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ANALISIS EKONOMI

Dasar-Dasar Konservasi Energi dan Produksi bersih

Teguh Sasono
Ref: Sullivan, William G., Wicks & Koelling, Engineering Economy,
Pearson Education, Inc., 14th edition, 2009

1
Pengantar Ekonomi Teknik

Evaluasi sistematis terhadap biaya dan benefit (keuntungan)


dari usulan teknis proyek
Prinsip dan metodologi ekonomi teknik yang digunakan untuk
menganalisis alternatif pemanfaatan sumberdaya finansial,
khususnya dalam kaitannya dengan aset-aset fisik dan operasi
suatu organisasi.

Keuntungan Ekonomi Teknik


Proses Pengambilan Keputusan yang rasional
Keputusan yang Ekonomis
Memprediksi masa depan (waktu dan ketidakpastian)
2
Pengambilan keputusan Rasional
1. Mengenali masalah
Saya memerlukan tempat tinggal sementara.
2. Mendefinisikan Goal atau tujuan
Saya akan mencari apartment yang indah dan tidak terlalu mahal.
3. Merangkai Data yang Relevan
Saya memerlukan informasi sewa, utilitas, umur apartemen, parkir, waktu
berkendaraan ke tempat belanja dan UF, tetangga , dan fasilitas (amenities) lain
yang diberikan (kolam renang, tenis meja, dsb.)
4. Mengidentifikasi alternatif yang layak (Feasible)
Saya menggunakan Yellow Pages, informasi dari teman, layanan menemukan
apartment, informasi dari UF, koran lokal, dan pengalaman pribadi untuk
mencari apartmen.
5. Memilih kriteria untuk menetapkan alternatif terbaik
Yang terpenting sewa plus biaya utiliti. Saya juga sangat peduli dengan waktu tempuh
berkendaraan ke UF, dan macam tetangganya.

3
Pengambilan Keputusan Rasional
6. Membangun Model
Saya akan menggunakan spreadsheet. Barisnya merupakan pilihan
apartemen, kolom berisi kriteria evaluai. Kemudian saya akan mencoba
mengisi interaksi antara apartemen dan kriteria.
Itu juga melibatkan penetapan aliran kas untuk analisis ekonomi teknik!

7. Prediksi hasil (Outcomes) setiap Alternatif


Saya akan mengisi estimasi biaya untuk spreadsheet dan tingkat fasilitas,
waktu berkendaraan, dsb.

8. Memilih Alternatif Terbaik


Apartemen C terlihat yang termurah, tetapi saya tidak menyukai
tetangganya. Jika saya membayar Rp500 ribu per bulan lebih besar , akan
mendapatkan Apartmen B dan saya mendapatkan tetangga yang lebih
menyenangkan dan hanya 15-menit berkendaraan ke UF. Mungkin saya akan
memilih Apartemen B.
9. Mengaudit hasil (keputusan)
Apakah saya telah melakukan pilihan yang baik
Setelah tinggal di Apartemen B elama enam bulan, saya bahagia dengan
pilhan ini!
Tetapi ini benar-benar bukan kasus setiap hari!
4
Konsep Biaya dan Terminologi
FIXED, VARIABLE, AND INCREMENTAL COSTS
Fixed costs are those unaffected by changes in activity level
over a feasible range of operations for the capacity or
capability available.
- Typical fixed costs include insurance and taxes on
facilities, general management and administrative
salaries, license fees, and interest costs on borrowed
capital.
- When large changes in usage of resources occur, or when
plant expansion or shutdown is involved fixed costs will
be affected.
Variable costs are those associated with an operation that
vary in total with the quantity of output or other measures of
activity level.
- Example of variable costs include : costs of material and
labor used in a product or service, because they vary in
total with the number of output units -- even though
costs per unit remain the same.
Incremental Cost is the additional cost that results from
increasing the output of system by one/more units
5
RECURRING AND NONRECURRING COSTS
Recurring costs are repetitive and occur when a firm
produces similar goods and services on a continuing
basis.
- Variable costs are recurring costs because they
repeat with each unit of output .
- A fixed cost that is paid on a repeatable basis is
also a recurring cost: eg.: Office space rental
Nonrecurring costs are those that are not repetitive,
even though the total expenditure may be
cumulative over a relatively short period of time;
- Typically involve developing or establishing a
capability or capacity to operate;
- Examples are purchase cost for real estate upon
which a plant will be built, and the construction
costs of the plant itself; 6
DIRECT, INDIRECT AND STANDARD COST
Direct costs can be reasonably measured and allocated to a
specific output or work activity -- labor and material directly
allocated with a product, service or construction activity;
Indirect costs are difficult to allocate to a specific output or
activity -- costs of common tools, general supplies, and
equipment maintenance ;
Overhead consists of plant operating costs that are not direct
labor or material costs; indirect costs, overhead and burden
are the same;
Prime Cost is a common method of allocating overhead costs
among products, services and activities in proportion the sum
of direct labor and materials cost ;
Standard Cost is a representative costs per unit of output that
are established in advance of actual production and service
delivery;

7
SOME STANDARD COST USES

Estimating future manufacturing or service


delivery costs;
Measuring operating performance by
comparing actual cost per unit with the
standard unit cost;
Preparing bids on products or services
requested by customers;
Establishing the value of work-in-process and
finished inventories;

8
CASH COST VERSUS BOOK COST

Cash cost is a cost that involves payment in


cash and results in cash flow;
Book cost or noncash cost is a payment that
does not involve cash transaction; book costs
represent the recovery of past expenditures
over a fixed period of time;
Depreciation is the most common example of
book cost; depreciation is what is charged for
the use of assets, such as plant and
equipment; depreciation is not a cash flow;

9
SUNK COST AND OPPORTUNITY COST

A sunk cost is one that has occurred in the


past and has no relevance to estimates of
future costs and revenues related to an
alternative course of action;
An opportunity cost is the cost of the best
rejected ( i.e., foregone ) opportunity and is
hidden or implied;

10
LIFE-CYCLE COST
Life-cycle cost is
the summation of
all costs, both
recurring and
nonrecurring,
related to a
product,
structure, system,
or service during
its life span.
Life cycle begins
with the
identification of
the economic
need or want (the
requirement) and
ends with the
retirement and
disposal activities.

11
Accounting Fundamentals
The Accounting Equation
Asset Accounts = Liability Accounts + Owners Equity Accounts
Cash Short-term debt Capital Stock
Receivables Payables Retained earnings (income
Inventories Long-term debt retained in the firm)
Equipments
Buildings
Land
Cost Accounting Example

12
UTILITY AND DEMAND

Utility is a measure of the value which


consumers of a product or service place on
that product or service;
Demand is a reflection of this measure of
value, and is represented by price per
quantity of output;

13
PRICE Price equals some
constant value minus some multiple
a
of the quantity demanded:
p=a-bD

a = Y-axis (quantity) intercept, (price at 0


amount demanded);
b = slope of the demand function;

D = (a p) / b
QUANTITY ( OUTPUT )
PRICE
MR=0 MR = dTR / dD = a 2bD = 0

Total Revenue = p x D
TR = Max = (a bD) x D
=aD bD2

QUANTITY ( OUTPUT )

14
Marginal
( Incremental) Cost

Cost / Revenue
Profit is maximum where
Total Revenue exceeds
Total Cost by greatest amount

Maximum
Quantity ( Output )
Profit
Marginal Demand
Revenue
Ct
Cost / Revenue

Profit Total Revenue

Cf

Quantity ( Output )
D1 D* D2 Demand
15
D1 and D2 are breakeven points
PROFIT MAXIMIZATION D*
Occurs where total revenue exceeds total cost by
the greatest amount;
Occurs where marginal cost = marginal revenue;
Occurs where dTR/dD = d Ct /dD;
D* = [ a - b (Cv) ] / 2

BREAKEVEN POINT D1 and D2


Occurs where TR = Ct
( aD - D2 ) / b = Cf + (Cv ) D
- D2 / b + [ (a / b) - Cv ] D - Cf = 0
Using the quadratic formula:
D = - [ ( a / b ) - Cv ] + { [ (a / b ) - Cv ] 2 - ( 4 / b ) ( - Cf ) }1/2
------------------------------------------------------------------------
2/b
16
Example-1

A company produce an electronic timing


switch.
CF = $73,000 per month,
cv = $83 per unit,
Price = p = $180 0.02 (D)
a) Determine the optimal volume for this product and
confirm that profit occurs,
b) Find the volumes at which breakeven occurs.

17
Solution-1
a) D* = (a cv)/(2b) = ($180 83)/(2(0.02))
= 2,425 units per month
The Conditions:
1. a cv = $180 83 = $97 > 0 o.k.
2. (TR CT) > 0 for D* = 2,425 units per month
($180(2,425) 0.02(2,425)2) ($73,000 + 83(2,425))= $44,612 o.k.
b) Total revenue = Total cost (breakeven point)
- bD2 + (a cv)D CF = 0
- 0.02D2 + ($180 - $83)D - $73,000 = 0
- 0.02 D2 + 97 D 73,000 = 0

D1,2

97 972 4 0.02 73,000 1/ 2

2 0.02
97 59.74 97 59.74
D1 932 units/month D2 3,918 units/month
0.04 0.04 18
COST ESTIMATING
Used to describe the process by which the
present and future cost consequences of
engineering designs are forecast
COST ESTIMATING USED TO
Provide information used in setting a selling price for
quoting, bidding, or evaluating contracts
Determine whether a proposed product can be made
and distributed at a profit (EG: price = cost + profit)
Evaluate how much capital can be justified for process
changes or other improvements
Establish benchmarks for productivity improvement
programs
19
Pendekatan Estimasi Biaya terintegrasi

1. Work Breakdown Structure (WBS) memberikan definisi


rician detail setiap level elemen pekerjaan atau disebut
struktur elemen pekerjaan
2. Struktur biaya dan pendapatan (klasifikasi)
pengkategorian ini digunakan untuk estimasi aliran kas
pada setiap level WBS
3. Teknik Estimasi (model) merupakan model matematis
yang terpilih untuk estimasi biaya atau pendapatan
mendatang selama periode analisis
Dengan ketiga komponen dasar dan tahap prosedur
terintegrasi akan mampu memberikan pendekatan secara
terorganisasi dalam mengembangkan aliran kas suatu
alternatif projek 20
Pendekatan Terintegrasi untuk Pengembangan Aliran Kas Alternatif

21
Contoh WBS (3 level) Projek Bangunan Komersial

22
COST ESTIMATION TECHNIQUES
1. A dimensionless number that shows how prices / costs vary
with time -- a measurement of inflation or deflation
2. Changes usually occur as a result of:
technological advances
availability (scarcity) of labor and materials
changes in consumer buying patterns
3. It establishes a reference from some base time period (i.e., a
base year)
4. When compared to a current-year index measures the amount
(%) change from the base period

23
TECHNIQUES FOR ESTIMATING COSTS / REVENUES
Index
A dimensionless number that shows how prices / costs vary with
time -- a measurement of inflation or deflation
Changes usually occur as a result of:
- technological advances
- availability (scarcity) of labor and materials
- changes in consumer buying patterns
It establishes a reference from some base time period (i.e., a base
year)
When compared to a current-year index measures the amount (%)
change from the base period
IN = Index for some current year, N
Ik = Index for some base year, k
Ck = cost of some item during base year
CN = Ck ( IN / Ik )
CN = cost of the item during the current year
Also referred to as the ratio technique
24
Example
A certain index for the cost of purchasing and installing utility
boilers is keyed to 1984, where its baseline value was arbitrarily set
at 100. Company XYZ installed a 50,000-lb/hr boiler for $525,000 in
1996 when the index had a value of 468. The same company must
install another boiler of the same size in 2003. The index 2003 is
542. What is the approximate cost of the new boiler?

Year Index Cost


1984 100 -
1996 468 $525,000
2003 542 ?

C2003 = $525,000 (542/468) = $608,013


25
Indexes for multiple items

W1 C n 1 / C k 1 W2 C n 2 / C k 2 W M C nM / C kM
In Ik
W1 W2 W M

M = total number of items in the index ( 1 m M)


Cnm = unit cost (or price) of the mth item in year n
Ckm = unit cost (or price) of the mth item in year k
Wm = weight assigned to the mth item
Ik = composite index value in year k

26
Examples-3
Based on the following data, develop a weighted index for the price
of gasoline in 2002, when 1986 is the reference year having an
index value of 99.2. The weight placed on regular unleaded gasoline
is three times that of either premium or unleaded plus, because
roughly three times as much regular unleaded is sold compared
with premium or unleaded plus.
Price (Cents/Gal) in Year
1986 1992 2002
Premium 114 138 120
Unleaded plus 103 127 109
Regular unleaded 93 117 105

I 2002
1120 / 114 1109 / 103 3105 / 93
99.2 109
11 3
If I2004 estimated to be 189 then:
Premium: 120 cents/gal (189/109) = 208 cents/gal
Unleaded plus: 109 cents/gal (189/109) = 189 cents/gal
27
Regular unleaded: 105 cents/gal (189/109) = 182 cents/gal
TECHNIQUES FOR ESTIMATING COSTS / REVENUES

The Unit Technique


Per unit factor
Cost / price per : kWh, MWh
inch, cm, foot, yard,
meter, mile, km
second, hour, day
pound, ton, kg
person, family
28
TECHNIQUES FOR ESTIMATING COSTS / REVENUES
The Factor Technique
An extension of the unit method
Sum of products of component quantities and
corresponding unit costs plus component costs estimated
directly

C = S dCd + S mfmUm
C = cost being estimated
Cd = cost of d estimated directly
fm = cost per unit of m
Um = number of units of m
29
TECHNIQUES FOR ESTIMATING COSTS / REVENUES
The Power-Sizing Technique
Also referred to as exponential model
Used for costing plants and equipment
Recognizes that cost varies as some power of the change in
capacity or size
Example
(CA / CB) = (SA / SB)X
CA = CB(SA / SB)X
CA = Cost of plant A CB = Cost of plant B
SA = Size of plant A SB = Size of plant B
X = cost-capacity factor (reflects economies of scale)
- Eg. X=0.68 for nuclear gnerating plants and 0.79 for fossil-fuel
generating plans
30
Example-4
Suppose that an aircraft manufacturer desires to make a
preliminary estimate of the cost of building a 600-MW fossil-fuel
plant for the assembly of its new long-distance aircraft. It is known
that a 200-MW plant cost $100 million 20 years ago when the
approximate cost index was 400, and that cost index is now 1,200.
The cost capacity factor for a fossil-fuel power plant is 0.79.
Year Power Cost index Cost
1989 200 MW 400 $100 m
2009 600 MW 1,200 ?
Cost capacity factor X = 0.79

CB = $100 m (1,200/400 ) = $300 m


CA = $300 m (600/200 )0.79 = $714 m
31
TECHNIQUES FOR ESTIMATING COSTS / REVENUES

The Learning and Experience Technique


Learning curve is a mathematical model that explains
increased worker efficiency and improved performance
from repetitive production
Also experience curve or manufacturing progress function
Zu = Kun
u = the output unit number
Zu = # resource units to produce output unit u
K = # resource units to produce 1st output unit
s = learning-curve slope parameter expressed as a decimal,
(eg. s=0.9)
n = log s / log 2 = the learning curve exponent
32
TECHNIQUES FOR ESTIMATING COSTS / REVENUES
produce one unit of production
Time or resources needed to
Learning and Improvement

Number of units produced

33
Capital

Wealth in the form of money or property that can be used to produce


more wealth; Comprise of
Equity capital is that owned by individuals who have invested their
money or property in a business project or venture in the hope of
receiving a profit.
Debt capital, often called borrowed capital, is obtained from
lenders (e.g., through the sale of bonds) for investment.
Financing Definition Instrument Description

Debt Borrow Bond Promise to


financing money pay
principle &
interest;

Equity Sell partial Stock Exchange


financing ownership of shares of
company; stock for
ownership of
company;
34
The Time Value of Money
Interest: The fee that a borrower pays to a lender for the use of his or her money.
Interest Rate: The percentage of money being borrowed that is paid to the lender
on some time basis.
How interest determined:
Money Supply
Interest
MS3 MS1 MS2
Rate

i3

ie

i2
Money Demand

Quantity of Money 35
SIMPLE INTEREST
The total interest earned or charged is linearly
proportional to the initial amount of the loan
(principal), the interest rate and the number of interest
periods for which the principal is committed.
When applied, total interest I may be found by
I = ( P ) ( N ) ( i ), where
P = principal amount lent or borrowed
N = number of interest periods ( e.g., years )
i = interest rate per interest period

36
COMPOUND INTEREST
Whenever the interest charge for any interest period is
based on the remaining principal amount plus any
accumulated interest charges up to the beginning of
that period.
Period Amount Owed Interest Amount Amount Owed
Beginning of for Period at end of
period ( @ 10% ) period
1 $1,000 $100 $1,100
2 $1,100 $110 $1,210
3 $1,210 $121 $1,331

37
ECONOMIC EQUIVALENCE
Established when we are indifferent between a
future payment, or a series of future payments,
and a present sum of money .
Considers the comparison of alternative options,
or proposals, by reducing them to an equivalent
basis, depending on:
interest rate;
amounts of money involved;
timing of the affected monetary receipts and/or
expenditures;
manner in which the interest , or profit on invested
capital is paid and the initial capital is recovered.
38
ECONOMIC EQUIVALENCE FOR FOUR REPAYMENT PLANS
OF AN $8,000 LOAN
Plan #1: $2,000 of loan principal plus 10% of BOY principal paid at the end of year;
interest paid at the end of each year is reduced by $200 (i.e., 10% of remaining
principal) Interest Total money
Amount owned of the Principal Total end of
Year accrued of the owned at end
beginning year (BOY) Payment year payment
year year
1 8,000 800 8,800 2,000 2,800
2 6,000 600 6,600 2,000 2,600
3 4,000 400 4,400 2,000 2,400
4 2,000 200 2,200 2,000 2,200
20,000 2,000
Total interest paid ($2,000) is 10% of total dollar-years ($20,000)
Plan #2: $0 of loan principal paid until end of fourth year; $800 interest paid at
the end of each year
Amount owned of Interest Total money Total end of
Principal
Year the beginning year accrued of owned at end year
Payment
(BOY) the year year payment
1 8,000 800 8,800 2,000 2,800
2 8,000 800 8,800 2,000 2,800
3 8,000 800 8,800 2,000 2,800
4 8,000 800 8,800 2,000 2,800
32,000 3,200 39
CASH FLOW DIAGRAMS / TABLE NOTATION
i = effective interest rate per interest period
N = number of compounding periods (e.g., years)
P = present sum of money; the equivalent value of one or
more cash flows at the present time reference point
F = future sum of money; the equivalent value of one or
more cash flows at a future time reference point
A = end-of-period cash flows (or equivalent end-of-period
values ) in a uniform series continuing for a specified
number of periods, starting at the end of the first period
and continuing through the last period
G = uniform gradient amounts -- used if cash flows increase
by a constant amount in each period
40
CASH FLOW DIAGRAMS / TABLE NOTATION
3 5
A = $2,524
1
1 2 3 4 5=N

2 4
P =$8,000 i = 10% per year
1
Time scale with progression of time moving from left to
right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.
2
Present expense (cash outflow) of $8,000 for lender.

3 Annual income (cash inflow) of $2,524 for lender.

4 5 Dashed-arrow line indicates


Interest rate of loan. 41
amount to be determined.
RELATING PRESENT AND FUTURE EQUIVALENT
VALUES OF SINGLE CASH FLOWS

Finding F when given P:


Finding future value when given present value
F = P ( 1+i ) N
(1+i)N single payment compound amount factor
functionally expressed as F = ( F / P, i%,N )
predetermined values of this are presented in column 2
of Appendix C of text.
P
N=
0
42
F=?
RELATING A UNIFORM SERIES (ORDINARY ANNUITY) TO
PRESENT AND FUTURE EQUIVALENT VALUES
Finding F given A: Finding P given A:
Finding future equivalent Finding present equivalent
income (inflow) value given a income (inflow) value given a
series of uniform equal series of uniform equal
Payments Payments
(1+i)N-1 (1+i)N-1
F=A P=A
i i(1+i)N
uniform series compound uniform series compound
amount factor in [ ] amount factor in [ ]
functionally expressed as functionally expressed as
F = A ( F / A,i%,N ) P = A ( P / A,i%,N )
predetermined values are predetermined values are
in column 4 of Appendix C in column 5 of Appendix C
of text of text
F=? 1 2 3 4 5 6 7 8
A=
1 2 3 4 5 6 7 8 43
A= P=?
Interest Factors Relationships
1
A / P , i%, N
P / A, i%, N
1
A / F , i%,N
F / A, i%,N
F / A, i%,N P / A, i%,N F / P , i%,N
N
P / A, i%, N P / F , i%, k
k 1
N
F / A, i%, N F / P , i%, N k
k 1

A / F , i%,N A / P , i%,N i
44
Deferred Annuities (Uniform Series)

F7 = A(F/A, i%, 4)
P3 = A(P/A, i%, 4)
A

0 1 2 3 4 5 6 7
i = interest rate

P=?

P = P3 (P/F, i%, 3) = A (P/A, i%, 4) (P/F, i%, 3)


P = F7 (P/F, i%, 7) = A (F/A, i%, 4) (P/F, i%, 7)
45
Equivalence Calculations Involving Multiple Interest Formulas

P0
$1,000
$600
$400 $400 $400 $400
$200

0 1 2 3 4 5 6 7

P0 = $200 (P/F, i%, 1) + 600 (P/F, i%, 2) + 1,000 (P/F, i%,3)


+ 400 (P/A, i%, 4) (P/F, i%, 3)

46
Equivalence Calculations Involving Multiple Interest Formulas

$1,000 F7
$600
$400 $400 $400 $400
$200

0 1 2 3 4 5 6 7

F7 = $200 (F/P, i%, 6) + 600 (F/P, i%, 5) + 1,000 (F/P, i%,4)


+ 400 (F/A, i%, 4)

47
Equivalence Calculations Involving Multiple Interest Formulas

P0
$1,000 F7
$600
A
$400 $400 $400 $400
$200

0 1 2 3 4 5 6 7

A = P0 (A/P, i%, 7)

A = F7 (A/F, i%, 7)

48
Example-5

Pa Pb =?
i = 10%

=?

Pa = Pb
Pa = 2H (P/A, 10%, 4) + H (P/A, 10%, 3) (P/F, 10%, 5)
Pb = Q (P/F, 10%, 2) Q (P/F, 10%, 7)

Pa = Pb
Pa = 7.8839 H
Q = 25.172 H
Pb = 0.31329 Q
49
RELATING A UNIFORM GRADIENT OF CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given G:


Find the present equivalent value when given the
uniform gradient amount
1 (1 + i ) N-1 N
P=G -
i i (1 + i ) N (1 + i ) N
Functionally represented as P = G ( P / G, i%,N )
The value shown in{ } is the gradient to present
equivalent conversion factor and is presented in
column 8 of Appendix C (represented in the above
50
parenthetical expression).
Cash Flow Diagram for a Uniform Gradient
Increasing by G Dollars per period

i = effective interest rate (N-1)G


per period
(N-2)G
(N-3)G

3G
2G
G

1 2 3 4 N-2 N-1 N
End of Period
51
RELATING A UNIFORM GRADIENT OF CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find A when given G:


Find the annual equivalent value when given the
uniform gradient amount
1 N
A= G -
i (1 + i ) N - 1
Functionally represented as A = G ( A / G, i%,N )
The value shown in [ ] is the gradient to uniform
series conversion factor and is presented in column
9 of Appendix C (represented in the above
52
parenthetical expression).
53
Nominal and Effective Interest Rates
Let:
P = $1,000
i = 6% per 6 months, (r = 12% per year compounded
semiannually)
F = ? After one year
F6months = $1,000 (1 + 0.06) = $1,060
F12months = $1,060 (1 + 0.06) = $1,123.60
F12months = $1,000 (1 + 0.12 / 2)2

F = P (1 + r/M)M = P (1 + i)
(1 + r/M)M = 1 + i i = (1 + r/M)M - 1
i = effective interest rate
r = nominal interest rate
M = number of compounding periods
54
MINIMUM ATTRACTIVE RATE OF RETURN
(MARR)
An interest rate used to convert cash flows into
equivalent worth at some point(s) in time
Usually a policy issue based on:
- amount, source and cost of money available for
investment
- number and purpose of good projects available for
investment
- amount of perceived risk of investment
opportunities and estimated cost of administering
projects over short and long run
- type of organization involved
MARR is sometimes referred to as hurdle rate 55
Minimum Attractive Rate of Return MARR

MARR Cost of Capital


Cost of Capital = Cost of Equity + Cost of Debt
Weighted Average Cost of Capital WACC
= Cost of Equity ( Equity ) + Cost of Debt ( Debt)

Source Percentage % Cost % WACC %


Debt 30 8 2.4
Equity 70 12 8.4
10.8

56
CAPITAL RATIONING
MARR approach involving opportunity cost viewpoint
Exists when management decides to restrict the total
amount of capital invested, by desire or limit of
available capital
Select only those projects which provide annual rate
of return in excess of MARR
As amount of investment capital and opportunities
available change over time, a firms MARR will also
change
57
FINDING PRESENT WORTH
Discount future amounts to the present by using the interest rate
over the appropriate study period
N
PW = S
k=0
Fk ( 1 + i ) - k
i = effective interest rate, or MARR per compounding period
k = index for each compounding period
Fk = future cash flow at the end of period k
N = number of compounding periods in study period
interest rate is assumed constant through project
The higher the interest rate and further into future a cash flow
occurs, the lower its PW
The project (Alternative) is acceptable for investment when:

PW 0
The better alternative is that of higher PW
58
Example-6

A piece of new equipment has been proposed by engineers to


increase the productivity of certain manual welding operation.
The investment cost is $25,000 and the equipment will have the
market value of $5,000 at the end of a study period of five years.
Increased productivity attributable to the equipment will amount
to $8,000 per year after extra operating costs have been
subtracted from the revenue generated by the additional
production.
If the firms MARR (before income taxes) is 20% per year, is this
proposal a sound one?
Use the PW method.

59
Solution Example-6
$5,000

$8,000 $8,000 $8,000 $8,000 $8,000

1 2 3 4 5=N
0
MARR = 20% per year

$25,000

PW = $25,000 + $8,000 (P/A, 20%, 5) + $5,000 (P/F, 20%, 5)


PW = $25,000 + $8,000 (2.9906) + $5,000 (0.4019)
PW = $934.3 > 0
The project is acceptable
60
FUTURE WORTH METHOD (FW )
FW is based on the equivalent worth of all cash inflows
and outflows at the end of the planning horizon at an
interest rate that is generally MARR
The FW of a project is equivalent to PW
FW = PW ( F / P, i%, N )
If FW > 0, it is economically justified
N
FW ( i % ) = S Fk ( 1 + i ) N - k
k=0
i = effective interest rate
k = index for each compounding period
Fk = future cash flow at the end of period k
N = number of compounding periods in study period

61
ANNUAL WORTH METHOD ( AW )
AW is an equal annual series of dollar amounts, over a
stated period ( N ), equivalent to the cash inflows and
outflows at interest rate that is generally MARR
AW is annual equivalent revenues ( R ) minus annual
equivalent expenses ( E ), less the annual equivalent capital
recovery (CR)
AW ( i % ) = R - E - CR ( i % )
AW = PW ( A / P, i %, N )
AW = FW ( A / F, i %, N )
If AW > 0, project is economically attractive
AW = 0 : annual return = MARR earned

62
Example-7

You purchase a building five years ago for $100,000.


Its annual maintenance expense has been $5,000 per year.
At the end of three years, you spent $9,000 on roof repairs.
At the end of five years (now), you sell the building for
$120,000.
During the period of ownership, you rented the building for
$10,000 per year paid at the beginning of each year.
Use the AW method to evaluate this investment when your
MARR is 12% per year.

63
Solution Example-7 $120,000

$10,000 $10,000 $10,000 $10,000 $10,000

1 2 3 4 5=N
0
$5,000 $5,000 $5,000 $5,000 $5,000

$100,000
$9,000
AW = -90,000 (A/P, 12%, 5) + $5,000 + $110,000 (A/F, 12%, 5)
- 9,000 (P/F, 12%, 3) (A/P, 12%,5)
AW = -90,000 (0.2774) + $5,000 + $110,000 (0.1574)
- 9,000 (0.7118) (0.2774) = -$4429.08

AW = -$4429.08 < 0, The building was not a good investment


64
INTERNAL RATE OF RETURN METHOD ( IRR )
IRR solves for the interest rate that equates the
equivalent worth of an alternatives cash inflows
(receipts or savings) to the equivalent worth of
cash outflows (expenditures)
Also referred to as:
investors method
discounted cash flow method
profitability index
IRR is positive for a single alternative only if:
both receipts and expenses are present in the cash flow
pattern
the sum of receipts exceeds sum of cash outflows
65
INTERNAL RATE OF RETURN METHOD ( IRR )
IRR isN
i %, using the following N
PW formula:
S
k=0
R k ( P / F, i %, k ) = S
k=0
E k ( P / F, i %, k )
R k = net revenues or savings for the kth year
E k = net expenditures including investment
costs for the kth year
N = project life ( or study period )
If i > MARR, the alternative is acceptable
To compute IRR for alternative, set net PW = 0
N N
PW = S R k ( P / F, i %, k ) - S E k ( P / F, i %, k ) = 0
k=0 k=0
i is calculated on the beginning-of-year unrecovered
investment through the life of a project
66
INTERPRETING IRR USING INVESTMENT-
BALANCE DIAGRAM
Investment Balance Diagram describes how much money is tied up in a project
and how the recovery of funds behaves over its estimated life.
P (1 + i)
[ P (1 + i) - (R1 - E1) ] (1 +i)
1 + i
Unrecovered 1 + i
Investment (R1 - E1) 1 + i
Balance, $ (R2 - E2)
(R3 - E3)
Initial investment
=P (RN-1 - EN-1) 1 + i
(RN - EN) $0
0 1 2 3 N
downward arrows represent annual returns (Rk - Ek) : 1 < k < N
dashed lines represent opportunity cost of interest, or interest on
BOY investment balance
IRR is value i that causes unrecovered investment balance to equal
0 at the end of the investment period. 67
Example-8

A piece of new equipment has been proposed by engineers


to increase the productivity of certain manual welding
operation.
The investment cost is $25,000 and the equipment will have
the market value of $5,000 at the end of a study period of
five years.
Increased productivity attributable to the equipment will
amount to $8,000 per year after extra operating costs have
been subtracted from the revenue generated by the
additional production.
If the firms MARR (before income taxes) is 20% per year, is
this proposal a sound one?
Use the IRR method.
68
Solution-8
$5,000

$8,000 $8,000 $8,000 $8,000 $8,000

1 2 3 4 5=N
0
MARR = 20% per year
$25,000

PW = - $25,000 + $8,000 (P/A, IRR, 5) + $5,000 (P/F, IRR, 5) = 0


i = 0% PW = -$25,000 + $8000 (5) + $5,000 (1) = $20,000
i = 10% PW = -$25,000 + $8000 (3.7908) + $5,000 (0.6209) = $8,430.90
i = 20% PW = -$25,000 + $8000 (2.9906) + $5,000 (0.4019) = $934.30
i = 25% PW = -$25,000 + $8000 (2.6839) + $5,000 (0.3277) = -$1,847.10

69
Solution-8
$934.30

20% 25%

IRR
$1847.10
IRR = 20% + 5% [934.30/(934.30 + 1847.10)]
IRR = 21.7% per year > 20% = MARR,
The project is acceptable

70
Solution-8

71
Solution-8 (Investment Balance Diagram)

72
PAYBACK PERIOD METHOD
Sometimes referred to as simple payout method
Indicates liquidity (riskiness) rather than profitability
Calculates smallest number of years ( ) needed for cash
inflows to equal cash outflows -- break-even life
ignores the time value of money and all cash flows
which occur after

S( Rk -Ek) - I > 0
k=1
If is calculated to include some fraction of a year, it is
rounded to the next highest year

73
PAYBACK PERIOD METHOD

The payback period can produce misleading results, and


should only be used with one of the other methods of
determining profitability
A discounted payback period ( where < N ) may be
calculated so that the time value of money is considered

S
k=1
( Rk - Ek ) ( P / F, i %, k ) - I > 0
i is the MARR
I is the capital investment made at the present time
( k = 0 ) is the present time
is the smallest value that satisfies the equation
74
Example-9 Payback Periode
Net Cash Cumulative
End of Year
Flow Cash Flow
0 -$25,000 -$25,000
1 8,000 -17,000
2 8,000 -9,000
3 8,000 -1,000
4 8,000 +7,000
5 13,000 +20,000

It ignores the time value of money.


It ignores the cash flow that happened after the
payback period. 75
FEASIBLE DESIGN ALTERNATIVES
Alternatives may be mutually exclusive (i.e., choice if
one excludes the choice of any other alternative)
because :
The alternatives being considered may require
different amounts of capital investment
The alternatives may have different useful lives
The subject of this section will help:
analyze and compare feasible alternatives
select the preferred alternative
The cash-flow analysis methods used in this process:
Present Worth ( PW )
Annual Worth ( AW )
Future Worth ( FW )
Internal Rate of Return ( IRR )
76
INVESTMENT AND COST ALTERNATIVES
Alternative
A B (B-A)

Capital Investment (60,000.00) (73,000.00) (13,000.00)

Annual revenues less expenses 22,000.00 26,225.00 4,225.00

PW(10%)A=-60.000+22.000(P/A. 10%, 4)=9.378


PW(10%)B=-73.000+26.225(P/A. 10%, 4)=10.131
PW(10%)Diff=-13.000+4.225(P/A. 10%, 4)=393

77
RULE FOR CHOOSING AMONG
ALTERNATIVES
The alternative that requires the minimum investment and
produces satisfactory functional results will be chosen
unless the incremental capital associated with an
alternative having a larger investment can be justified with
respect to its incremental savings (or benefits ).
The alternative requiring the least investment is the base
alternative.
Rule ensures that as much capital as possible is invested at
a rate of return equal to or greater than the MARR.

78
ENSURING COMPARABLE BASIS FOR SELECTING
MUTUALLY-EXCLUSIVE ALTERNATIVES
Include any economic impacts of alternative differences
in estimated cash flows Two Rules:
Rule 1. When revenues and other economic benefits are
present, select alternative that has greatest positive
equivalent worth at i = MARR and satisfies project
requirements.
Rule 2. When revenues and economic benefits are not
present, select alternative that minimizes cost.

79
PLANNING HORIZON
The selected time period over which mutually exclusive
alternatives are compared -- study period
May be influenced by factors including:
service period required
useful life of the shorter-lived alternative
useful life of the longer-lived alternative
company policy
It is key that the study period be appropriate for the
decision situation under investigation
Useful life of an asset is the time period during which it
is kept in productive use in a trade or business.
80
REPEATABILITY ASSUMPTION

The study period over which the alternatives are being


considered is either indefinitely long or equal to a
common multiple of the lives of the alternatives.
The economic consequences that are estimated to happen
in an alternatives initial useful life span will also happen in
all succeeding life spans (replacements)
Actual situations in engineering practice seldom meet both
conditions

81
REPEATABILITY ASSUMPTION

B A

N=4 N=3

A
3 6 9 N = 12

B
4 8 N = 12

82
Example-10
The following data have been estimated for two mutually
exclusive investment alternatives, A and B, associated with a
small engineering project for which revenues as well as
expenses are involved.
they have useful lives of four and six years, respectively.
If the MARR = 10% per year, show which alternative is more
desirable by using equivalent worth methods.
Use repeatability assumption.
A B
Capital investment $3,500 $5,000
Annual revenue 1,900 2,500
Annual expenses 645 1,020
Useful life (years) 4 6
Market value at end of useful life 0 0 83
Solution-10
A B
$1,255 $1,480

4 8 N = 12 6 N = 12

$3,500 $3,500 $3,500 $5,000 $5,000

PW(10%)A = $3,500 PW(10%)B = $5,000


$3,500 (P/F, 10%, 4) $5,000 (P/F, 10%, 6)
$3,500 (P/F, 10%, 8) + $1,480 (P/A, 10%, 12)
+ $1,255 (P/A, 10%, 12)
PW(10%)A = $1,028 PW(10%)B = $2,262
PW(10%)A < PW(10%)B
Alternative B is desirable
84
COTERMINATED ASSUMPTION
A finite and identical study period is used for all
alternatives
This planning horizon, combined with appropriate
adjustments to the estimated cash flows, puts the
alternatives on a common and comparable basis
Used when repeatability assumption is not
applicable
Approach most frequently used in engineering
practice

85
COTERMINATED ASSUMPTION
Guidelines when useful life(s) different in length than
study period
Useful life < study period
a. Cost alternatives -- each cost alternative must provide
same level of service as study period : 1) contract for
service or lease equipment for remaining time; 2)
repeat part of useful life of original alternative until
study period ends
b. investment alternatives -- assume all cash flows
reinvested in other opportunities at MARR to end of
study period
86
COTERMINATED ASSUMPTION
Guidelines when useful life(s) different in length than
study period
Useful life > study period
Truncate the alternative at the end of the study
period using an estimated market value. This
method assumes disposable assets will be sold at
the end of the study period at that value

87
COTERMINATED ASSUMPTION
Study Period = 7 years,
Study period = 4 years < Useful lives
Useful Life A < Study Period < Useful life B

SA SA
A A
N=4 N=5 N=5 N=7
SB SB

B B
N=4 N=7
Study period = 10 years, > Useful lives

A
N=5 N = 10

SB

B
N=8 N = 10 88
SELECT THE EQUIVALENT WORTH ALTERNATIVE WITH
THE GREATER WORTH
If : PWA (i) < PWB (i)
then
PWA (i) ( A / P,i,N ) < PWB (i) ( A / P,i,N )
and
AWA (i) < AWB (i)
similarly
PWA (i) ( F / P, i, N ) < PWB (i) ( F / P, i, N )
and
FWA (i) < FWB (i)
Select alternative B 89
RATE OF RETURN METHOD
RULES
1. Each increment of capital must justify itself by producing a
sufficient rate of return on that increment.
2. Compare a higher investment alternative against a lower
investment alternative only when the latter is acceptable.
3. Select the alternative that requires the largest investment
of capital as long as the incremental investment is justified
by benefits that earn at least the MARR. This maximizes
equivalent worth on total investment at i = MARR.

90
INCONSISTENT RANKING PROBLEM
Ranking errors can occur when a selection among
mutually exclusive alternatives is based wrongly on
maximization of IRR on the total cash flow, as opposed to
the PW of the total cash flow
When the MARR is less than the IRR of the difference
between alternative cash flows, an incorrect choice will be
made by selecting an alternative that maximizes the IRR of
its total cash flow, because
-- the IRR method assumes reinvestment of cash flows at the
calculated rate(s) of return
-- the PW method assumes reinvestment at the MARR

91
INCREMENTAL INVESTMENT ANALYSIS PROCEDURE
( Helps avoid incorrect ranking problem )
1. Order the feasible alternatives.
2. Establish a base alternative
a. Cost alternatives -- The first alternative is the base
b. Investment alternatives - If the first alternative is
acceptable, select as base. If the first alternative is not
acceptable, choose the next alternative
3. Use iteration to evaluate differences (incremental cash flows)
between alternatives until no more alternatives exist
a. If incremental cash flow between next alternative and
current alternative is acceptable, choose the next
b. Repeat, and select as the preferred alternative the last one
for which the incremental cash flow was acceptable
92
THREE ERRORS COMMON TO INCREMENTAL
INVESTMENT ANALYSIS PROCEDURE APPLIED TO IRR

Choosing the feasible Alternative with:


1. the highest overall IRR on total cash flow
2. the highest IRR on an incremental capital
investment
3. the largest capital investment that has an IRR
greater than or equal to the MARR
Incremental analysis must be used with rate of return
methods to ensure the best alternative is selected

93
INCREMENTAL ANALYSIS PROCEDURE USED WITH
EQUIVALENT WORTH METHODS
Equivalent worth methods may also be applied using the
incremental analysis procedure to compare mutually exclusive
alternatives
Alternative ranking will be consistent with equivalent worth values
based on total investment of each alternative
Ranking will be consistent with ROR methods when using
incremental analysis
When equivalent worth of investment cash flow > 0 at i =
MARR, its IRR > MARR
Equivalent worth methods using incremental investment analysis can
be used as a screening method for the IRR method

94
IMPUTED MARKET VALUE TECHNIQUE
When current marketplace data is unavailable for an asset,
it is sometimes necessary to estimate the market value of
an asset
Referred to as an imputed or implied market value
Estimating is based on logical assumptions about the
remaining life for the asset
MVT = [ EW at the end of year T of remaining capital recovery
amounts ] + [ EW at the end of year T of original market
value at the end of useful life ]
T < useful life
EW is equivalent worth at i = MARR 95
COMPARING ALTERNATIVES USING THE
CAPITALIZED WORTH METHOD
Capitalized Worth (CW) method -- Determining the
present worth of all revenues and / or expenses over an
infinite length of time
Capitalized cost -- Determining the present worth of
expenses only over an infinite length of time
Capitalized worth or capitalized cost is a convenient basis
for comparing mutually exclusive alternatives when a
period of needed services is indefinitely long and the
repeatability assumption is applicable

96
CAPITALIZED WORTH METHOD
Capitalized worth of a perpetual series of end-of-
period uniform payments, A, with interest i% per
period:
A ( P /A, i%, )

8
CW = PWN --> = A ( P / A, i%, )

8
8
( 1+i )N - 1
= A lim ------------- = A(1/i)
N -->
8

i ( 1 + i )N

97
Example-11
A selection to be made between two structural designs.
Because revenues do not exist (or can be assumed to be
equal), only negative cash flow amounts (costs) and the
market value at the end of useful life are estimated, as
follows:
Structure M Structure N
Capital Investment $12,000 $40,000
Market Value 0 $10,000
Annual Expenses $2,200 $1,000
Useful life (years) 10 25

Using the repeatability assumption and the CW method of


analysis, determine which structure is better if the MARR is
15% per year. 98
Solution-11
Structure M Structure N
Capital Investment $12,000 $40,000
Market Value 0 $10,000
Annual Expenses $2,200 $1,000
Useful life (years) 10 25

AW(15%)M = $12,000 (A/P, 15%, 10) $2,200 = $4,592


AW(15%)N = $40,000 (A/P, 15%, 25) + $10,000 (A/F, 15%, 25)
$1,000 = $7,141

CW(15%)M = AWM / i = $4,592 / 0.15 = $30,613


CW(15%)N = AWN / i = $7,141 / 0.15 = $47,607

Based on the CW of each structural design, alternative M should be selected


because it has the lesser negative value ($30,613).

99
THREE GROUPS OF MAJOR INVESTMENT
ALTERNATIVES
1. Mutually exclusive :
At most one project out of the group can be chosen
2. Independent :
The choice of a project is independent of the choice of any other
project in the group, so that all or none of the projects may be
selected or some number in between
3. Contingent :
The choice of the project is conditional on the choice of one or more
other projects

100
REPLACEMENT ANALYSIS
The evaluation of changes in economics of assets
associated with their use in an operating environment.
Considers asset
replacement
retirement
Augmentation

Reason for Replacement Analysis:


Physical Impairment (Deterioration)
Altered Requirements
Technology
Financing

101
PHYSICAL IMPAIRMENT
(DETERIORATION)
Efficiency loss resulting from continued use --
aging
Increased routine and corrective maintenance
costs
Greater energy requirements
Increased need for operator intervention
Unanticipated problems leading to equipment
deterioration
102
ALTERED REQUIREMENTS
Significant change in demand for related
products or services
Significant change in the composition or
design of associated products or services
May be considered a form of obsolescence

103
TECHNOLOGY
Impact of technological change varies with
associated industry
Technological changes typically reduce cost
per unit and improve quality of output
Results in earlier replacement of existing
assets with improved assets
May be considered a form of obsolescence

104
ECONOMIC LIFE
The period of time (years) that results in the minimum
Equivalent Uniform Annual Cost (EUAC) of owning and
operating an asset
EUAC is a term sometimes used to identify the annual worth
of a primarily cost cash flow pattern
Assuming good asset management, economic life should
coincide with time from date of acquisition to date of
abandonment, demotion in use, or replacement from
primary intended service
Sometimes called minimum-cost life or optimum
replacement interval
For a new asset, economic life can be computed if capital
investment, annual expenses, and year-by-year market
values are known or can be estimated
105
OWNERSHIP LIFE, PHYSICAL LIFE ,
&USEFUL LIFE
OWNERSHIP LIFE:
Period between date of acquisition and date of disposal
by a specific owner
A given asset may have different categories of use
during this period
PHYSICAL LIFE:
Period of time between original acquisition and final
disposal of an asset over its succession of owners
USEFUL LIFE:
The time period in years that an asset is kept in
productive service either in primary or backup mode
An estimate of how long an asset is expected to be used
in a trade or business to produce income
106
BEFORE-TAX ANALYSIS
Determining Present worth of total costs
PWk ( i%) = I - MVk (P / F, i%,k) + Sk Ej (P / F, i%, j)
j=1

Sum of
PW of initial capital investments occurring after time 0
PW of MV at end of year k
PW of annual expenses through year k

107
BEFORE-TAX ANALYSIS
Determining Present Worth of Marginal Costs
Marginal cost is the difference in present worth
of total cost for year k minus the present worth
of total cost for year k - 1
Total amount of this marginal cost is found by:
TCk(i%) = (PWk - PWk-1) (F / P, i%,k)

108
BEFORE-TAX ANALYSIS
Determining Present Worth of Marginal Costs
Simplification of Total calculation of marginal cost
TCk(i%) = MVk-1 - MVk + iMVk-1 + Ek
This is the sum of:
the loss in MV during year of extended service
the opportunity cost of capital invested in the asset at
the beginning of year k
the annual expenses incurred in year k

109
BEFORE-TAX ANALYSIS
The total marginal (Year-by-year) costs are
used to find the EAUC through each year K
The minimum EAUCk value during the useful
life of the asset, determines its before-tax
economic life
Before-tax economic life = N*

110
AFTER-TAX ANALYSIS
Extending the Before-Tax Analysis equation to account
for income tax effects:
PWk(i%) = I + Sk [ ( 1 - t ) Ej - tdj ] ( P / F, i%, j ) -
j=1
[ ( 1 - t )MVk + t ( BVk ) ] ( P / F, i%, k)
Equation finds PW of ATCF through year k by:
adding initial capital investment and sum of after-tax
PW of annual expenses through year k, including
adjustments for annual depreciation amounts
adjusting the total after-tax PW of costs by the after-
tax consequences of gain or loss on disposal of asset at
end of year k

111
AFTER-TAX ANALYSIS
Determining Present Worth of Marginal Costs
Total amount of this after-tax marginal cost:
TCk = ( PWk - PWk-1 ) ( F / P, i%, k )
Simplifying
TCk (i%) = (1 - t)(MVk-1 - MVk + iMVk-1 + Ek) + i (t)(BVk-1)
The economic life of the asset on an after-tax basis is N*AT

112
DETERMINING THE ECONOMIC LIFE OF A
DEFENDER
When major outlay for alteration or overhaul is required,
the life that will yield least EUAC is likely time to next
alteration or overhaul
When defender MV is 0 and operating expenses expected
to increase annually, the remaining life that will yield least
EAUC will be 1 year
When MVs are greater than 0 and expected to decline
from year to year, calculate remaining economic life in
same manner as for before-tax analysis
By using outsider viewpoint, the present realizable MV is
considered its investment value
113
EVALUATING PROJECTS WITH THE
BENEFIT / COST RATIO METHOD
BENEFITS, COSTS, AND DISBENEFITS
Benefits - The favorable consequences of the
project to the project sponsors (i.e., the public for
public projects)
Costs -- Monetary disbursements required (i.e., of
the government for public projects)
Disbenefits -- The negative consequences of the
project to the project sponsors

114
PRIVATE VERSUS PUBLIC PROJECTS
PURPOSE
Private Project -- Maximize profit, minimize costs
Public Project -- Offer social benefits (i.e., health,
employment ) without profit
CAPITAL SOURCES
Private Project -- Private investors and lenders
Public Project -- Taxation; Private Lenders
FINANCING
Private Project -- Individuals (for sole proprietorships and
partnerships); stocks and corporate bonds (for corporations)
Public Projects -- Direct taxes, Low, no-interest or private
loans, bonds, subsidies

115
PRIVATE VERSUS PUBLIC PROJECTS
MULTIPLE PURPOSES
More frequently for public projects ( i.e., reservoir for:
flood control, power source, irrigation, recreation)
PROJECT LIFE
Private Project -- 5 to 20 years;
Public Project -- 20 to 60 years
CAPITAL PROVIDER RELATIONSHIP TO PROJECT
Private Project -- Direct
Public Project -- Indirect or none
NATURE OF BENEFITS
Private Project -- Monetary or near monetary
Public Project -- Non-monetary; difficult to equate
to monetary terms
116
PRIVATE VERSUS PUBLIC PROJECTS
PROJECT BENEFICIARIES
Private Project -- Those undertaking project
Public Project -- General public
CONFLICT OF PURPOSES
More common for public projects (i.e., dam for flood control vs
environmental preservation)
CONFLICT OF INTERESTS
More common for public projects (i.e., intra-agency conflicts)
POLITICAL INFLUENCE
More common for public projects ( i.e., changing decision makers,
pressure groups, financial and residential restrictions)
EFFICIENCY MEASUREMENT
Private Project -- Rate of Return on capital
Public Project -- No direct comparison with private projects
117
BENEFIT / COST RATIO METHOD
The time-value of money must be considered to
account for the timing of cash flows (benefits)
occurring after inception of project
A ratio of discounted benefits to discounted costs
The ratio of equivalent worth (i.e., AW, PW or FW)
of benefits to the equivalent worth of costs
Also known as savings-investment ratio by some
governmental agencies

118
CONVENTIONAL BENEFIT / COST (B/C) RATIO WITH
PRESENT WORTH (PW)
PW (benefits of the proposed project) PW(B)
B/C = ---------------------------------------- = -------------
PW(total costs of the proposed project) I +PW(O&M)
where: PW() = present worth of ()
B = benefits of the proposed project
I = initial investment of the proposed project
O&M = operating and maintenance costs of the proposed project

AW (benefits of the proposed project) AW(B)

B/C = ---------------------------------------- = -------------


AW(total costs of the proposed project) CR +AW(O&M)
where: AW() = annual worth of ()
B = benefits of the proposed project
CR = capital recovery amount (i.e., the equivalent annual cost of the
initial investment, I, including an allowance for salvage value, if any)
O&M = operating and maintenance costs of the proposed project
119
BENEFIT / COST ANALYSIS IN DETERMINING
ACCEPTABILITY OF A PROJECT
All of the preceding formulations for benefit / cost analysis
result in consistent acceptance or rejection:
B / C > 1.0 --- Project accepted
B / C = 1.0 --- Project accepted
B / C < 1.0 --- Project Rejected
Conventional B / C ratios for PW and AW formulations
result in the same numerical values
Modified B / C ratios for PW and AW formulations result in
the same numerical values (but not the same as the
conventional B / C ratios)

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DISBENEFITS IN THE BENEFITS / COST (B / C)
RATIO
The traditional approach to incorporating
disbenefits into a benefit / cost analysis to reduce
the benefits by the amount of disbenefits (i.e., to
subtract disbenefits from benefits in the numerator
of the B/C ratio).
Alternatively, the disbenefits could be treated as
costs (i.e., add disbenefits to costs in the
denominator).

121
Terimakasih

30 maret (06, 08, 29, 32) absen

122

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