ANALISA EKONOMI TEKNIK

Present Worth Analysis Annual Cash Flow Analysis Rate of return Analysis

ANALISA EKONOMI TEKNIK 1

Present Worth Analysis

Kita sdh bahas: Konsep ekivalensi Arus Kas Bunga majemuk Selanjutnya: Memahami kriteria ekonomi. Penggunaan metoda present worth . Asumsi2 dalam solusi analisa ekonomi teknik.

Economic Decision Making Problems Fall Into Three Categories

Three criteria that apply to all of our analysis techniques:
1. For fixed input situations, maximize the benefits or other outputs. 2. For fixed output situations, minimize the costs or other inputs. 3. Where inputs and outputs vary, maximize = benefits costs.

First step is to decide which category applies. See the back inside cover of the text.
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Economic Criteria Restated Present Worth Techniques

Situation Fixed input Amount of capital available fixed Criterion Maximize present worth of benefits : PWB Max PWB Minimize present worth of costs: PWC Min PWC Maximize net present worth: NPW Max NPW = PWB - PWC

Fixed output

$ amount of benefit is fixed or fixed outcome

Neither fixed

Neither capital nor $ benefits are fixed

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Economic Criteria - Examples

Alt A Situation Fixed input Example $150,000 budgeted for raw materials Criterion Purchase the most you can for the money. Maximize output.

Fixed output

20,000 sq ft building needed

Negotiate for minimum cost/sq ft. Minimize input

Neither fixed

Purchasing rental property

Maximize the profit - The biggest margin between benefit & cost. Maximize PWB - PWC

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Applying Present Worth Techniques

With PW analysis the analysis period used is a major consideration. Several cases:
Useful life of the alternative(s) equals the analysis period. Alternatives have useful lives different from the analysis period. The analysis period is infinite or long enough to be treated as infinite, n =
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Useful Lives Equal the Analysis Period

1. Example 5-1: Require a project to last five years. 2. The equipment and tooling will last five years. 3. Calculate the PW or NPW over a five year span and junk the equipment at the end of the five years (salvage value = 0). 4. Two alternatives with cost of $1000 and useful live of 5 years. Assume i = 7%.
Year 0 1 2 3 4 5 A -1000 300 300 300 300 300 B -1000 400 350 300 250 200
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Example 5-1: Fixed input, therefore maximize PW of Benefits.

Alternative A
Find the PW of all cash flows related to benefits of Alternative A. Also include additional costs that come later. PW of Benefits = 300 (P/A, 7%, 5) = 300 (4.100) = $1230

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Example 5-1: Fixed input, therefore maximize PW of Benefits (contd)

Alternative B - Here we have a combination of a uniform series (A = 400) and a negative gradient (G = 50). Decompose to use the factors available.
PW of Benefits = 400 (P/A, 7%, 5) - 50 (P/G, 7%, 5) = 400 (4.100) - 50 (7.647) = $1257.65

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Example 5-1 Contd

PWB Alternative A = $1230.00 PWB Alternative B = $1257.65 Since our criteria was to maximize PW of Benefits, Alternative B is preferred. Notice that each alternative provided the same total cash flow, but alternative B provided it sooner so that it was available sooner to the company to use.

MONEY NOW IS BETTER THAN MONEY LATER

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More Examples
Example 5-2: Two stage construction. Fixed output so Minimize PW of Cost Use PW factors to find PW of second stage costs and benefits at time 0. Example 5-3: Salvage value included Fixed output, so Minimize PW of Cost Use PW factors to find PW of salvage value. Operating & maintenance costs were assumed equal. Example 5-4: Neither input nor output fixed Maximize (PWB - PWC) or Maximize NPW Salvage value treated as a negative cost ( a benefit)

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Useful Lives Different From the Analysis Period

Consider (based on Example 5-3):
Speedy: Useful life = 5 years. P = 1500, S = 200, PWC = $1357 Allied: Suppose useful life = 10 years instead of 5 years. P = 1600, Salvage value = 325. PWC = $1435.

If we have two alternatives with different useful lives, is it proper to compare PWB and/or PWC directly? Solution: Require the project to last 10 years.
Answer: No, because we have 5 additional years of benefits for Allied that would be ignored

For Speedy assume that you will purchase new equipment and tooling twice: At the beginning of year one and six. Junk the equipment and tooling at the end of each five year period and replace with the same equipment.
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Useful Lives Different From the Analysis Period

Calculate the PW or NPW over a 10 year span. Now Allied is the preferred choice since PWC is less than for Speedy
Speedy: PWC = $2325

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Techniques for Dealing with Unequal Useful Lives

Repeated Project Policy - We will assume the same costs and benefits and repeat a project all the way to the end of the analysis period. This is a major part of PW analysis. Least Common Multiple - Find useful life that coincides with multiple lives of each alternative under consideration: e.g. If useful lives are 3 years and 4 years, then the least common multiple is 12 years.
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Techniques for Dealing with Unequal Useful Lives

Terminal year
Sometimes the least common multiple method (LCM) creates an unrealistic useful life (e.g., 13 years and 7 years = LCM of 91 years). Instead, pick a terminal year and repeat all projects up until the terminal year. Truncate all costs and benefits after the terminal year (See Figure 5-1 on page 175 for an illustration)
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Infinite Analysis Period

For n = infinity, A = i P Therefore:
P=A/i i=A/P

When you have a very long analysis period, use the infinity assumption to simplify problems. Example 5-6: If we can resolve our desired task or service into an equivalent A, then we can use P = A / i to simplify the process of finding P.
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Assumptions in Solving Economic Analysis Problems

End-of-year (or period) convention (simplifies calculations) Viewpoint (generally the firm) Sunk costs (past has no bearing) Borrowed money (consider investing only) Effect of inflation (prices are not stable) Income taxes (must be considered for realism)

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ANALISA EKONOMI TEKNIK 2

Annual Cash Flow Analysis

Annual Cash Flow Calculations

Resolving a Present Cost to an Annual Cost
Simplest case is to convert the PV to an Aseries (annual worth):
A = P(A/P, i, n)

A is -PMT in EXCEL.
To duplicate the A/P factor, put the value for P in place of PV in the PMT fields: PMT(rate, nper, pv, fv, type) (fv and type are 0)

Where there is salvage value:

A = F(A/F, i, n)
See Examples 6 -1 & 2

To duplicate the A/F factor, put the value for F in place of FV in: PMT(rate, nper, pv, fv, type) (pv and type are 0)

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Annual Cash Flow Four Essential Points

EUAC = PWC(A/P, i, n) EUAB = PWB(A/P, i, n) EUAW = EUAB - EUAC EUAW is

Decreased by a cost. Increased by a benefit.

In MS Excel use -PMT to calculate EUAW

(remember the minus sign)

For an irregular cash flow over the analysis period first determine the PW then convert to EUAW.

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Annual Cash Flow Analysis

Situation Criterion

Fixed input

Amount of capital available fixed

Maximize EUAB

Fixed output

$ amount of benefit is fixed

Minimize EUAC

Neither fixed

Neither capital nor $ benefits are fixed

Maximize EUAW

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Two More Examples of Resolving a PW to an EUAW These two examples further illustrate:
The equivalency of PW and EUAW. Example 6-5 (Example 5-1) Example 6-6 EUAW

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Analysis Period Considerations

Analysis period equal to alternative lives. Analysis period a common multiple of alternative lives. Analysis period for a continuing requirement. Some other period such as project life.

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Analysis Period Equal to Alternative Lives.

Base the comparison on the life of the alternatives. This is the case we have most often considered in our examples.

This is rarely the case in real life organizations.

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Analysis Period a Common Multiple of Alternative Lives.

When the lives of the equipment in the two alternatives varies, use a common multiple of the two lives. Example 6-7 However, calculations are simplified. You only need to use one useful life to get the EUAW.

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Analysis Period for a Continuing Requirement.

Where the project will last forever (nothing does) use an infinite time period.

In most analyses organizations often use a representatively long time period to get a reasonable estimate. Example 6-9: Alt A has infinite analysis period. Use A = P i

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Some Other Period Such As Project Life.

Most often physical equipment has a useful life that varies from the project life. In this case use the project life as the analysis period.

This is the most common case in real organizations.

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ANALISA EKONOMI TEKNIK 3

Rate of Return Analysis

Three Major Methods of Economic Analysis

PW - Present Worth AW - Annual Worth

IRR - Internal Rate of Return

If P = A(P/A, i, n) Then (P/A, i, n) = P/A Solve for (P/A, i, n) and look up interest in Compound Interest Tables

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Internal Rate of Return (IRR)

The interest rate paid on the unpaid balance of a loan such that the payment schedule makes the unpaid loan balance equal to zero when the final payment is made. Ex: P = $5000, i = 10%, n = 5
Year 1 2 3 4 5 6 Principal Prin. Paid 5000.00 818.99 4181.01 900.89 3280.13 990.97 2289.15 1090.07 1199.08 1199.08 0.00 Int Paid 500.00 418.10 328.01 228.92 119.91 Payment 1318.99 1318.99 1318.99 1318.99 1318.99 0.00
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Calculating Rate of Return

The IRR is the interest rate at which the benefits equal the costs. IRR = i*
PW Benefit - PW Cost = 0 PW Benefit/PW Cost = 1 NPW = 0 EUAB - EUAC = 0 PW Benefit = PW Cost

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Calculating IRR - Example 7-1

PWB/PWC = 1 2000(P/A, i, 5)/8200 = 1 (P/A, i, 5) = 8200/2000 = 4.1

From Table, IRR = 7%

From Compound Interest Tables Interest rate 6% (P/A,i,5) 4.212

7%
8%
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4.100
3.993
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Calculating IRR - Example 7-2

Sometimes we have more than one factor in our equation. When that happens we cannot solve for just one factor. If we use: EUAB - EUAC = 0 100 + 75(A/G, i, 4) - 700(A/P, i, 4) = 0

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Calculating IRR - Example 7-2 (contd)

No direct method for calculating. Use trial and error and iterate to get answer. Try i = 5%:
100 + 75(A/G, 5%, 4) - 700(A/P, 5%, 4) = + 11 + 11 is too high. The interest rate was too low

Try i = 8%
100 + 75(A/G, 8%, 4) - 700(A/P, 8%, 4) = - 6 - 6 is too low. The interest rate was too high

Try i = 7%
100 + 75(A/G, 8%, 4) - 700(A/P, 8%, 4) = 0 Therefore IRR = 7%

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Calculating IRR - Example 7-3

Example 7-3 shows a series of cash flows that does not match any of our known patterns. We must use trial and error. Using NPW = 0, suppose we start with i = 10% . NPW = + 10.16, which is too high. Using i = 15%, NPW = - 4.02. IRR is between 10% & 15% The iterations may be graphed and the true IRR will be indicated at the point where the NPW curve = 0.

Yr 0 1 2 3 4 5

CF - 100 + 20 + 20 + 30 + 40 + 40

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Calculating IRR - Example 7-3 (Contd)

We can use linear interpolation to find estimate the point where the curve crosses 0. IRR = i* = 10% + (15%-10%)[10.16/(10.16 + 4.02)] = 13.5% This is a linear interpolation of a non-linear function so the answer is slightly inaccurate, but good enough for decision making here (after all, the guesswork in our future cash flows introduces uncertainty in the analysis).
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Calculating IRR - Example 7-3 (Contd)

To get an exact answer, we can use the IRR function in EXCEL Select the IRR function from the fx icon. Block the column on the spreadsheet that has the cash flows for all years. The function returns the IRR.

-100 20 30 20 40 40 13.47%

The IRR function in EXCEL allows you to evaluate the return of investments very easily

=IRR(A1:A6)
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Calculating IRR for a Bond - Example 7-4a

Bond Costs and Benefits:
Purchase price = $1000 Dividends = $40 every six months Sold after one year for $950

Calculation of Periodic interest rate & IRR:

m = 2 compounding periods/year 1000 = 40(P/A, i, 2) + 950(P/F, i, 2) By trial and error and interpolation i* 1.5% IRR Nominal rate = 2 x 0.015 = 0.03 (3%) IRR Effective rate = (1 + 0.015)2 - 1 = 0.0302 (3.02%)

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Example 7-4a EXCEL Solution

Use IRR function to find periodic IRR (i) Find nominal using r = i * m Use EFFECT function to find effective interest rate

Period 0 1 2

Buy/sell Dividend -1000 40 950 40

Total -1000 40 990 1.52% 3.04% 3.06%

periodic nominal effective

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Rate Of Return (ROR) Analysis

Most frequently used measure of merit in industry. More accurately called Internal Rate of Return (IRR).

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Calculating ROR
Where two mutually exclusive alternatives will provide the same benefit, ROR is performed using an incremental rate of return (DROR) on the difference between the alternatives. You cannot simply choose the higher IRR alternative.
Two-alternative situation Decision

DROR MARR DROR < MARR

Choose higher-cost alternative Choose lower-cost alternative

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The Minimum Attractive Rate of Return (MARR)

The MARR is a minimum return the company will accept on the money it invests The MARR is usually calculated by financial analysts in the company and provided to those who evaluate projects It is the same as the interest rate used for Present Worth and Annual Worth analysis.

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ROR on Alternatives With Equivalent Benefits

Example 7-5: Consider the lease vs. buy situation. MARR = 10% Leasco: Lease for five years for 3 annual payments of $1000 each Saleco: Purchase up front for $2783 Both alternatives have a $1200/year benefit for 5 years

Year 0 1 2 3 4 5 IRR/period

Cash flow - Cash flow - Cash flow alternative alternative alternative A (Leaseco) B (Saleco) B-A -$1,000.00 $200.00 $200.00 $1,200.00 $1,200.00 $1,200.00 48.72% -$2,783.00 $1,200.00 $1,200.00 $1,200.00 $1,200.00 $1,200.00 32.60% -$1,783.00 $1,000.00 $1,000.00 $0.00 $0.00 $0.00 8.01%
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Example 7-5 (Contd)

Cannot simply pick the highest IRR if alternatives have different investment costs Must examine the incremental cash flows!! Subtract the cash flows for the Lower First Cost alternative from the cash flows of the Higher First Cost alternative to obtain the Incremental Cash Flow or D Compute the IRR on the incremental cash flow. This is the DROR. For this problem the DROR is 8.01% which is < MARR, therefore choose the lower cost alternative.
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Example 7-5 (Contd)

Q. Why did we do this? A. Both alternatives were acceptable compared only to
the MARR. Since either alternative will work, the question is whether we want to spend the additional $1783 to go from the lower cost to the higher cost alternative. The benefit for doing so is the savings of two years of $1000 lease payments. Essentially we are getting an 8.01% return on that $1783 investment. The company can get 10% ROR on its money elsewhere, so reject the increment. That is, spend $1000 now on Leaseco and invest the other $1783 for a higher return.

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Analysis Period
Just as in PW and AW analysis the analysis period must be considered:
Useful life of the alternative equals the analysis period. Alternatives have useful lives different from the analysis period. The analysis period is infinite, n =

For an example of that uses a common multiple of the alternate service lives, see Example 7-10. EXCEL would be useful here because of the irregularity of the cash flows.

7-10

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