problem constraints.

Identification of cost elements which act as cost drives for the LCC of an

asset in order to focus design, development, acquisition or asset support v. Provide an estimate of resources required and a

efforts. reporting schedule for the analysis to ensure that the

LCC results will be available to support the decision-

Make the detailed schedule with regard to planning of time period for each making process for which they are required.

phase, the operating, technical and maintenance support required for the

asset. Next step in LCC Analysis planning is the selection or

development of an LCC model that will satisfy the

Identify any underlying conditions, assumptions, limitations and constraints objectives of the analysis. LCC Model is basically an

(such as minimum asset performance, availability requirements or accounting structure which enables the estimation of an

maximum capital cost limitations) that might restrict the range of acceptable asset components cost.

options to be evaluated. Identify alternative courses of action to be

evaluated.

Stage 2: Life Cost Analysis preparation

The Life Cost Analysis is essentially a tool, which can be used to control and

manage the ongoing costs of an asset or part thereof. It is based on the LCC

Model developed and applied during the Life Cost Planning phase with one

important difference: it uses data on real costs.

The preparation of the Life Cost Analysis involves review and development

of the LCC Model as a real-time or actual cost control mechanism.

Estimates of capital costs will be replaced by the actual prices paid.

Changes may also be required to the cost breakdown structure and cost

elements to reflect the asset components to be monitored and the level of

detail required.

Targets are set for the operating costs and their frequency of occurrence

based initially on the estimates used in the Life Cost Planning phase.

However, these targets may change with time as more accurate data is

obtained, from the actual asset operating costs or from the operating cost

of similar other asset.

Stage 3: Implementation and Monitoring

Implementation of the Life Cost Analysis involves the continuous

monitoring of the actual performance of an asset during its operation

and maintenance to identify areas in which cost savings may be made

and to provide feedback for future life cost planning activities.

For example, it may be better to replace an expensive building

component with a more efficient solution prior to the end of its

useful life than to continue with a poor initial decision.

Phases in a Life Cycle of a product

Every product goes through a life cycle. A product life cycle can be divided into five phases.

Development

Introduction

Growth

Maturity

Decline

(a) Development. The product has a research and development stage where costs are incurred but no revenue is generated.

(b) Introduction. The product is introduced to the market. Potential customers will be unaware of the product or service, and the

organization may have to spend further on advertising to bring the product or service to the attention of the market.

(c) Growth. The product gains a bigger market as demand builds up. Sales revenues increase and the product begins to make a profit.

(d) Maturity. Eventually, the growth in demand for the product will slow down and it will enter a period of relative maturity. It will

continue to be profitable. The product may be modified or improved, as a means of sustaining its demand.

(e) Decline. At some stage, the market will have bought enough of the product and it will therefore

reach 'saturation point'. Demand will start to fall. Eventually it will become a loss-maker and this is

the time when the organization should decide to stop selling the product or service.

Power Supply Reliability

System Reliability Consumer Centric

Modern society excepts that the supply of electricity should be continuously available on

demand. This exactly may not be possible due to random system failures which are

generally beyond the control of power system engineers.

The probability of consumers being disconnected, however, can be reduced by increased

investment on power systems by providing high quality equipment or redundancy and

better maintenance.

The economic and reliability constraints are conflicting in nature and make the planning

decisions difficult.

The reliability of supply to consumers is judged from the frequency of interruptions, the

of each interruption and the value a consumer places on the supply of electricity at the

time that service is not provided.

The value to consumers is determined by the benefits which they can derive from using

it e.g. the production of goods, lighting, TV viewing, air conditioning and heating at home

and in shops and offices, improvement in their standard of living and for entertainment

purposes in theatres, cinemas etc.

These factors depend upon the individual reliability of equipment, circuit length and

loading, network arrangement etc.

Uncertainty

System planners advise the decision makers by evaluating the major alternatives for facing the

future. The economic crisis experienced during the recent years, the technological developments

and the changes in the sociological environment reinforced the importance of the factors which

were poorly taken into account in the past-the uncertainty of the future and the call for security

from the system.

A first answer to the problem of uncertainty consists in devising a system sufficiently robust to

withstand the impacts. This approach was usually followed in the past. However, at the present

time the amplitude and the number of the possible impacts is such that the cost of a robust

system becomes prohibitive, if one wants to face most of the uncertainty factors.

A second answer adapted to the present time is to introduce flexibility within the system

development. From the planners point of view a flexible system which will be able to be adapted

quickly to any external change. This is achieved either because the planner made provisions to

change over to diverse fuels or diverse power generations or because it was decided to install

equipment which makes better use of existing system.

In most utilities, a temporary degradation of the reliability in case of deviation of the

development parameters will be accepted, but some countries do not accept such degradation

and consider that this is not acceptable for facing external impacts.

Uncertainty contd

In recent years the need for flexibility has become particularly

apparent because both planners and operators had to cope with

more and more significant trends:

Industry structure trends:

Financial trends:

Technical trends:

Environment and health issues

POWER SUPPLY RELIABILITY

TOPICS

SYSTEM RELIABILITY

RELIABILITY PLANNING

RELIABILITY EVALUATION

FUNCTIONAL ZONES

RELIABILITY INDICES

INTRODUCTION

Modern society expects supply of Electricity should be continuously

available on demand

Probability of failures fail to supply reliable power to consumers

Providing high Quality equipment or redundancy and better

maintenance with increased investment on power system improves

reliability of supply

SYSTEM RELIABILITY

Judged from

Freq. of interruptions,

Duration of each interruption,

And value a consumer when supply fails.

Value to consumers is determined by

Benefits from using appliances (production of goods, lighting, TV, air

conditioner, etc).

Reliability factors depends on

Individual reliability of equipment

Circuit length and loading

Network arrangement etc.

SYSTEM RELIABILITY- Uncertainty

(Contd)

System planners advise decision makers to consider major

alternatives for future like

economic crisis

Technological development

Changes in sociological environment

Which are not taken in past

Two ways to solve uncertainty of supply

Devising robust system to withstand uncertain impacts

Introduce flexibility by the planner within system

development to meet external changes

SYSTEM RELIABILITY- Uncertainty

(Contd))

Need for flexibility among plannners and operators to cope with

more significant trends are:

1. Industry structured trends

De-regulation

Privatisation

Vertical disaggregation

Wheeling for non-utility generation, transmission access for

consumers for power purchases from other utilities

2. Financial trends

Capital availability and cost uncertainity

Rate base incentives and constraints

Stockholder risks and uncertain rates of return

Construction expenditure recovery risks

SYSTEM RELIABILITY- Uncertainty (Contd)

3. Technical trends

Load management and conservation

Generation technology and licensing issues

Transmission technology

4. Environment and health issues

Emission limits

Power frequency and electromagnetic field constraints

Radio active waste storage/ disposal

SYSTEM ADEQUACY AND SECURITY

Adequacy :

Capability of system to meet system demand within major component ratings and in

the presence of scheduled and un-scheduled outages of generation, transmission and

distribution facilities.

Relates to static system conditions

Security :

Capability of system to withstand disturbances arising from faults and un-scheduled

removal of equipment without further loss of facilities or cascading.

Relates to dynamic system conditions

SYSTEM ADEQUACY AND SECURITY

(Contd)

Basic aim power utility is to meet

Various demands of energy and power at lowest possible cost to consumers

while maintaining acceptable levels of quality (V, f, wave shape, flicker, etc.)

Continuity of supply.

Task of power system planning is

To configure an electric power system

With compromise between requirements perceived by consumers for

adequacy and security

To achieve continuity and quality of supply

Economics of power system in terms of operating and capital cost.

RELIABILITY PLANNING

Basic function of power system is to meet electricity requirements with adequate

quality and reliability in an economical manner.

Reliability levels are interdependent with economics since more investments are

necessary to increase reliability / even maintain it at current and acceptable

levels

Reliability preferences can shift over time due to

Changes In technology

Consumer needs and lifestyles

Economic factors

Above requires periodical revision

RELIABILITY PLANNING (Contd)

Fig (b): Reliability occurs at minimum system cost, interruption

cost and total cost

OPTIMUM RELIABILITY (Contd)

Lowest point in the total cost curve defines optimal balancing of system cost

and consumer cost and determines optimum reliability level, reserve margin,

LOLP, EUE (Expected Un-served Energy).

RELIABILITY PLANNING (Contd)

From implementation standpoint, following analysis is required

For each of the pre-selected reserve margins, optimum resource mix is first

determined

For each such resource mix, production costing, revenue requirements and

reliability calculations are performed to estimate total cost as:

Revenue requirement + (EUE) x (Outage cost in Rupees/kWh)

EUE-Expected Unserved Energy

RELIABILITY PLANNING CRITERIA

reliability criteria on deterministic and probabilistic basis

Lines

System contingency for lines 66-800kV = N-1

Loading under normal operating condictions with 20% margin for

lines

400kV S/C line : 360-800MW

220kV S/C line : 160-200MW

132kV S/C line : 50-70MW

RELIABILITY PLANNING CRITERIA

(Contd)

Generation

Transmission system configurations depends on

generation scenarios worked out by CEA.

Peaking capacities and energy generation capabilities are

determined based on following norms:

1. Thermal and nuclear plants :

Norms for availability of peaking capability :

Rated capacity (Maintenance @ 5% + Partial outage

rate @ 15% + Forced outage rate @ 17% + Auxilliary

consumption @ 10% + Spinning reserve @ 5% )

2. Annual energy generation

500 MW units 6000kWh/kW

200/210MW units- 5500kWh/kW

Units with ratings less than 200MW 5000kWh/kW

RELIABILITY PLANNING CRITERIA

(Contd)

3. Availability from new units

Peaking capacity and annual generation capability of newly

commissioned thermal and nuclear units would be taken as:

During Next After 1 First Second Third Fourth

first 3 nine year year year year year

months months

Nil 50% 100% 2500kW 4000kW 5000kW 6000kWh/

h/kW h/kW h/kW kW

RELIABILITY PLANNING CRITERIA

(Contd)

4. Hydro plants

Norms for deciding overall peaking capacities of hydro units:

Rated capacity- (maintanance @3% + Forces outage rate @ 9.5%

+Auxilliary consumption @ 0.5 %)

5. Generation expansion

LOLP = 1%, 2%, 5%

RELIABILITY EVALUATION

The power system reliability studies are conducted for two

purposes

1. Long term reliability evaluations may be performed to assist

long range system planning

in day-to-day operation decisions including system security

RELIABILITY EVALUATION (Contd)

1. Define the system--list the components and collect the

necessary component failure data from field surveys available.

2. Define the criteria for system failure

3. List the assumptions to be used.

4. Developing the system model.

5. Perform failure effects analysis and compute the system

reliability indices

6. Analyze and evaluate the results.

Reliability Calculations

The scope of reliability engineering in power systems depends upon:

The collection and evaluation of component failure data and load

curve model of the system.

The definition of reliability measures and the determination of

reliability requirements or standards for the various applications.

The development of mathematical models for system reliability and

the solution of these models.

The verification of the results.

The evaluation of results and the preparation of recommmendations.

Reliability Programs

Computer programs (eg) WASP, ISPLAN, EGEAS which are equipped with

several solution techniques have been developed by CEA for evaluating

HL-II adequacy.

In Tamilnadu Electricity Board, VINCOM is used for load curve, load

management

includes systematic selection and evaluation of disturbance, the classification

of each disturbance according to failure criteria and the accumulation of

reliability indices.

bus and the overall HL-II indices.

RELIABILITY EVALUATION

Sensitivity Analysis

Several sensitivity studies carried out to examine effect of variations in

various power planning parameters

1. Variation in the electricity demand projection by 10% and 20%

2. Low level of Hydro development

3. Improvement in performance of thermal power plants

4. Improvement in system load factor by employing available load

management techniques etc.

System Reliability Analysis

The essence of total system analysis is simulation of system

operation with respect to both reliability and economy of electric

power supply

estimated to include most of the economic impacts of the

alternatives being studied.

Flow chart for reliability cost Analysis

System Reliability Analysis

Alternate cases to be studied are defined by types and sizes

of proposed generating units, listed in sequences in which

they are to be added

Reliability calculation then determines timing of additions as

required to maintain a stipulated reliability, considering

magnitude of load for each year of the system expansion.

With pattern of unit additions established, production cost

calculation determines how total system should be operated

for adequate reliability and maximum economy.

Fixed charges are calculated for each year as product of

each units line capital cost and fixed charge rate.

Sum of production, losses costs and fixed charges is the

total cost .

Functional zones

Three basic functional zones are generation, transmission and distribution

Functional zones are combined into hierarchical level(HL).

Three hierarchical levels are

1. HL-I consists of generation facilities alone.

2. HL-II includes both generation and transmission facilities in order to

assess system adequacy to meet the demand at major area load

centres.

3. HL-III adequacy assessment involves starting at generating points and

terminating at the individual consumer loads.

Functional zones (Contd)

The reliability performance of a network can be expressed by appropriate

indices.

The primary adequacy indices at HL-I are

Loss of load probability (LOLP)

Loss of load expectation (LOLE)

Loss of Energy Expectation (LOEE)

Expected Energy not supplied (EENS)

The frequency of loss of load and its duration.

In HL-II studies bulk transmission is included and there are two sets of

adequacy indices namely individual load bus indices and system indices.

Functional zones (Contd)

The basic HL-III system indices are

The system average interruption frequency index(SAIFI)

The system average interruption duration index(SAIDI)

Consumer average interruption frequency index(CAIFI)

Consumer average interruption duration index(CAIDI) etc

The most commonly used indices are SAIDI,SAIFI,CAIDI

Reliability indices

1. The system average interruption duration

index(SAIDI): Average total duration of interruptions

of supply per annum that a consumer experiences.

2. The system average interruption frequency

index(SAIFI): Average number of interruptions of

supply in the year for consumers who experience

interruption of supply.

3. Consumer average Interruption Duration

index(CAIDI): Average duration of an interruption of

supply in the year for consumers who experience

interruption of supply.

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