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CH6 Solutions - 306-310 ENGINEERING ECONOMY SOLUTIONS TO...

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1 3 0 6 - 3 1 0 E N G I N E E R I N G E C O N O M Y SOLUTIONS TO PROBLEM SET #6 – PROJECT EVALUATION CRITERIA 1. The time distribution of cash flows associated with the project is as follows: Time 0 : -50 000 Years 1 to 15 : 20 000 - 8000 = 12 000 To determine whether the project is worthwhile economically, the net present value may be computed, i.e., the annual cash flows are first discounted at a rate of 20 percent, the minimum acceptable return on investment, and then summed algebraically. NPV = -50 000 + 12 000 (P/A,20%,15) = -50 000 + 12 000 (4.6755) = $6106 The net present value is positive. Therefore, the project is worthwhile . 2. The cash flow profiles of the proposals are: PROPOSAL 1 Year Time 0 1 2 3 4 5 Cash Flow ($) -1500 200 400 600 800 1000 PROPOSAL 2 Year Time 0 1 2 3 4 5 Cash Flow ($) -1 500 ? 200 200 200 200 i) The rate of return (r) is the discount rate at which the net present value is zero. For pro- posal 1, we have: NPV = -1500 + [200 + 200 (A/G,r,5)] (P/A,r,5) = 0 Solving by trial and error (or with a financial calculator): At r=21%, NPV=35.92 At r=22%, NPV=-5.77 By linear interpolation, the rate of return is: 21 + [35.92 / (35.92 + 5.77)] 1% = 21.9% ii) Given that the proposals are equally acceptable at a discount rate of 14%, their net present values must be equal at that rate.
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