mme 4272 sem 2 2014-2015

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Investment Analysis

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  • INVESTMENT ANALYSIS 1

    MME 4272 Engineering Management Part II

    INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

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  • Category of Projects

    To help formulate alternatives, a project is categorized as one of the following:Mutually exclusive: Only one of the viable projects can be selected by the economic analysisIndependent: More than one viable project may be selected by the economic analysis

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  • Tools for Evaluating Alternatives

    Various tools/methods to evaluate alternatives economically (economic equivalence) using the factors learned Purpose:Compare mutually exclusive alternativesBasis: present worth, future worth & annual worth analysis

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  • Tools for Evaluating alternatives

    Present Worth AnalysisFormulating Mutually Exclusive AlternativesPresent Worth Analysis of Equal-life AlternativesPresent worth Analysis of DifferentLife AlternativesFuture Worth AnalysisPayback Period AnalysisAnnual Worth AnalysisRate of Return AnalysisBenefit/Cost Ratio Analysis

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  • PW Analysis of Equal-Life Alternatives

    One alternative: Calculate PW at the MARRIf PW 0, the requested MARR is met or exceeded (alternative is financially viable)Two or more alternatives: Calculate the PW of each alternativeSelect alternative with largest PW value (alternative with less negative or more positive)

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  • PW Analysis of Equal-Life Alternatives

    If the projects are independent, the selection guideline is as follows:

    For one or more independent projects, select all projects with PW 0 at the MARR

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    PW1PW2Selected alternative$ -1500$ -5002 -500+10002+2500-5001+2500+15001
  • Perform a present worth analysis of equal-service machine with costs shown below, if the MARR is 10% per year. Revenue for all the alternatives are expected to be the same

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    PW Analysis of Equal-Life Alternatives

    Electricpowered Gas poweredSolar poweredFirst cost, $Annual operating cost (AOC), $Salvage value S, $Life, years- 2500 - 900 200 5- 1500 - 700 350 5- 6000 - 50 100 5
  • These are service alternatives: The PW of each machine is calculated at i = 10% for n = 5 years

    PWE = -2500 - 900(P/A,10%,5) + 200(P/F,10%,5)= $-5788

    PWG = -3500 - 700(P/A,10%,5) + 350(P/F,10%,5)= $-5936

    PWS = -6000 - 50(P/A,10%,5) + 100(P/F,10%,5)= $-6127

    [See the calculations in excel file]

    The electric-powered machine is selected since the PW of its costs is the lowest (has numerically the largest PW value)

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    PW Analysis of Equal-Life Alternatives

  • PW Analysis of Different-Life Alternatives

    A project engineer with EnvironCare is assigned to start up a new office in a city where a 6-year contract has been finalized to take and to analyze ozone-level readings. Two lease options are available, each with a first cost, annual lease cost, and deposit-return estimates as shown below:

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    Location ALocation BFirst cost, $Annual lease cost, $ per yearDeposit return, $Lease term, years- 15,000 -3,500 1,000 6- 18,000 -3,100 2,000 9
  • Determine which lease option should be selected on the basis of a PW comparison, if MARR is 15% per year

    EnvironCare has a standard practice of evaluating all projects over a 5-year period. If a study period of 5 years is used & the deposit returns are not expected to change, which location should be used?

    Determine location over a 6-year study period if deposit return at location B is estimated to be $6000 after 6 years

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    PW Analysis of Different-Life Alternatives

  • Break-Even Point

    Breakeven AnalysisSingle-product CaseMulti-product CaseAssumptionsGraphical and Algebraic ApproachDetermining BEP for single and multi-product cases

    [Reference: Operations Management, Heizer & Render, 8th ed (p-287)]

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  • Break-Even Analysis

    A critical tool for determining capacity a facility must have to achieve profitabilityObjective is to find the point in dollars or ringgits & units at which, cost equals revenueRequires estimation of fixed costs, variable costs, & revenueFixed costs are costs that continue even if no units are produced (depreciation, taxes, debt, mortgage payments)Variable costs are costs that vary with the volume of units produced (labor, materials, portion of utilities)

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  • Break-Even Analysis

    Variable costs are costs that vary with the volume of units produced (labor, materials, portion of utilities)Contribution is the difference between selling price and variable costAssumptions:Costs and revenue are linear functions (In reality, the case is not so)There is no time value of money

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  • *

    Break-Even Analysis

    Profit corridor

    Loss corridor

    Total revenue line

    Total cost line

    Variable cost

    Fixed cost

    Break-even point

    Total cost = Total revenue

    900

    800

    700

    600

    500

    400

    300

    200

    100

    ||||||||||||

    010020030040050060070080090010001100

    Cost in dollars

    Volume (units per period)

  • *

    Break-Even Analysis

    TR = TC

    or

    Px = F + Vx

    Break-even point occurs when

    Profit= TR - TC

    = Px - (F + Vx)

    = Px - F - Vx

    = (P - V)x - F

    BEPx=Break-even point in units

    BEP$=Break-even point in dollars

    P=Price per unit (after all discounts)

    x=Number of units produced

    TR=Total revenue = Px

    F=Fixed costs

    V=Variable costs per unit

    TC=Total costs = F + Vx

    BEPx =

    F

    P - V

    F

    (P - V)/P

    F

    P - V

    F

    1 - V/P

    BEP$= BEPx P

    = . P

    =

    =

  • *

    Fixed costs = $10,000 Material = $0.75/unit

    Direct labor = $1.50/unit Selling price = $4.00 per unit

    Break-Even Analysis

    F

    1 - (V/P)

    $10,000

    1 - [(1.50 + 0.75)/(4.00)]

    BEP$ = =

    $10,000

    1 - [(1.50 + 0.75)/(4.00)]

    F

    1 - (V/P)

    $10,000

    .4375

    = = $22,857.14

    F

    P - V

    $10,000

    4.00 - (1.50 + 0.75)

    BEPx = =

    = 5,714

  • *

    Break-Even Example

    50,000

    40,000

    30,000

    20,000

    10,000

    ||||||

    02,0004,0006,0008,00010,000

    Dollars

    Units

    Fixed costs

    Total costs

    Revenue

    Break-even point

  • *

    Break-Even Example

    Multi-product Case

    whereV= variable cost per unit

    P= price per unit

    F= fixed costs

    W= percent each product is of total dollar sales

    i= each product

    Fixed costs = $3,500 per month

    Annual Forecasted

    ItemPriceCostSales Units

    Sandwich$2.95$1.257,000

    Soft drink.80.307,000

    Baked potato1.55.475,000

    Tea.75.255,000

    Salad bar2.851.003,000

    Vi

    Pi

    1 - x (Wi)

    F

    BEP$ =

  • *

    Multiproduct BEP Example

    Sandwich$2.95$1.25.42.58$20,650.446.259

    Soft drink.80.30.38.625,600.121.075

    Baked 1.55.47.30.707,750.167.117

    potato

    Tea.75.25.33.673,750.081.054

    Salad bar2.851.00.35.658,550.185.120

    $46,3001.000.625

    AnnualWeighted

    SellingVariableForecasted% ofContribution

    Item (i)Price (P)Cost (V)(V/P)1 - (V/P)Sales $Sales(col 5 x col 7)

  • *

    Multiproduct Example

    1 - x (Wi)

    Vi

    Pi

    F

    BEP$ =

    $3,500 x 12

    .625

    = = $67,200

    $67,200

    312 days

    = = $215.38

    Daily sales

    .446 x $215.38

    $2.95

    = 32.6 33

    sandwiches

    per day

  • *

    Problems for practice (to be solved in the class)

    Given the following data, calculate BEP(x), BEP ($), and the profit at 100,000 units:

    P= $8/unit, V = $4/unit and F =$50,000.

    (2) A prolific author is considering starting her own publishing company. She will call it DSI Publishing, Inc. DSIs estimated costs are

    -------------------------------------------------------------------

    Fixed$250,000.00

    Variable cost per book $20.00

    Selling price per book $30.00

    How many books must DSI sell to break even? What is its break-even point in dollars?

  • Depreciation - Terminology

    Depreciation - reduction in value of an asset (usually annual depreciation is tax deductible - it is subtracted from income when calculating amount of taxes due each yearFirst cost (or unadjusted basis) - the delivered & installed cost of the asset including purchase priceBook value (BV)represents the remaining (undepreciated) capital investment in the books after total amount of depreciation charges to date have been subtracted from the basis

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  • Depreciation - Terminology

    Book value (BV) - usually determined at the end of each year; consistent with the end-of-year conventionRecovery period (n)- the depreciable life, n of the asset in yearsSalvage value (S)- the estimated trade-in or market value at the end of the assets useful lifeDepreciation rate or recovery rate (dt)- the fraction of first cost removed by depreciation each year (may be same for straight line method or different for each year of the recovery period)

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  • Depreciation Methods

    Straight Line (SL) DepreciationBook value decreases linearly with timeDepreciation rate (dt = 1/n = d)is the same each year of the recovery period, nConsidered the standard against which any depreciation model is comparedThe annual SL depreciation is determined by multiplying the first cost minus salvage value by d

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  • *

    Straight Line (SL) Depreciation

    In

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