Department of Chemical Engineering

& Energy Sustainability

Faculty of Engineering

KNC 3262 ENGINEERING ECONOMY

CASE STUDY
ON
APPLICATION OF MONEY-TIME RELATIONSHIP

By

Dayangku Nur Hamiza Binti Awang Kedari (45221)

Ahmad Auzaee Bin Mohamed Ali (45428)
Nor Liyana Binti Yusop (48052)
Nur Jihan Nazihah Binti Amin (45886)
Mohd Fazlieman Bin Gurahman (45688)

Bachelor of Engineering with Honours

(Chemical Engineering)
2017
 TABLE OF CONTENTS

1.0 Overview of the case 1

2.0 Problem Statement 2

3.0 Solution Methodology (Formula) 2

a) By using the Present Worth (PW) method

b) By using the Future Worth (FW) method

c) By using the Annual Worth (AW) method

4.0 Recommendations and Conclusion 5

5.0 References 6

6.0 Learning Outcomes 7

1.0 Overview of the case

The case study shows an application of Money-Time Relationship. New

equipment has been proposed by process engineers to increase the productivity

of a certain manual welding operation. The investment cost is RM 25,000.

Investment cost means the amount of money spent for the investment,

investment expenditure required to exercise the option. The equipment will

have a market value of RM 5000 at the end of a study period of five years.

Market value refers to the current or most recently-quoted price for a market-

traded security. Increased productivity attributable to equipment will amount to

RM 8000 per year after extra operating costs have been subtracted from the

revenue generated by the additional production. Revenue is the income

generated from sale of goods or services, or any other use of capital or assets

associated with the main operations of an organization before any costs or

expenses are deducted. While operating cost is expenses associated with the

maintenance and administration of a business.

A cash-flow diagram for this investment opportunity is given in Figure

1.1. Noted, the firms MARR is 20% per year. An analysis to the investment of

new equipment is prepared by using three different method which are Present

Worth (PW), Future Worth (FW) and Annual Worth (AW) method. PW is all

cash inflows and outflows are discounted to the present time at the MARR. FW

is the value of an asset at a specific date. AW of project is the equivalent

annualized series of dollar amounts for the cash inflows and outflows at a given

interest rate or MARR. From this analysis, it can be decided whether this

investment is economically feasible or not.

1
2.0 Problem Statement

New equipment has been proposed to increase the productivity of a

certain manual welding operation. The investment cost is RM 25,000, and the

equipment will have a market value of RM 5000 at the end of a study period of

five years. Increased productivity attributable to equipment will amount to RM

8000 per year after extra operating costs have been subtracted from the revenue

generated by the additional production.

However, the managing director must be convinced that the investment

of new equipment is economically feasible. Thus, an investment analysis is

documented in this report. By using method such as the present worth method,

future worth method and annual worth method, the investment analysis can be

made.

3.0 Solution Methodology (Formula)

Question 1:

New equipment has been proposed by process engineers to increase the

productivity of a certain manual welding operation. The investment cost is RM

25,000, and the equipment will have a market value of RM 5000 at the end of a

study period of five years. Increased productivity attributable to equipment will

amount to RM 8000 per year after extra operating costs have been subtracted

from the revenue generated by the additional production. A cash-flow diagram

for this investment opportunity is given in Figure 1.1. Noted, the firms MARR

is 20% per year.

2
 RM 5000

RM 8000 RM 8000 RM 8000 RM 8000 RM 8000

1 2 3 4 5
Years
= 20%/

RM 25000

Figure 1.1: Cash Flow Diagram for the investment of new equipment

As process engineers you must prepare an analysis to the investment of

new equipment to convince the Managing Director (MD) whether this is

economically feasible or not by using different methods as mentioned below:

a) By using the Present Worth (PW) method

b) Evaluate the Future Worth (FW) of the potential improvement

project.

c) By using the Annual Worth (AW) method

Solution

The table below summarizes the equivalency factors. The Name column

shows the traditional names for the factors. Each factor has a formula that

depends on i, the interest rate per compounding period, and N, the number of

compounding periods in the interval. The factors are valid for i strictly greater

than zero and N integer.

3
 Table 1: Factor formula

The solution for the questions above are shown in table below

No Method Calculation

1. Present Worth P P
= ( , 20%, 5) + AV (A , 20%, 5) + FV (F , 20%, 5)

(PW) (1+) 1
= (1) + AV ( (1+) ) + FV ((1 + ) )

(1+) 1
= 25000 + 8000 ( (1+) ) + 5000 (1 + )

(1+0.2)5 1
= 25000 + 8000 ( (1+0.2)5 ) + 5000 (1 + 0.2)5

4
 = 2009.3879 + 23924.8971 25000

= 934.28

2. Future Worth F
= ( , 20%, 5) + AV (A , 20%, 5) + FV (F , 20%, 5)
F

(FW) 1 (1+) 1
= ((1+) ) + AV (
) + FV (1)

1 (1+) 1
= ((1+) ) + AV (
) + FV (1)

1 (1+) 1
= 25000 ((1+) ) + 8000 (
) + 5000

1 (1+0.2)5 1
= 25000 ((1+0.2)5 ) + 8000 ( ) + 5000
0.2

= 8359.492 + 59532.8 + 5000

= 2324.8

3. Annual Worth A
= ( , 20%, 5) + AV (A , 20%, 5) + FV ( F , 20%, 5)
A

(AW) (1+)
= ((1+) ) + AV (1) + FV ( )
1 (1+) 1

(1+)
= 25000 ((1+) ) + 8000 + 5000 ( )
1 (1+) 1

0.2 (1+0.2)5 0.2

= 25000 ( (1+0.2)5 1 ) + 8000 + 5000 (0.2 (1+0.2)5 1)

= 8359.492 + 8000 + 671.8985

= 312.41

4.0 Recommendations and Conclusion

Recommendation

Using the present worth method, there are 2 analyses that can be done

which is if the value obtained is negative or less than zero, the investment is

deemed unprofitable and if the value obtained is positive, the investment can

bring profit. From the calculation done previously, the value obtained is positive

which means that the future value of the machine will be greater than the

5
future cost and it is suggested that the equipment should be bought and it is

economically feasible.

Using the future worth method, there are also 2 possible analyses that

can be made which is the same as the present method. Based on the calculations

done previously using the future worth method, the suggested answer is also the

same which is the investment is recommended and it is economically feasible.

Last but not least, using the annual worth method, there are also 2

possible analyses that can be made whether it is greater or less than zero. From

the calculations done previously, the value obtained is positive and the

suggestion is also the same where the equipment should be bought and it is

economically feasible.

Conclusion

For this case, there are various ways to determine the economic

feasibility of the investment which is through the present worth method, future

worth method and the annual worth method. Each of the methods have

different calculations and formula used but for this case, all the methods points

to a single answer where the investment of the new equipment is economically

feasible and can bring profit to the company. Hence it is suggested that the

managing director invest on the new equipment to increase the productivity of

the manual welding operation

5.0 References

Utexas (2017) Factor Formulas Available at:

https://www.me.utexas.edu/~me353/lessons/S2_Evaluation/L02_Equivalence/fac

tor_formulas.html Accessed on 14 March 2017.

6
6.0 Learning Outcomes

Key word Learning/Idea/Recommendation Reference

Investment Definition: The amount of money spent IGI Global (2017), What is

cost forthe investment, investment expenditure Investment Cost, Available

required to exercise the option (cost of at: http://www.igi-

converting the investment opportunity into global.com/dictionary/invest

the options underlying asset. ment-cost/15660, Accessed

on 12 March 2017

Revenue Definition: The income generated from sale Business Dictionary (2017),

of goods or services, or any other use of Revenue, Available at:

capital or assets associated with the main http://www.businessdictiona

operations of an organization before any ry.com/definition/revenue.ht

costs or expenses are deducted. ml, Accessed on 12 March

2017

Operating Definition: Operating costs are expenses Investopedia (2017),

cost associated with the maintenance and Operating Cost Definition,

administration of a business on a day-to- Available at:

day basis. http://www.investopedia.co

m/terms/o/operating-

cost.asp#ixzz4b5rVJZkX,

Accessed on 12 March 2017

Present All cash inflows and outflows are Berrado, A. (2017), Chapter

worth discounted to the present time at the 5: Present Worth Analysis,

7
 MARR http://www.aui.ma/personal/

~A.Berrado/EGR2302/EGR2

If PW(i %) 0, then the project is 302_Ch05.pdf, Accessed on

economically justified 12 March 2017

Blank, L. & Tarquin, A.

(2005), Engineering
= ( , , ) + ( , , ) + ( , , )

Economy, New York,
(1 + ) 1
=
(1 + ) McGraw Hill.

= (1 + )

Future If FW (i %) 0, then the project is Man-Cho So, A. (2016),

worth economically justified Engineering Economics,

Department of System

Engineering & Engineering

Management, Hong Kong,

China.

Blank, L. & Tarquin, A.

= ( , , ) + ( , , ) + ( , , )

(2005), Engineering

= (1 + )
Economy, New York,
(1 + ) 1 McGraw Hill.
=

Annual AW of project is the equivalent annualized Man-Cho So, A. (2016),

worth series of dollar amounts for the cash inflows Engineering Economics,

and outflows at a given interest rate or Department of System

8
MARR Engineering & Engineering

If AW (i %) 0, then the project; is Management, Hong Kong,

economically justified China.

Blank, L. & Tarquin, A.

= ( , , ) + ( , , ) + ( , , )

(2005), Engineering
(1 + )
=
(1 + ) 1 Economy, New York,

McGraw Hill.
=
(1 + ) 1