ENGINEERING ECONOMICS II Ⅰ VVESTMENT ANALYSIS o Companies(and individuals invest money in order to earn money ◆ examples E Build a factory to make washing machines and dryers E Open a laundromat BWrite a novel what is being invested here ?) E Get a degree in chemical engineering 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 1 ENGINEERING ECONOMICS II INVESTMENT ANALYSIS t Companies (and individuals) invest money in order to earn money t Examples ðBuild a factory to make washing machines and dryers ðOpen a laundromat ðWrite a novel (what is being invested here?) ðGet a degree in chemical engineering
PROJECT LIFE CYCLE ◆ nitial investment E Purchase of productive facilities x Land and buildings a Equipment E Startup funds Working capital Project life E Start up-come up to full potential OPerate at full potential until end of project life 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 2 PROJECT LIFE CYCLE t Initial Investment ðPurchase of productive facilities X Land and buildings X Equipment ðStartup funds ðWorking capital t Project Life ðStart up - come up to full potential ðOperate at full potential until end of project life
PROJECT CASH FLOW DIAGRAM Perfect CASH FLOW Startup Investment Period Payout Time K TIME Real starte 10/1899 Engineering economics ll 3
10/18/99 Engineering Economics II 3 Payout Time Investment Period CASH FLOW TIME Perfect Startup Real Startup Project Life PROJECT CASH FLOW DIAGRAM
PROJECT ACCOUNTING I ◆ Gross Profit (aka Profit Before Taxes or PBt) Pbt=Sales revenue-Operating Expenses ◆ Operating Expenses Raw materials UTilities → Labor E Maintenance → Overhead 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 4 PROJECT ACCOUNTING I t Gross Profit (aka Profit Before Taxes or PBT) PBT = Sales Revenue - Operating Expenses t Operating Expenses ðRaw materials ðUtilities ðLabor ðMaintenance ðOverhead
PROJECT ACCOUNTING II ◆ Net profit (aka profit After Taxes or pat) PAT=(1-Trate)(PBT-Depreciation where Trate= corporate income tax rate(48%) ◆ Depreciation Allowance for the depreciation of the fixed investment (equipment wears out, etc. Depreciation=/Fixed Investment //Nd "Straight line” where Nd= depreciation period 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 5 PROJECT ACCOUNTING II t Net Profit (aka Profit After Taxes or PAT) PAT = (1 - Trate) (PBT - Depreciation) where Trate = corporate income tax rate (~ 48%) t Depreciation Allowance for the depreciation of the fixed investment (equipment wears out, etc. Depreciation = [Fixed Investment]/Nd “Straight line” where Nd = depreciation period
PROJECT ACCOUNTING III ◆ Cash flow What is left after expenses and taxes have been paid. CF= PBT-Taxes ( Trate) PBT Trate Deprec ◆ Example Revenue= S1.0MMlyr; Expenses=S0.5 MMyr Investment=$0.5 MM; Nd=5; Deprec= SO.1 MM PBT= SI.0 MM-SO5 MM= S0.5 MM: Trate= SO.48 CF=(1-0.48)0.5+10.48)0.1=S0.308MM 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 6 PROJECT ACCOUNTING III t Cash Flow What is left after expenses and taxes have been paid. CF = PBT -Taxes = (1 - Trate) PBT + Trate Deprec t Example Revenue = $1..0 MM /yr; Expenses = $0.5 MM/yr Investment = $0.5 MM ; Nd = 5; Deprec = $0.1 MM PBT = $1.0 MM - $0.5 MM = $0.5 MM; Trate = $0.48 CF = (1 - 0.48) 0.5 + (0.48) 0.1 = $0.308 MM
PROJECT ACCOUNTINGⅣ ◆ Accounts receivable Money owed to the business for goods shipped or ded services provice ◆ Accounts Payable Money owed by the business to suppiers and employees (payroll amdfpr taxes o Working Capital(Wcap Money set aside by the business to A Provide a buffer between accounts payable and accounts receivable a Provide funds for emergency repairs, etc. Rule of Thumb: Wcap =15% of Total Investment 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 7 PROJECT ACCOUNTING IV t Accounts Receivable Money owed to the businsess for goods shipped or services provided t Accounts Payable Money owed by the business to suppiers and employees (payroll) amd fpr taxes t Working Capital (Wcap) ð Money set aside by the business to X Provide a buffer between accounts payable and accounts receivable X Provide funds for emergency repairs, etc. Rule of Thumb: Wcap = 15% of Total Investment
PROFITABILITY EVALUATION I Q Return on Investment(ROD E Before Tax(ROIBt ROIBT = PBT/Total Investment-Wcap/ (This can be compared with other before-tax investment rates such as CD's and Corporate bonds E After Tax(ROAT ROIAT= CF / Total Investment-Wcapl This can be compared to other tax-exempt investments such as municipal bonds. 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 8 PROFITABILITY EVALUATION I t Return on Investment (ROI) ð Before Tax (ROIBT) ROIBT = PBT/[Total Investment - Wcap] (This can be compared with other before-tax investment rates such as CD’s and Corporate Bonds) ð After Tax (ROIAT) ROIAT = CF /[Total Investment - Wcap] (This can be compared to other tax-exempt investments such as municipal bonds.)
PROFITABILTY EVALUATION I ◆ Payout Time(Tpy) Time required to pay back initial investment (less cap Pay= Fixed Capital Start-Up//CF ◆ ROI and Pay E Approximate estimates of profitability Easily evaluated o Rigorous evaluation based on DCFROR(MBA's method 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 9 PROFITABILTY EVALUATION II t Payout Time (Tpay) Time required to pay back initial investment (less Wcap) Tpay = [Fixed Capital + Start-Up] / CF t ROI and Tpay ð Approximate estimates of profitability ð Easily evaluated t Rigorous evaluation based on DCFROR (MBA’s method)
DISCOUNTED CASH FLOW I Let cf(n=the cash flow for the nth time period Recall that the present value py(n ofcf(n is Py(n=CF(n/(+i For a series of n cash flows the net present value (NPy is NPV=∑CF()/1+in This is the discounted cash flow for a series of n cash flows CF(n 10/1899 Engineering economics ll
10/18/99 Engineering Economics II 10 DISCOUNTED CASH FLOW I Let CF(n) = the cash flow for the nth time period Recall that the present value PV(n) of CF(n) is PV(n) = CF(n)/(1 + i)n For a series of N cash flows the net present value (NPV) is N NPV = å CF(n)/(1 + i)n i=n This is the discounted cash flow for a series of N cash flows CF(n)
