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ENS191 ENGINEERING ECONOMY > FINALS > Flashcards

FINALS Flashcards

1
Q

What does all engineering economy studies of capital projects should consider?

A

The return that a given project will or should produce.

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2
Q

To be attractive, a capital project must what?

A

Provide a return that exceeds a minimum level established by the organization.

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3
Q

Formula for rate of return

A

Rate of return = net annual profit/capital invested

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4
Q

Define Minimum Attractive Rate of Return (MARR)

A

It is chosen by the top management to maximize the economic well-being of an organization.

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5
Q

4 Considerations in establishing the MARR

A
  1. The amount of money available for investment, and the source and cost of these funds (i.e.,equity funds or borrowed funds)
  2. The number of good projects available for investment and their purpose (i.e.,whether they sustain present operations and are essential, or whether they expand on present operations
  3. The amount of perceived risk associated with investment opportunities available to the firm and the estimated cost of administering projects over short planning horizons versus long planning horizons
  4. The type of organization involved (i.e.,government, public utility, or private industry)
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6
Q

Define Present Worth (PW) Method

A

All cash inflows and outflows are discounted to the present point in time at an interest rate that is generally the MARR.

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7
Q

What does a positive PW or positive FW mean?

A

A positive PW or FW for an investment project at a given MARR means that the project is acceptable or it satisfies the MARR.

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8
Q

Formula for PW

A

PW = PWinflows - PWoutflow

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9
Q

Define Future Worth (FW) Method

A

It is based on the equivalent worth of all cash inflows at the end of the study period at an interest rate that is generally the MARR.

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10
Q

Define Annual Worth (AW) Method

A

Annual equivalent revenue or savings (A) minus annual equivalent expenses (E), less its annual capital recovery (CR) amount.

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11
Q

What does a positive AW mean?

A

A positive AW for an investment project means that the project is economically justified.

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12
Q

Formula for AW

A

AW = A - E - CR

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13
Q

Define capital recovery (CR)

A

It is the equivalent annual cost for the investment made.

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14
Q

Capital recovery covers two items:

A
  1. Loss in value of the asset
  2. Interest on invested capital (i.e., at the MARR)
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15
Q

Formula for CR

A

CR(i%) = I (A/P, i%, n) - S (A/F, i%, n)
where:
I = initial investment, Co
S = salvage value, CL

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16
Q

Define Internal Rate of Return (IRR)

A

Interest rate that equates the equivalent worth of an alternative’s cash inflows (revenue, R) to the equivalent worth of cash outflows (expenses, E)

17
Q

Formula for IRR

A

Summation R(P/F, i%, n) = Summation E(P/F, i%, n)

18
Q

When is the project acceptable for IRR?

A

If the IRR for a project is greater than or equal to the MARR, then the project is acceptable.

19
Q

Define External Rate of Return (ERR)

A

It takes into account the interest rate, epsilon, external to a project at which net cash flows generated (or required) by a project over its life can be reinvested (or borrowed).

20
Q

2 advantages of ERR over IRR:

A
  1. It can usually be solved for directly, without needing to resort to trial and error.
  2. It is not subject to the possibility of multiple rates of return.
21
Q

When is the project economically justified for ERR?

A

If ERR is greater than or equal to MARR, the project is economically justified.

22
Q

Define payback period method

A

It mainly indicates a project’s liquidity rather than its profitability. The simple payback period is the number of years required for cash inflows to just equal cash outflows.

23
Q

Formula for payout period (years)

A

Payout Period (years) = (investment-salvage value)/net annual cash flow

24
Q

Making decision means?

A

Making decision means comparing alternatives.

25
Q

Rules for Choosing among Alternatives

A

➢ 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.
➢ For alternatives that have a larger investment than the base:
If the extra benefits obtained by investing additional capital are better than those that could be obtained from investment of the same capital elsewhere in the company at the MARR, the investment should be made.

26
Q

Ensuring Comparable Basis for Selecting Mutually Exclusive Alternatives include?

A

Any economic impacts of alternative differences in estimated cash flows.

27
Q

Two Rules Ensuring Comparable Basis for Selecting Mutually Exclusive Alternatives

A

Rule 1. When revenues and other economic benefits are available, select alternative that has greatest positive equivalent worth at i = MARR and satisfies project requirements.

Rule 2. When revenues and economic benefits are not available, select alternative that minimizes cost.

28
Q

Two Basic Types of Alternatives

A
  1. Investment Alternatives
    Those with initial (or front-end) capital investment that produces positive cash flows from increased revenue, savings through reduced costs, or both.
  2. Cost Alternatives
    Those with all negative cash flows, except for a possible positive cash flow from disposal of assets at the end of the project’s useful life.
29
Q

Select the alternative that gives you the most _____!

A

money

30
Q

Difference between investment alternatives and cost alternatives

A

For investment alternatives
* The present worth of all cash flows must be positive, at the MARR, to be attractive.
* Select the alternative with the largest present worth.

For cost alternatives
* The present worth of all cash flows will be negative.
* Select the alternative with the largest (smallest in absolute value) present worth

31
Q

6 Methods in Comparing Alternatives

A
  1. The Rate of Return (RoR) on Additional Investment Method
  2. The Annual Cost (AC) Method
  3. The Present Worth Cost (PWC) Method
  4. The Equivalent Uniform Annual Cost (EUAC) Method
  5. The Capitalized Cost (CC) Method
  6. The Payback (Payout) Period Method
32
Q

Define The Rate of Return (RoR) on Additional Investment Method

A

▪ If the rate of return on additional investment is satisfactory, then the alternative requiring a bigger investment is more economical and should be chosen.

▪ The alternative that requires the largest investment of capital is selected as long as the incremental investment is justified by the benefits that earn at least the MARR.

33
Q

Fromula for The Rate of Return (RoR) on Additional Investment

A

Rate of Return (RoR) on Additional Investment = annual net savings/additional investment

34
Q

Define The Annual Cost (AC) Method

A

▪ The annual cost of the alternatives including interest on investment is determined.

▪ The alternative with the least annual cost is chosen.

▪ Applies only to alternatives which has a uniform cost data for each year and a single
investment of capital at the beginning of the first year of the project life.

35
Q

Define The Present Worth Cost (PWC) Method

A

▪ The present worth of the net cash outflows for each alternative for the same period of
time is determined.

▪ The alternative with the least present worth of cost is selected.

36
Q

Define The Equivalent Uniform Annual Cost (EUAC) Method

A

▪ All cash flows (irregular or uniform) must be converted to an equivalent uniform annual
cost, i.e. a year-end amount which is the same each year.

▪ The alternative with the least equivalent uniform annual cost is preferred.

▪ When used, the equivalent uniform annual cost of the alternative must be calculated for
one life cycle only.

37
Q

Define The Capitalized Cost Method

A

▪ A variation of the present worth cost pattern.
▪ Used for alternatives having long lives.
▪ The capitalized cost of all alternatives is determined.
▪ The alternative with the least capitalized cost is chosen.

38
Q

Define The Payback (Payout) Period Method

A

▪ The payback period of each alternative is computed

▪ The alternative with the shortest payback period is adopted

▪ Seldom used

39
Q

Formula for The Payback (Payout) Period Method

A

Payout period (in years) = (investment-salvage value)/net annual cash flow

ENS191 ENGINEERING ECONOMY (5 decks)

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