NEW VISION OF ENGINEERING ECONOMY COURSE (VISION) MODULE 3 LECTURE 1-2 Cairo, 13 July 2005

JULY 2005TEI OF PIRAEUS2 Module 3 Contents Introduction Investments Evaluation The Cost Benefit Model Applications of the Cost – Benefit Model Dealing with Uncertainties Replacement Analysis CASE STUDIES: Evaluation of Energy and Environmental Projects

JULY 2005TEI OF PIRAEUS3 Greek Project Team TEAM MEMBERCONTRIBUTIONSPECIALISATION / LAB EMILIA KONDILIMaterial Development, Survey, Website, Project Management, Evaluation, Seminar Optimisation of Production Systems ( J. K. KALDELLISMaterial Development, Survey, Website, Project Management, Evaluation, Seminar Soft Energy Applcations and Environmental Protection Lab, K. KAVADIASMaterial Development, Training “ C. CHALVATZISMaterial Development, Training “

JULY 2005TEI OF PIRAEUS4 Greek Project Team Technological Educational Institute of Piraeus

JULY 2005TEI OF PIRAEUS5 Greek Project Team Technological Educational Institute of Piraeus

JULY 2005TEI OF PIRAEUS6 Optimisation of Production Systems Lab (1/2) Dr. Emilia Kondili, Chemical Engineer Educational and Research Interests in the field of Optimization of Energy and Environmental Production Systems Modules being provided :  Production Management,  Project Management,  Engineering Economics,  Operations Research,  Waste Management

JULY 2005TEI OF PIRAEUS7 Optimisation of Production Systems Lab (2/2) Research Interests / Activities  Optimisation of Production Systems with the use of Operations Research (Mathematical Programming) Tools.  Production Management  Implementation of optimization tools in energy and environmental systems.  Water Resources Management with the Use of Optimisation Tools

JULY 2005TEI OF PIRAEUS8 SEALAB Presentation (1/3) Energy Related Courses: Introduction to RES Lab of RES Applications of RES Energy Engineering & Management of Natural Resources Design & Optimisation of Energy Systems

JULY 2005TEI OF PIRAEUS9 SEALAB Presentation (2/3) Environment Related Courses: Environment & Industrial Development Basic Principles of Ecology Air Pollution-Pollution Prevention Technologies Environmental Measurements Technology Waste Management Systems

JULY 2005TEI OF PIRAEUS10 SEALAB Presentation (3/3) Research Interests/Activities: Wind and Solar Energy Applications Feasibility studies on Energy Investments Hybrid Energy Systems Energy Storage Systems Energy Saving Cogeneration Systems RES based Desalination Environmental Impact of Power Stations

JULY 2005TEI OF PIRAEUS11 Module 3 Learning Outcomes Investments Evaluation Criteria Comparison and Suitability of Evaluation Criteria Development of a General Cost Benefit Model Applicability of the Cost-Benefit Model for the Evaluation of a Wide Range of Energy and Environmental Projects of Special Interest to our trainees

JULY 2005TEI OF PIRAEUS12 Investment Evaluation Objective: To evaluate the profitability of an investment, or To compare mutually exclusive alternatives and select the most economical, or To compare alternative and not mutually exclusive investments and rank them according to their profitability.

JULY 2005TEI OF PIRAEUS13 Evaluation Criteria Payback Period Net Present Value Internal Rate of Return Benefit / Cost Ratio (Lecture 2)

JULY 2005TEI OF PIRAEUS14 Payback Period PBP = Depreciable Fixed Investment/ Average Annual Cash Flow It expresses the minimum length of time necessary to recover the original fixed capital investment in the form of cash flow from the project No weighting of earlier vs. later cash flows, no consideration of project earnings after the initial investment has been recovered, no consideration of time value of money. Suitable only for rough calculations

JULY 2005TEI OF PIRAEUS15 Payback Period ( including interest) PBP including interest = (Depreciable Fixed Investment + interest on total capital investment during estimated service life)/ (Average Annual Profit + average annual depreciation) This method increases the PBP found with no interest.

JULY 2005TEI OF PIRAEUS16 Evaluation Criteria – Net Present Value If projects are mutually exclusive, choose the one with the highest NPV If multiple projects are feasible, rank according to NPV and select the top ones first The NPV is computed as the Present Value of all Revenues – the Present Value of all Costs

JULY 2005TEI OF PIRAEUS17 Net Present Value - Practical issues The interest reflects the minimum accepted rate of return of the investment Determine the expected cash flows for the project, that may be different for each year NPV Rule: NPV > 0 indicates that the investment has an annual rate of return greater that the minimum acceptable. Reject the project if its NPV < 0

JULY 2005TEI OF PIRAEUS18 Net Present Value - Practical issues (2) It is easy to compute, it works with all cash flow patterns, It gives correct ranking in most project evaluations. However The size of NPV for a single investment sometimes fails to indicate relative profitability

JULY 2005TEI OF PIRAEUS19 Internal Rate of Return (IRR) The internal rate of return is the interest rate that makes the NPV = 0, ie. it is the break-even interest rate. It is a familiar and easy to understand concept It treats variable cash flows It requires trial and error calculations

JULY 2005TEI OF PIRAEUS20 Example I INVESTMENT AINVESTMENT B Initial Investment 75,000105,000 Annual Revenue 16,00022,000 Annual Cost 3,0005,000 Residual Value 10,00015,000 Life Time 10 NPV (I = 0,12) , ,67 IRR 0,180,17

JULY 2005TEI OF PIRAEUS21 Example II An energy intensive industrial unit, for energy conservation purposes, intends to install a Natural Gas based cogeneration unit. To that effect, two alternative proposals are examined, their data being presented in Table I. The investments must be depreciated within 10 years, but their economic life is 15 years. Taxation is 40% on the profits. Determine the annual energy conservation of each investment that will result in an IRR of 12%. INVESTMENT 1INVESTMENT 2 Initial Investment Cost (€) Natural Gas Cost (€) Maintenance Cost (€)