Feedback on tutorial number 9 (Ch 16 TVM / NPV)

Good day
I thank the students who participated.
My suggested solutions follow:

Question 16c.18 (Choosing between alternatives)

Sometimes engineers have to evaluate alternatives by means of time value of money analysis. Which
one of the following two machines will you purchase? Assume that they are similar in terms of
performance. Also assume a 10-year life for each machine, no salvage values and an
interest/discount rate of 12%. The initial purchasing prices and annual maintenance costs follow:

Machine A

Machine B

Initial cost

R200 000

R150 000

Annual maintenance cost

R40 000

R50 000

(5)

Adapted from: Grisky, R.G., 1997, Chemical Engineering for Chemists, American Chemical Society:
Washington DC, Chapter 8, Engineering Economics and Process Design, pp. 286 (example 8.1)

Answer 16c.18 (Choosing between alternatives)

Proposed methodology: take all costs to the same point in time (year 0 / beginning of year 1) and
compare.

(1 + i )n - 1
to calculate
n
i(1 + i )

Use the following formula: PVA = A x PVIFA(i, n); where PVIFA(i, n) =

the present value of all maintenance costs.

(1 + 0,12 )10 - 1
= 5,65022
10
0
,
12
0
,
12
(1
+
)

PVIFA(i = 12%, n = 10) =

Present value of a machines life cycle cost = PV of purchasing price + PV of all maintenance costs.

{2}

PV of machine As life cycle cost = R200 000 + 5,6022 x R40 000 = R426 009

{1}

PV of machine Bs life cycle cost = R150 000 + 5,6022 x R50 000 = R432 511

{1}

Choose machine A because its life cycle costs is lower.

{1}
(5)

Question 16c.23
The following cash flow stream is estimated for an engineering project. Should your company invest in
this project if the required discount rate for the project is 27%?
Initial investment (at the beginning of year 1):

Cash inflow (at the end of year 1):

Cash inflow (at the end of year 2):

Cash inflow (at the end of year 3):

Answer 16c.23 (CF)

R850 000

R200 000

R350 000
R450 000

(3)

NPV = -850 000 + 200 000 / 1,27 + 350 000 / (1,27)2 + 450 000 / (1,27)3 = -R255 834
NPV < 0, therefore the project should be abandoned.

(3)

Question 16c.38
Use the following figure to explain the typical cash flow during the life of a factory, plant, mine,
hospital or any other type of facility.
Answer 16c.38 (CF fig)
Cash flow during life cycle of facility (METS-3: 341)

(7)

Disposal
and/or
rehabilitation
Income

Project stage of life cycle

Break-even point
R0
time
Investment

Operational stage of life cycle

End of life

Money is usually spend during the project stage investment in physical infrastructure.
During the operational phase, products and services will be produced. From this an income and cash
inflow will be generated.
At the end of the facilitys life some money may be required for rehabilitation or renewal.
During the operational phase various cash outflows may occur, for example when equipment is
replaced and plants are maintained. Usually more cash however will flow in, resulting in a positive
cash flow.
The breakeven point is achieved after a while (breakeven period).
All cash flows over both the project and operational stages will be estimated and evaluated before a
decision is made to implement such a project.
Often the assumption is made that cash flows will happen at the end of a month or year for project
evaluation purposes.

(7)

Question 16c.44 (2 invest)

Two investment opportunities are available to you. Project X is expected to pay R500 a year for the
first 4 years, R300 per year for the next 8 years and nothing thereafter. Project Y is expected to pay
R700 per year for 11 years and nothing thereafter.

Risk considerations make appropriate an 8

percent yield for Project X, and a 10% yield for Project Y. Which project has the highest present
value?

Answer 16c.44 (2 invest)

Please see the answers by G L MYENI and P E WANYAMA.

Question 16c.51 (sinking)

You have to establish a sinking fund that will retire an outstanding obligation of R2 000 000 due in
four years. What uniform sum must be set aside each year to accomplish this if money can be
invested at a rate of 12%?

(3)

Answer 16c.51
n = 4; i = 12%

(1 + i )n 1 (1 + 0,12 )4 1
FVA = A x FVIFA(i, n); where FVIFA(i, n) =
=

0,12
i

= 4,7793

{2}

FVA = 2 000 000 = A x FVIFA(12%, 4)

A = 2 000 000 / 4,7793 = R418 468,87

{1}
(3)

Question 16c.57
Use a scoring model to choose between three mining projects (A, B and C). The ore reserves are in
three different countries. Each country consumes only a small percentage of the product that they
have in abundance. A score of 1 to 10 has been allocated to each project for each criterion in the
table below. A weight has been allocated to each criterion by a panel of experts. The materials
involved are bulky (e.g. iron ore or coal) and therefore transportation infrastructural capacity to a
harbour for the export of the minerals is important.
Criterion

Risk of mineral resource nationalism. A score of 1 indicates that

Weight

Project
A

0,3

0,15

there is a high probability that the ruling political party may

implement policies such as mine nationalisation, indigenisation
or windfall taxes.
Labour supply and productivity. A score of 10 means that

experienced and skilled labour is available and that little labour

unrest and disease impacts on labour productivity.
Transportation and other infrastructure. A score of 1 means

0,15

0,4

that the country is land-locked and little rail, road and other
infrastructural capacity exists for transport to the nearest
harbour.
Financials. A score of 10 means that the quality of the ore body
is such that good profit and return on investment can be
realised if the above factors are not considered.

A score of 1 means high risk, least favourable return on investment or least favourable conditions and
investment climate. A score of 10 means least risk, most favourable return on investment or most
favourable conditions and investment climate. Determine in which project your company should
invest. Motivate your answer and show all calculations.

(8)

{Similar to Example 16.9, (METS-3: 340)}

Answer 16c.57
Criterion

Weight

Project
A

Risk of mineral resource nationalism.

0,3

7 x 0,3 = 2,1

2 x 0,3 = 0,6

5 x 0,3 = 1,5

Labour supply and productivity.

0,15

8 x 0,15 = 1,2

6 x 0,15 = 0,9

5 x 0,15 = 0,75

Transportation and other infrastructure.

0,15

7 x 0,15 =

5 x 0,15 =

8 x 0,15 = 1,2

1,05

0,75

6 x 0,4 = 2,4

9 x 0,4 = 3,6

7 x 0,4 = 2,8

6,7 {2}

5,85 {2}

6,25 {2}

Financials.
Totals

0,4

Investment decisions are guided by return and risk. The project with the highest score should
therefore be selected since that means that the best combination of least risk and highest return on
investment will be achieved under the various circumstances in the different countries.

{1}

Project A should be selected since it has the highest weighted score.

{1}

(8)
Question 16c.58 (Mountain pass versus tunnel?)
You are employed as an engineering manager by a national roads agency that constructs new roads
and maintains existing roads. The organisation is considering the replacement of 11km of an existing
mountain pass by a 3,9km long tunnel. The tunnel will improve the safety of users and save them
some time and fuel. Once constructed, a toll of R25 per vehicle will be implemented for the use of the
tunnel. Assume the following:

3 million vehicles will use the tunnel per year.

The cost of developing the tunnel is R120 000 per metre.

The operating cost of the tunnel is R25 million per year (assume this will remain constant
ignore inflation)

The cost of capital is 8% per year

The useful life of the tunnel is 25 years

Do an NPV analysis to determine whether your employer should implement the tunnel-project or not.
If implemented, the construction of the tunnel will take a number of months. For calculation purposes
you may assume that the total development cost is incurred at the beginning of year 1 of the 25 year
period that the tunnel will be in operation.

(6)

Answer 16c.58 (Mountain pass versus tunnel?)

Cost of construction (investment) = R120 000 x 3900 = R468 million

{0,5}

Income per year = 3 000 000 x R25 = R75 million

{0,5}

Net CF per year = R75 R25 = R50 million

{0,5}

PV of all 25 cash flows

= 50m x PVIFA(i = 0,1, n = 25)

(1 + i )n - 1 (1 + 0,08 )25 - 1
=
n
25
i(1
+
i
)

0,08(1 + 0,08 )

PVIFA(i, n) =

= 10,67478
NPV = -468 + (10,67478 x 50) = R65,7388m
Conclusion: The NPV is positive, therefore the project should be implemented.

{1}

{1}

{1}
{0,5}
{1}
(6)

I agree with most of the answers that were uploaded.

Please check my answers.

Regards, Willie