Matakuliah Tahun : D0762 – Ekonomi Teknik : 2009 Selection Analysis Method Course Outline 9 Outline • • • • • Mutually Exclusive Basic Concepts Method for Comparing Mutually Exclusive Alternatives Alternatives Selection Choice of MARR 2 Mutually Exclusive • Engineering projects can be accomplished by more than one feasible design alternative • Selection one of these alternatives excludes the choice of any of the others, the alternatives are called mutually exclusive. • Sometimes alternatives may have different useful lives. 3 Basic Concepts For Comparing • Develop the alternatives – The choice (decision) is among alternatives. The Alternatives need to be identified and then defined for subsequent analysis • Focus on Differences – Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision • Use a Consistent Viewpoint – The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint • Use a Common Unit of Measure – Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of4 the alternatives Basic Concepts For Comparing • Consider All Relevant Criteria – Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner • Make Risk and Uncertainty Explicit – Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison • Revisit Your Decision – Improved decision making result from an adaptive process; to the extent practicable, the initial projected outcomes of the 5 selected alternative should be subsequently compared with Choosing Analysis Method We have now seen three major economic analysis techniques: 1. present worth analysis (PW analysis), 2. annual cash flow analysis (ACF analysis), 3. rate of return analysis (ROR analysis). Which method should be used for any particular problem? The following points are important: You must know the MARR to use PW analysis or ACF analysis. PW analysis and ACF are often simpler than ROR analysis. In some contexts, ROR is easiest to explain. In others, ACF analysis is easier to explain The company you work for may dictate the analysis method you must use. ROR analysis is most often used in industry. 6 Comparing Mutually Exclusive Alternatives Evaluation Period Type of Alternatives Recommended Method Series to evaluate Equal lives of alternatives Revenue or service Public Sector AW or PW B/C based on AW or PW Cash Flow Incremental Cash Flow Unequal lives of alternatives Revenue or service Public Sector AW B/C based on AW Cash Flow Incremental Cash Flow Study period Revenue or service Public Sector AW or PW B/C based on AW or PW Updated Cash Flow Updated Incremental Cash Flow Long to infinite Revenue or service Public Sector AW or PW B/C based on AW Cash Flow Incremental Cash Flow After choosing method, define interest rate best on evaluate method, show on next table 7 Evaluation Method for Selecting Alternatives Evaluation Method Equivalence Relation Lives of Alternatives Time Periods for Analysis Series to Evaluate Rate of Return; Interest Rate Decision Guideline: Select* Present Worth PW Equal Lives Cash flow MARR Numerically largest PW PW Unequal LCM Cash flow MARR Numerically largest PW PW Study period Study period Updated cash flow MARR Numerically largest PW CC Long to infinite Infinity Cash flow MARR Numerically largest CC Future Worth FW Same as present worth for equal lives, unequal lives, and study period Numerically largest FW Annual Worth AW Equal Or unequal Lives Cash flow MARR Numerically largest AW AW Study period Study period Updated cash flow MARR Numerically largest AW AW Long to infinite Infinity Cash flow MARR Numerically largest AW * Lowest equivalent cost or largest equivalent income 8 Evaluation Method for Selecting Alternatives Evaluation Method Equivalence Relation Lives of Alternatives Time Periods for Analysis Series to Evaluate Rate of Return; Interest Rate Decision Guideline: Select* Rate of Return PW or AW Equal Lives Incremental cash flow Find Di* Last Di*> MARR PW or AW Unequal LCM of pair Incremental cash flow Find Di* Last Di*> MARR AW Unequal Lives Cash flow Find Di* Last Di*> MARR PW or AW Study period Study period Updated Incremental cash flow Find Di* Last Di*> MARR PW Equal or Unequal LCM of pair Incremental cash flow Discount rate Last D B/C > 1.0 AW Equal or Unequal Lives Incremental cash flow Discount rate Last D B/C > 1.0 AW or PW Long to infinite Infinity Incremental cash flow Discount rate Last D B/C > 1.0 Benefit / Cost * Lowest equivalent cost or largest equivalent income 9 Choice of MARR Or you can choose MARR based on: • Choice of MARR when Project Financing is Known • Choice of MARR when Project Financing is Unknown • Choice of MARR under Capital Rationing 10 Choice of MARR when Project Financing is Known Explicit accounts For debt flows When you find the Net present worth of the project, use cost of equity (ie) as the discount rate. 11 Choice of MARR as a Function of Budget Project AO Cash Flow A1 IRR 1 -$10,000 $12,000 20% 2 -10,000 11,500 15 3 -10,000 11,000 10 4 -10,000 10,800 8 5 -10,000 10,700 7 6 -10,000 10,400 4 Borrowing rate (k) = 10% Lending rate (r) = 6% Bina Nusantara Rate of return (%) An Investment Opportunity Schedule 24 22 20 18 16 14 12 10 8 6 4 2 Project 1 Project 2 Project 3 Project 4 Project 5 20% 0 15% 10% 8% 7% $20,000 $40,000 Required capital budget Bina Nusantara Project 6 4% $60,000 Rate of return (%) A Choice of MARR under Capital Rationing 24 22 20 18 16 14 12 10 8 6 4 2 Borrowing rate (k) = 10% Lending rate (r) = 6% Project 1 Project 2 k = 10% Project 3 MARR Project 4 Project 5 Project 6 20% 0 15% 10% 8% 7% $20,000 $40,000 Required capital budget Bina Nusantara 4% $60,000 r = 6% Capital Budgeting • Evaluation of Multiple Investment Alternatives – Independent projects – Dependent projects • Capital Budgeting Decisions with Limited Budgets Bina Nusantara Independent Projects Alternative Bina Nusantara Description Xa Xb 1 Reject A, Reject B 0 0 2 Accept A, Reject B 1 0 3 Reject A, Accept B 0 1 4 Accept A, Accept B 1 1 Mutually Exclusive Projects Bina Nusantara Alternative (XA1, XA2) (XB1,XB2) 1 (0,0) (0,0) 2 (1,0) (0,0) 3 (0,1) (0,0) 4 (0,0) (1,0) 5 (0,0) (0,1) 6 (1,0) (1,0) 7 (0,1) (1,0) 8 (1,0) (0,1) 9 (0,1) (0,1) Contingent Projects Alternative XA XB XC 1 0 0 0 2 1 0 0 3 1 1 0 4 1 1 1 Bina Nusantara Four Energy Saving Projects under Budget Constraints (Budget Limit = $250,000) Project Investment Annual O&M Cost Annual Savings (Energy) Annual Savings (Dollars) IRR 1 $46,800 $1,200 151,000 kWh $11,778 15.43% 2 104,850 1,050 513,077 kWh 40,020 33.48% 3 135,480 1,350 6,700,000 CF 32,493 15.95% 4 94,230 942 385,962 kWh 30,105 34.40% Bina Nusantara Marginal Cost of Capital Schedule (MCC) and Investment Opportunity Schedule (OSC) Bina Nusantara Optimal Capital Budget Bina Nusantara