Basic Methods for Making Economy Studies in Engineering

Overview

• Focus: Advanced topic in engineering economy, specifically on methods for making economic studies.
• Methods Covered:
  • Rate of Return Method
  • Annual Worth Method
  • Present Worth Method
  • Future Worth Method
  • Payback or Payout Period Method

Problem Statement

• Scenario: An investment of ₱270,000 in a project.
  • Produces uniform annual revenue of ₱185,400 for 5 years.
  • Salvage value of 10% of investment after 5 years.
  • Operating and maintenance costs: ₱81,000/year.
  • Desired capital return: 25% before taxes.
  • Taxes and insurance: 4% of investment.
• Questions: Is this a desirable investment? What is the payback period?

Methods and Calculations

Initial Investment Details

• Initial Investment: ₱270,000.
• Annual Revenue: ₱185,400/year.
• Salvage Value (SV): 10% of₱270,000 = ₱27,000.
• Operating & Maintenance Costs: ₱81,000/year.
• Taxes & Insurance: 4% of ₱270,000 = ₱10,800/year.
• Total Annual Cost: ₱121,408.76 (including maintenance, depreciation, taxes, and insurance).

Rate of Return Method

• Formula: Rate of Return (ROR) = (Net Annual Profit / Capital Invested) * 100
• Calculation:
  • Net Annual Profit = Annual Revenue - Annual Cost = ₱185,400 - ₱121,408.76 = ₱63,991.24.
  • ROR = (₱63,991.24 / ₱270,000) * 100 ≈ 23.70%
  • Verdict: Not justified (ROR < Desired ROR of 25%).

Annual Worth Method

• Calculation:
  • Interest on Original Investment: ₱67,500 (25% * ₱270,000).
  • Total Annual Cost: ₱188,908.76 (including interest).
  • Annual Worth = Annual Revenue - Total Annual Cost = ₱185,400 - ₱188,908.76 ≈ -₱3,508.76.
  • Verdict: Not justified (Annual Worth < 0).*

Present Worth Method

• Formula: Present Worth (PW) = PW of Net Cash Inflows - PW of Net Cash Outflows.
• Calculation:
  • PW of Inflows = ₱507,439.87
  • PW of Outflows = ₱516,875.90
  • PW = ₱507,439.87 - ₱516,875.90 ≈ -₱9,436.03.
  • Verdict: Not justified (PW < 0).

Future Worth Method

• Formula: Future Worth (FW) = FW of Net Cash Inflows - FW of Net Cash Outflows.
  • Calculation:
  • FW of Inflows = ₱1,548,101.50
  • FW of Outflows = ₱1,577,380.08
  • FW = ₱1,548,101.50 - ₱1,577,380.08 ≈ -₱29,278.58.
  • Verdict: Not justified (FW < 0).

Payback Period Method

• Formula: Payback Period = (Initial Investment - Salvage Value) / Net Annual Cash Flow.
• Calculation:
  • Net Annual Cash Flow = ₱93,600 (Annual Revenue - Annual Cost).
  • Payback Period = (₱270,000 - ₱27,000) / ₱93,600 ≈ 2.59 years.
  • Verdict: Required time to recover the investment is 2.59 years.

Conclusion

• All methods indicate that the investment is not justified based on the provided requirements and calculations.
• The payback period is approximately 2.59 years.