W4_Mohammed_ Applying ERR and Payback period on the Pipeline projects Economical Evaluation

Problem definition

Reference to the W3 Blog, for the Economical evaluation of Pipeline scenarios. Which consider the cost of the required line pipes, the cost of the required intermediate pump station, the CAPEX and OPEX of this pipeline. The out comes of the evaluation was assessed based on NPV and ERR as to recommend the most optimum case of crude transportation scenarios, however as per the request of CfH the ERR and Payback period will be consider as to compare their results with the NPV and IRR results.

Development of the feasible alternatives

The proposed scenarios are as following:

Case 1: Construct 12” Pipeline with intermediate Pump Station.

Case 2: Construct 12” Pipeline without intermediate Pump Station.

Case 3: Construct 14” Pipeline without intermediate Pump Station.

Develop the outcomes for each alternative

Case 1: Construct 12” Pipeline with intermediate Pump Station: study the feasibility of constructing a 12” pipeline with intermediate pump station and with total length of 147km, by applying the economical evaluation factors.

Case 2: Construct 12” Pipeline without intermediate Pump Station: study the feasibility of constructing a 12” pipeline without intermediate pump station and with total length of 147km, by applying the economical evaluation factors.

Case 3: Construct 14” Pipeline without intermediate Pump Station: study the feasibility of constructing a 14” pipeline without intermediate pump station and with total length of 147km, by applying the economical evaluation factors.

Acceptable Criteria

The three transportation philosophies have been studied considering the following economical indicators:

Ø  Net Present Value (NPV): The difference between the present value of cash inflows and the present value of cash outflows.  The alternative with the largest (positive) NPV should be selected.

Ø  Internal Rate of Return (IRR): The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. The higher an option’s internal rate of return, the more desirable it is to undertake the project.

Ø  External Rate of Return (ERR): A method of yield calculation. ERR is a modified internal rate of return (IRR) that allows for the incorporation of specific reinvestment- borrowing and sinking fund assumptions.

Ø  Payback Period: in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment

Analysis and comparison of the alternatives

Alternatives Cases:

	Case1 (147Km)	Case 2 (147Km)	Case 3 (147Km)
Pipeline Size (in)	12”	12”	14”
Designed Flow Rate KBOPD	40 LC/HC	40 LC/HC	40 LC/HC
Intermediate Pump Station (IPS)	Yes	No	No

CAPEX:

	Case1 (147Km)	Case 2 (147Km)	Case 3 (147Km)
Total CAPEX	65,482.90	59,109.30	61,263.70

Revenue and OPEX:

	STD Barrel USD	Production Rate	Days/Year	Total-USD	Years	Grand Total-USD
Revenue	7	10,000	365	25,550,000	20	511,000,000
OPEX	1.2	10,000	365	4,380,000	20	87,600,000

Calculation of IRR:

Case 1 Calculated by Excel

MARR	20%
ε	20%
Capital Investment	65,482,900
Market Value	35,000,000
Annual revenue	25,550,000
Annual Expenses	4,380,000
Study Period - Years	20
	Cash Flow
0	($65,482,900)	0	($65,482,900)
1	$21,170,000	1	$21,170,000
2	$21,170,000	2	$21,170,000
3	$21,170,000	3	$21,170,000
4	$21,170,000	4	$21,170,000
5	$21,170,000	5	$21,170,000
6	$21,170,000	6	$21,170,000
7	$21,170,000	7	$21,170,000
8	$21,170,000	8	$21,170,000
9	$21,170,000	9	$21,170,000
10	$21,170,000	10	$21,170,000
11	$21,170,000	11	$21,170,000
12	$21,170,000	12	$21,170,000
13	$21,170,000	13	$21,170,000
14	$21,170,000	14	$21,170,000
15	$21,170,000	15	$21,170,000
16	$21,170,000	16	$21,170,000
17	$21,170,000	17	$21,170,000
18	$21,170,000	18	$21,170,000
19	$21,170,000	19	$21,170,000
20	$21,170,000	20	$51,170,000
20	$30,000,000
		NPV	$186,159,994
		IRR	32%

Calculation Of ERR

R_k           =          excess of receipts over expenses in period k,

E_k           =          excess of expenses over receipts in period k,

N         =          project life or number of periods, and

ε          =          external reinvestment rate per period.

	Case1 (147Km)	Case 2 (147Km)	Case 3 (147Km)
ERR	31.76%	35.14%	33.90%

Calculation of Payback Period

Colum 1 End of year K	Column 2 Net Cash Flow	Column 3 Comulative PW
0	($65,482,900)	($65,482,900)
1	$21,170,000	($44,312,900)
2	$21,170,000	($23,142,900)
3	$21,170,000	($1,972,900)
4	$21,170,000	$19,197,100
5	$21,170,000
6	$21,170,000
7	$21,170,000
8	$21,170,000
9	$21,170,000
10	$21,170,000
11	$21,170,000
12	$21,170,000
13	$21,170,000
14	$21,170,000
15	$21,170,000
16	$21,170,000
17	$21,170,000
18	$21,170,000
19	$21,170,000
20	$56,170,000

The Payback Period is 4 years because the cumulative balance turns positive at EOY 4

Summary of NPV/IRR for the three cases:

	Case1 (147Km)	Case 2 (147Km)	Case 3 (147Km)
NPV	186,159,994.28	192,533,594.28	190,379,194.28
IRR	32.27%	35.78%	34.51%
ERR	31.76%	35.14%	33.90%
Payback Period	4 years	3 years	3 years

Selection of the preferred alternatives

Case-2 (12” transit line without intermediate pumping station for batch transportation philosophy) shows the best economic indicators in term of NPV, IRR, ERR and Payback Period. The Case-3 demonstrates as well a good NPV close to the most opportune case and payback Period same to it. Therefore Case-2 (12” transit line without intermediate pumping station for batch transportation philosophy) is highly recommended.   

Performance monitoring and the post evaluation of results

More studies and economical methodologies will be applied for tuning and for the final result of the recommended.

Conclusion

Applying the NPV, IRR, ERR and Payback Period methods over the three options gives an indicator to which is more economical option, the second case was found as the most optimum choice and its added value over the two other cases. However more studies are needed to determine the said conclusion.

References

i. Sullivan, G. William, Wicks, ELIN M & KOELLING, C. Patrick (2012). Engineering Economic 15th Edition: Chapter 5 Evaluation a Single Project, pp. 194.

ii. Pearson Education, introduction to Engineering Economy “Sullivan, G. William, Wicks, ELIN M & KOELLING, C. Patrick (2012)”. Engineering Economic 14th Edition: Chapter 5 Evaluation a Single Project. Power Point Presentation.

iii.Mahakam13, W3_MR_ Economical Evaluation for three Pipeline scenarios, http://aacemahakam.blogspot.com/