cee167-unknown-final-unknown-soln

# cee167-unknown-final-unknown-soln - Final: Total 200 points...

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Final: Total 200 points (3-hour exam) [Engineering Economics] IRR Calculation [15 points] One alternative for improving a company’s operations is to do nothing for the next 2 years and then spend \$10,000 on operations. If this course of action is followed, the following cash flow will result: End of Year Cash Flow 0 + \$3000 1 \$0 2 - \$10,000 3 + \$2000 4 + \$2000 5 + \$2000 6 + \$2000 What rate of return can be expected from this cash flow? And under what condition would this proposal be attractive? Solution: IRR Net Present Worth 0% + \$1000 9.4% \$0 10% - \$25 20% - \$350 30% - \$353 40% - \$215 50% - \$2 51% \$0 According to the results of mathematical calculation, the proposal is attractive when the external rate of return is below 9.4% or above 51%. However, 51% of interest rate is not realistic. This means that IRR method has flaw of having more than one rate in some cases and this flaw should be considered in making decisions. [Project Evaluation and Selection] Challenger-Defender Method (Incremental Method) [20points] You have three alternative plans of operation for the next 6 years. All transactions occur in the beginning of the year. (Interest Tables and Formulas are attached at the end.)

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1) Plan A: Do nothing for first 2 years and invest \$10,000 in the third year. This will yield an annuity of \$3,200 starting in the 4th year until the 7th year. 2) Plan B: Do nothing this year and invest \$7,000 next year. The annuity will be \$1,800 from the 3rd year to the 7th year. 3) Plan C: Invest \$8,000 now and earn an annuity of \$1,200 starting in the 2nd year. The minimum attractive rate of return is 8%. Which plan would you choose? Answers: Cash Flow Year Transaction Point on Cash Flow Diagram Plan A Plan B Plan C 1st 0 0 0 - 8,000 2nd 1 0 - 7,000 + 1,200 3rd 2 - 10,000 + 1,800 + 1,200 4th 3 + 3,200 + 1,800 + 1,200 5th 4 + 3,200 + 1,800 + 1,200 6th 5 + 3,200 + 1,800 + 1,200 7th 6 + 3,200 + 1,800 + 1,200 Step 1: PV (Plan A) = – 10,000 (P/F, 8%, 2) + 3,200 (P/A, 8%, 4)(P/F, 8%, 2) = – 10,000 * 0.8573 + 3,200 * 3.3121 * 0.8573 = \$513 Æ OK PV (Plan B) = – 7,000 (P/F, 8%, 1) + 1,800 (P/A, 8%, 5)(P/F, 8%, 1) = – 7,000 * 0.9259 + 1,800 * 3.9927 * 0.9259 = \$173 Æ OK PV (Plan C) = - 8,000 + 1,200 (P/A, 8%, 6) = - 8,000 + 1,200 * 4.6229 = - \$2452 Æ Reject! Step 2: Compare the amount of investment (ignore the different timing of investment): B < A Cash Flow Year Transaction Point on Cash Flow Diagram B Æ A (A – B) 1st 0 0 2nd 1 + 7,000 3rd 2 - 11,800 4th 3 + 1,400 5th 4 + 1,400 6th 5 + 1,400 7th 6 + 1,400 PV 340 Decision A
PV (B Æ A) = 7,000 (P/F, 8%, 1) – 11,800 (P/F, 8%, 2) + 1,400 (P/A, 8%, 4) (P/F, 8%, 2) = 7,000 * 0.9259 – 11,800 * 0.8573 + 1,400 * 3.3121 * 0.8573 = \$340 Æ Going from B to A is good, Choose A Final Choice is A Decision Tree [20 points] A project manager is planning an activity that requires use of a crane. He has two alternatives; a medium size crane or a large size crane. The rent is \$10,000 for the medium sized one and \$15,000 for the large one. Because of its greater capacity, the large crane can accomplish the

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## This note was uploaded on 12/01/2011 for the course CE 13972 taught by Professor Chow during the Spring '09 term at University of California, Berkeley.

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cee167-unknown-final-unknown-soln - Final: Total 200 points...

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