Construction
CE 401 ProjectPractices
Planning and
and Management
Construction
Management
Project Evaluation
Analysis of Capital Investment
Decision
The process of investment in land, productive
equipment, buildings, working capitals, raw material
deposits and other assets for future economic gain is
particularly difficult and calls for careful analysis.
We will discuss the analytical techniques which are
used to support investment decisions.
Construction
CE 401 ProjectPractices
Planningand
andManagement
Construction
Management
Project Evaluation
Analysis of Capital Investment
Decision
Three elements of investment analysis
Net investment
Economic life.
Operating cash flows
Project Evaluation
Analysis of Capital Investment
Decision
B= Benefit
O
n YEARS
C= Cost
Fundamental reason for investment of capital is “to
obtain sufficient economic returns over a future period to
justify the original outlay; i.e. enough receipts to
justify enough cash spent”.
Project Evaluation
Method of analysis
Definitions
Net Investment Refers to the net outlay
Operating Cash Flow Are the not economic benefits.
The time period over which one can
Economic life
expect to obtain the benefits.
Project Evaluation
Method of analysis
Pay back Is a simple relationship of the annual benefit of
(Time Period) a project to the investment required.
Net Investment
Pay back =
Av. Annual operating cash flow
Simple Return on Investment: - inverse of the payback
Av. Annual Cash Flow
Return on investment =
Net Investment
Average Return on Investment
Av. Operating Cash Flow
Average Return =
Av. Net Investment
Project Evaluation
Method of analysis
Advance concept (Time Value Concept)
Use of time value of money
Present Value (PV) concept
Techniques of Compounding and Discounting
Project Evaluation
Compounding Growth
Now 1 Year 2 Years 3 Years
$(1+i) (1+I) $(1+i)2 (1+I)
$1 $(1+i)
Or Or
$ (1+i)2 $ (1+i)3
for i = 10% (i.e. 0.1)
$1 $1.10 $1.21 $1.331
Project Evaluation
Now 1 Year 3 Years
2 Years
$1
$1.10
TIME VALUE OF $1.21
MONEY
S 1.331
Project Evaluation
DISCOUNTING
Now 1 Year 2 Years 3 Years
$1 $1.1
$1 $1.21
$1.21
$1
(1/1.10)
$
0.909
$1
(1/1.21)
$ $1
0.826
$ (1/1.331)
$1
0.751
Project Evaluation
SUM OF AMMOUNTS IN DIFFERENT YEARS
Now 1 Year 2 Years 3 Years
$X $A $B $C
Considering the time value of money –
Is $X = $ (A+B+C)
Or, $X Greater than $ (A+B+C)
Or $X Less than $ (A+B+C)
Project Evaluation
Method of analysis
1. Compound Amount (CA): Given P, Find F
F
CA= (1+i)n P
i= interest rate (Cost of Capital)
Opportunity Cost of Capital (OCC) n YEARS
Project Evaluation
Method of analysis
2. Present Worth (PW)
F
Given F, to find P
P
PW
n YEARS
(discount factor)
Project Evaluation
Method of analysis
3. Sinking Fund (SF)
For series amount Give F, to find A
A A
F
A A A
n YEARS
i.e. How much must be deposited at i% each year for n
years to have accumulated F?
SF
Project Evaluation
Method of analysis
Sinking Fund Provision
Problem:
To replace the pumps in 15 years, will
cost US $ 875,000. How much should be
the annual collection from the farmers?,
given, i=12%
Project Evaluation
Method of analysis
4. Capital Recovery Factory (CRF)
P Given P, to find A,
A
A A A A
n YEARS
CRF A=P x CRF
Project Evaluation
Method of analysis
5. Compound Amount (Series)
Given A, to find F
SCA
Project Evaluation
Method of analysis
6. Present Worth (Series) (SPW)
P Given A, to find P
A A A A A
n YEARS
SPW
P=A x SPW
SPW= Annuity Factor
Project Evaluation
Method of analysis
CBA= Const Benefit Analysis
Measures/Criteria for Investment Decisions
The most commonly used measures of discounted figures are
Net present value (NPV)
Benefit/Cost (B/C) ratio
Internal Rate of Return (IRR)
Present Value Payback(PVP),
Present Value Index (PVI)
First Year Rate of Return (FYRR) etc
Project Evaluation
Method of analysis
Example
Purchasing a piece of equipment a company may have the option of
paying in two different ways. Each way involve payments over a five
year period but the actual payments per year vary in each option as
follows:
Year 1 Year 2 Year 3 Year 4 Year 5
Option A 10,000 20,000 30,000 40,000 60,000
Option B 45,000 30,000 20,000 20,000 20,000
If payments are made at the end of each year and the discount (interest)
rate is constant over the five years and is equal to 10% p.a., which payment
option should the company choose?
Project Evaluation
Method of analysis
Problem
Once a cement factory is in full production in 1997, the
sixth year of the project (t6), it will produce cement value
Tk. 1,475,000 annually over the economic life of the plant,
taken to be 15 years.
What is the Present Worth of the cement production
from 1997 through 2006 (t6-t15) discounted at 12%?
Find the Present Worth of an annuity Factor.
Project Evaluation
Method of analysis
Solution
1 2 3 4 5 6
0 1997 15
A= 1,475,000 SPW=
PWB= (SPW15- SPW6)*A
DF
Here,
SPW15= 6.811
SPW6 = 3.605
Project Evaluation
Method of analysis
Present Worth of Cement Production
Annual Production = 1,475,000
Annuity Factor= A
Year 1 2 3 4 5 A A A A
t1
1997 20065
T6
t6(3.605)
Spw6
Spw15 t15
(6.811)
Project Evaluation
Method of analysis
PW of Total Cement Production
= PWB
=(Spw15- Spw6)*A
= (6.811-3.605)*1,457,000
Project Evaluation
Method of analysis
CBA (Cost Benefit Analysis)
Computational Exercise
Calculation of –
I. Payback Period,
II.Benefit-Cost Ratio,
III.
Net Present Value(NPV),
IV.Internal Rate of Return (IRR) or Discounted Cash Flow (DCF)
Return,
V. First Year Rate of Return(FYRR)
Project Evaluation
Method of analysis
Problem
Case A : Discount Factor-10%
Case B : Discount Factor 20%
Test: “Sensitivity” Analysis
Project Evaluation
Method of analysis
CASE-A (DISCOUNT FACTOR-10%)
Yr Capital O+M1 Total D.F2 PWC Gross D.F2 PWB Net
cost cost 10% benefit 10% benefit
1 7500 - 7500 .909 6818 - .909 - (6818)
2 6000 - 6000 .826 4956 - .826 - (4956)
3 - 1300 1300 .751 976 6000 .751 5606 3530
4 - 1300 1300 .683 888 6000 .683 4098 3210
5 - 1300 1300 .621 807 6000 .621 3726 2919
6 - 1300 1300 .564 733 6000 .564 3384 2651
7 - 1300 1300 .513 667 66003 .513 3386 2719
Total 13500 6500 - - 15845 - - 19100 3255
Project Evaluation
Method of analysis
1 Operation and maintenance Exercise: Calculate
(O&M) costs
2 Discount Factor (1/ n
(1+i) ) (i) Payback
3 Includes Salvage value of 600 (ii) B/C ratio at 10%
(iii) Net Present Worth at
10% and 20% D.F.
B/C = PWB/PWC
NPV/NPW = Total PWB – (iv) IRR (Internal Rate of
Total PWC Return)
IRR = Discount Rate at which (v) FYRR
NPV=0
CASE-B: (D.F.= 20%)
Project Evaluation
Method of analysis
Results of Worksheet
Solution:
1. Payback (i) at 10% 3.8 yrs.
(ii) at 0% 2.9 yrs.
2. B/C ratio –at 10% 19100
= 1.21
15845
3. Net Present Worth(NPW) or NPV
= Present Worth of Total Benefits - Present Worth of Total Costs
= PWB - PWC =19100-15845=3255
Project Evaluation
Method of analysis
Computation of IRR (Graphical Method)
NPV
Project Evaluation
Method of analysis
4. Internal Rate of Return or Discounted Cash Flow
Return, (at NPV=0)
= Lower discount rate + Difference between discount rates
NPV at lower discount rate
X
difference between NPVs rate
= 10+(20-10)
3255
3740
= 10+8.7
= 18.719% NPV at 20% (485)
IRR= 19%
Project Evaluation
Method of analysis
Algebraically,
IRR = Low DR + Difference of DR’s (NPV at Lower
DR/Total Difference between NPVs)
=10%/(20%-10%)*(3255/3740)
=10+ 10 (0.87)
=18.7
=19%
Project Evaluation
Economic Appraisal of
Project
In general Five decision criteria are in use
** Net Present Value (NPV)
** Benefit: Cost Ratio (BCR)
** Internal Rate of Return (IRR)
** Payback period
** First Year Rate of Return (FYRRY)
Project Evaluation
Economic Appraisal of
Project
Discussions
NPV Method is recommended as the best of the
above five techniques for economic analysis.
It is subjected to the least ambiguity, it produces
information which is readily understood.
It is least likely to be affected by assumptions
(definition of costs, benefits and is easiest to
calculate).
IRR can be compared with yields from investments,
and is readily understood by decision markers.
Project Evaluation
Economic Appraisal of Project
Internal Rate of Return (IRR)
Significance
Another way of using discounted case flow for measuring
the worth of a project
It is the discount rate which just makes the net present
worth of the cash flow equal zero.
This discount rate is termed the internal rate of return
and in a sense, It represents the average earning power
of the money used in the project over the project life:
Project Evaluation
Method of analysis
Internal Rate of Return (IRR)
i.e. at that particular discount rate, the Project just
breaks even-i.e. it will earn back all the capital &
operating costs expended upon it and pay us that
percent (i.e. 12 or 15% etc.) for the use of our money in
the project.
Computation:
Use trial or interpolation method illustrated in the
example.
Project Evaluation
Equipment Replacement
Replacement Studies
One of the problems which individuals and business
encounter frequently is deciding whether existing
equipment or property should be replaced with new and
more modern facilities.
Wear and tear of equipment, coupled with rapid
technological progress which results in new and
improved devices, make this an ever present problem.
Project Evaluation
Equipment Replacement
Reasons for Replacement
Four basic reasons for replacement
1. Physical impairment: Existing equipment is
completely or partially worn out.
2. Inadequacy: do not have sufficient capacity.
3. Obsolescence: caused either by or lessening in demand or
by the availability of more efficient equipment.
4. Rental possibilities: to rent identical or comparable
equipment; thus freeing capital for other and more
profitable use.
Project Evaluation
Equipment Replacement
Project Evaluation
Equipment Replacement
DIESEL Versus GALOLIN cont.
Given the Following assumptions on costs and the working
life of the respective equipment engines, make a decision on
which model to purchase
if you have alternative investment opportunities that
yield 10% interest compounded annually;
if you have alternative investment opportunities that
yield 20% interest compounded annually.
Project Evaluation
Equipment Replacement
DIESEL MODEL
Operating life 10 years
Price per Engine 100,000
Ann. operating & maint. costs 10,000
GASOLINE MODEL
Operating life 5 years
Price per Engine 50,000
Ann. operating & maint. costs 15,000
Note: There is no salvage value at the end of operating life for
either model.
Which Model to Buy?
Project Evaluation
Equipment Replacement
DIESEL Vs. GASOLINE –WORKSHEET
DIESEL:
End of Annual Discount Present Discount Present
Year Outlays Factor 10% Worth 10% Factor 20% Worth 20%
1 110000 .909 99,990 .833 91,630
2 10000
3 10000
4 10000
5 10000
6 10000
7 10000
8 10000
9 10000
10 10000
52,350 33,590
Total Present Wroth PW= 152,340 125,230
Project Evaluation
Equipment Replacement
GASOLINE
End of Annual Discount Present Worth Discount Present
Year Outlays Factor 10% 10% Factor 20% Worth 20%
1 65000
2 15000
3 15000
4 15000
5 15000
6 65000
7 15000
8 15000
9 15000
10 15000
Total Present PW= 165,810 121,295
worth
Conclusion: At 10%, Diesel is Preferable
At 20%, Gasoline is Preferable
Project Evaluation
Equipment Replacement
DIESEL Versus GALOLIN
CROSSOVER DISCOUNT RATE:
DISCOUNT Total Present Worth Difference between
RATE Cross over Discount
DIESEL GASOLINE Rate: PWs
10% 152,340 165,810 13,470
20%
Between
125,230
10% and 20% there is 3,935
121,295
a
discount rate which will make us
Total Present Worths of the two models will be equal (point of
indifferent
indifference) at a discount rate of:between two
alternatives.(Present Worth of
13,470
10% (20% 10costs
%) will be same)
13,470 3,935
=10%+7·7% = 17·7%18%
Project Evaluation
Equipment Replacement
Graphical Solution
Total Total
PWs PWs
Gasoline
Crossover
165,810 Discount Rate
152,340
Diesel 125,230
121,295
110,000
10% 17.7% 20%
Discount Rate
IRR
(NPV=0)
Project Evaluation
Equipment Replacement
From the Figure, Crossover Discount Rate = 17.7%
Crossover Discount Rate
Between 10% and 20%, there is a discount rate
which will make rate which will make us
indifferent between two alternatives.
Project Evaluation
Equipment Replacement
Crossover Discount Rate
The Preference ranking of the alternatives (indicated
by the cost stream with the lowest present worth) may
change between lower and higher discount rates.
The discount rate at which the preference changes is
know as the crossover discount rate.
Project Evaluation
Equipment Replacement
Crossover Discount Rate (contd)
This is also called as “equalizing” discount rate, at
which the total Present Worth of two alternatives will
be approximately equal.
In the replacement example, between 10% and 20%,
there is a discount rate which will make us indifferent
between the two alternatives.
Project Evaluation
Exercise- Comparing Alternatives
Compare the economics of two alternative material handling systems.
The Pertinent data are as follows:
System X Y
First Cost $80,000 $200,000
Economic life 20 years 40 years
Annual cash disbursement $18,000 $6,000
Salvage value at end of life $20,000 $40,000
Assuming a 6% minimum attractive rate of return (MARR), show
which alternative is the best by the:
Annual Cost (A.C) Method
Present Value (PV) Cost Method.
Internal Rate of Return (IRR) Method
Project Evaluation
Project Analysis
What is a Project?
A Project is an activity or which we spend money in
expectation of returns and which logically seems to lend
itself to Planning, Financing and Implementing as a unit.
It is the smallest operational element prepared and
implemented as a separate entity in a National Plan or
Program.
It is a specific activity with a specific starting point and
specific ending point intended to accomplish a specific
objective.
Project Evaluation
Project Analysis
Plans and Projects Plans: National plan to accelerate
economic growth- requires good projects.
Good Project requires: Sound Planning; sound planning
requires considerable information, data.
Project Format: Is the framework for analysis of
information from a broad range of sources.
Project Evaluation
Project Activities
Net Social Surplus: = “Good”s - “Bad”s - Inputs
Project Evaluation
Project Analysis
Tools and Techniques for Project management
Project Selection:
Cost-benefit analysis
Risk and Sensitivity Analysis
Project Execution Planning:
Work break - down structure
Project execution plan
Project responsibility matrix &
Project management manual.
Project Evaluation
Project Analysis
Project Scheduling & Coordinating:
Bar charts
Life cycle curves
Line of balance (LOB)
Network techniques (PERT/CPM)
Project Evaluation
Project Analysis
Project Monitoring & Progressing
Progress measurement technique
Value engineering
Project Communication & Clean-up
Control room
Computerized information systems.
Project Evaluation
The Project Cycle
There tends to be a natural sequence in the way projects are
planned and carried out – known as Project Cycle.
Identification- To find the potential projects (sources are
from technical specialists or social leaders)
Preparation & analysis- First step is to undertake a
feasibility study that will provide enough knowledge to
help to determine whether or not to proceed with more
detailed planning
Project Evaluation
The Project Cycle
(Contd)
Appraisal- After project has been prepared, it is
appropriate for a critical review or an independent
appraisal to be conducted.
Implementation- Implementation becomes the most
critical/important part of project cycle.
Evaluation- The final phase in the project cycle is
evaluation: looks at systematically the elements of success
& failure.
Project Evaluation
The Project Cycle
Project Evaluation
The
Project
Cycle
Project Evaluation
Project Analysis
Some Aspects of Project Preparation & Analysis
Technical aspects:
Concerns the inputs and outputs of real goods and
services
Technical skills and assistance
Institutional Aspects:
Organizational and Managerial aspects.
Social Aspects:
Social implications of proposed investments
i.e. income distribution and others social concerns
Project Evaluation
Project Analysis
Some Aspects of Project Preparation & Analysis
Commercial Aspects:
Arrangements for marketing outputs produced.
Supply of materials and services needed etc.
Financial Aspects:
Financial impacts
Budgets, Sources etc.
Economic Aspects:
Contribution to the development of total economy etc.
(National growth).
Project Evaluation
Project Analysis
Determining Economic values
A Project may be analyzed either from “Financial”
point of view or from “Economic” point of view.
Financial Analysis:
Based on “Market” prices of goods
and services.
Economic Analysis:
Based on “Economic” value(shadow
price - From the view point of entire
economy.
Project Evaluation
Project Analysis
When we change the market price of any good or service
to make it more nearly represent the opportunity cost to
the society, the new value we assign to it becomes its
“Shadow Price” is not the Market Price but is an
estimate of the economic value of the good or service in
question.
Example :- Determining the value of Foreign Exchange.
Feasibility Reports
Examine these aspects for preliminary assessment of
the project.
Project Evaluation
Feasibility Study
Purpose:
The Feasibility study is an in-depth analysis which is
undertaken in order to establish:
whether the proposed project will solve the problems
which have motivated the identification,
whether it has the proper scope and the relevant inputs,
whether it is possible to implement and to sustain in the
future and
whether alternative solutions should be considered.
Project Evaluation
Feasibility Study
Perspectives:
The Feasibility study analyses The feasibility study typically
the proposal form many angles, requires a multi-professional
such as: team as it address a wide-
ranging complex of different
• Technical, and often interlinked issues.
• Economic, The study is normally
• Financial, undertaken by external
• Social, consultants.
• Institutional,
• Organizational and
• Environmental.
Project Evaluation
Feasibility Report
1. Summary of the Project
General Presentation of Basic data
Specialization, Goods/Services
Capacity; total volume
Profitability
2. Market Study
Market problem in relation to specific project (nature of
markets)
Specifications of goods/services
Type of consumers
Demand forecasting, projection of demand
Economic policy
Project Evaluation
Project Analysis
3. Size & Location
Justification of capacity & location
Minimum cost & freight
Availability of resources
4. Project Engineering
Preliminary research
Technical alternatives, Efficiency
Flexibility of productive capacity
Construction, Work schedule/program
Project Evaluation
Feasibility Study
5. Investments
Cost Items; Composition & Volume of capital
investments
Cost of organization and equipment
Investment Program
6. Budget Expenditure & Income Budget
Annual Cost & Income budgets
Profits and unit production costs, Selling prices
Prepare such data (personnel, fuel, materials,
depreciation, intangible benefits)
Project Evaluation
Feasibility Study
7. Evaluation
Issues/Social view points
Methodologies for evaluation(Economic vs Financial)
Criteria of evaluation, Net Return, B/C ratio, IRR, Value
added etc.
8. Financing & Organization
(i) Financing: Sources, dates of availability of funds,
Currency involved.
(ii) Organization: Organizational internal matters; Structure;
Legal; Administrative; Decision making;
Forecasting; Future development.
