Sunday, November 18, 2012

W8_FELIX_SELECTING INVESTMENT USING IRR & NPV



1.      Problem Recognition, Definition and Evaluation
My company have a plan to upgrade the refinery unit by constructed a new H2 Plant. We develop the contract strategy using Turnkey Project which is from FEED, Detailed Design until Construction will be taken by EPC Contractor. We only seek the performance and the profit.
I have been request to check alternative technology and calculate which one is more acceptable basically from economical point of view.

2.      Feasible alternatives
There is two contractor offer difference technology with different price.
a.       Contractor A use new technology with invest $ 1,908,199 and estimate will earn revenue turn over $ 628,395 on the first year, $ 832,394 on second year and $ 736,290 in the third year.
b.      Contractor B use old technology with only invest $ 737,921 and estimate earn $ 295.378 on the first year and $ 590,759 in the second year.
Discount Rate is now at 5%.
Based on those data i was request to check which one is better investment.

3.      The cash flow for each feasible alternatives
  

4.      Selection of the acceptable criteria.
Using the NPV and IRR, we will analyze which one from both of the Investmentwill give the best profit.

5.      Analysis for the alternatives
From above cash flow calculation we determine that Both Contractor can be accept since both have positive value NPV > 0, at MARR 5% and IRR > MARR.
HoweverNPV contractor A > contractor B, and IRR contractor A < contractor B, as we can describe at below table.
 

To find out which one is better investment than we need to deep dive the calculation.
Based from Engineering Economy, chapter 6, Comparison and Selection among alternatives, we need to find  NPV and IRR for the delta (A-B).

 

6.      Select the preferred alternative
From above analysis we can take conclusion NPV and IRR for ∆ (A-B) still have positive value, i.e. NPV > 0 and IRR > MARR. So new technology from contractor A even almost 2.6 times higher investment than Contractor B is better form economical point of view.

7.      Performance Monitoring & Post Evaluation of Result
Performance and the quality of these calculation will be proposed to management for further decision.

8.      Reference:
·        

·         William G.Sullivan, ElinM.Wicks, and C.PatrickKoelling.Engineering Economics-Fifteen Edition, chapter 6, Comparison and Selection among alternatives(London, 2012).
·         Understanding The Time Value Of Money,www.investopedia.com
·         Time value of money,http://en.wikipedia.org/wiki/Time_value_of_money

 

2 comments:

  1. Mr Felix,
    I just wondering why do you calculate project economic evaluation only for turn key period (3 years for project A and 2 year for B)? Does it also represent the whole project lifetime?
    CMIIW,
    BUD

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  2. Good question, Pak Budiono!!!

    I would also like to see Pak Felix using the same case study but this time, using ERR and Payback Period. See if all 4 approaches yield the same results.

    Great case study Pak Felix but I'd like to see you do more with it using the tools & techniques you are learning about. For your W10 posting, take this same case study but this time, apply ERR and Payback Analysis. Compare all 4 methods to see if the result is the same.

    Keep in mind that if you post a problem from your real life working experience and demonstrate that you understand how to use the tools & techniques from your Engineering Economy, that you can count it BOTH as credit for your blog AND credit for your problem assignments.

    A "twofer"- earned value credit for TWO assignments at the "cost" of only one.....

    BR,
    Dr. PDG, Jakarta

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