FINALS

Question 1

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

Answer 1

The return that a given project will or should produce.

Question 2

To be attractive, a capital project must what?

Answer 2

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

Question 3

Formula for rate of return

Answer 3

Rate of return = net annual profit/capital invested

Question 4

Define Minimum Attractive Rate of Return (MARR)

Answer 4

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

Question 5

4 Considerations in establishing the MARR

Answer 5

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)

Question 6

Define Present Worth (PW) Method

Answer 6

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

Question 7

What does a positive PW or positive FW mean?

Answer 7

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

Question 8

Formula for PW

Answer 8

PW = PWinflows - PWoutflow

Question 9

Define Future Worth (FW) Method

Answer 9

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.

Question 10

Define Annual Worth (AW) Method

Answer 10

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

Question 11

What does a positive AW mean?

Answer 11

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

Question 12

Formula for AW

Answer 12

AW = A - E - CR

Question 13

Define capital recovery (CR)

Answer 13

It is the equivalent annual cost for the investment made.

Question 14

Capital recovery covers two items:

Answer 14

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

Question 15

Formula for CR

Answer 15

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

Question 16

Define Internal Rate of Return (IRR)

Answer 16

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

Question 17

Formula for IRR

Answer 17

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

Question 18

When is the project acceptable for IRR?

Answer 18

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

Question 19

Define External Rate of Return (ERR)

Answer 19

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).

Question 20

2 advantages of ERR over IRR:

Answer 20

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.

Question 21

When is the project economically justified for ERR?

Answer 21

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

Question 22

Define payback period method

Answer 22

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.

Question 23

Formula for payout period (years)

Answer 23

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

Question 24

Making decision means?

Answer 24

Making decision means comparing alternatives.

Question 25

Rules for Choosing among Alternatives

Answer 25

➢ 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.

Question 26

Ensuring Comparable Basis for Selecting Mutually Exclusive Alternatives include?

Answer 26

Any economic impacts of alternative differences in estimated cash flows.

Question 27

Two Rules Ensuring Comparable Basis for Selecting Mutually Exclusive Alternatives

Answer 27

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.

Question 28

Two Basic Types of Alternatives

Answer 28

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.

Question 29

Select the alternative that gives you the most _____!

Answer 29

money

Question 30

Difference between investment alternatives and cost alternatives

Answer 30

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

Question 31

6 Methods in Comparing Alternatives

Answer 31

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

Question 32

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

Answer 32

▪ 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.

Question 33

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

Answer 33

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

Question 34

Define The Annual Cost (AC) Method

Answer 34

▪ 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.

Question 35

Define The Present Worth Cost (PWC) Method

Answer 35

▪ 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.

Question 36

Define The Equivalent Uniform Annual Cost (EUAC) Method

Answer 36

▪ 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.

Question 37

Define The Capitalized Cost Method

Answer 37

▪ 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.

Question 38

Define The Payback (Payout) Period Method

Answer 38

▪ The payback period of each alternative is computed ▪ The alternative with the shortest payback period is adopted ▪ Seldom used

Question 39

Formula for The Payback (Payout) Period Method

Answer 39

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