Industrial Management And Process Economics

Assignment

Submitted By:
Abubakar Fareed
2015-CHE-101

Submitted To:
Dr.Aamir Shafiq

University of the Punjab Lahore

.
 Qno.1
Payback Period

I. The payback period means the amount of time it takes to recover the cost of an
investment or how much time it takes for an investor to reach breakeven.
II. Account and fund managers use the payback period to determine whether to go
through with an investment.
III. Shorter paybacks mean more attractive investments, On the other hand longer
payback periods are less desirable.
IV. The payback period is calculated by dividing the amount of the investment by the
annual cash flow.
The desirability of an investment has a direct relation with its payback period. Shorter
paybacks mean more attractive investments.

Although calculating the payback period is useful in financial and capital budgeting, it is also
applications in other industries. Homeowners and businesses can also use it for their calculations
of the return on energy-efficient technologies such as solar panels and insulation, including
maintenance and upgrades.

o Return on Investment (ROI)

Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an

investment or compare the efficiency of a number of different investments. ROI tries to directly
measure the amount of return on a particular investment, relative to the investment’s cost. To
calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment.
The result is expressed as a percentage or a ratio.
How to Calculate ROI
The return on investment formula is as follows:
current value of investment −cost of investment
ROI=
cost of investment

"Current Value of Investment” refers to the proceeds obtained from the sale of the investment of
interest. Because ROI is measured as a percentage, it can be easily compared with returns from
other investments, allowing one to measure a variety of types of investments against one another.

o Net Present Value (NPV)

Net present value (NPV) is the difference between the present value of cash inflows and the
present value of cash outflows over a period of time. NPV is used in capital budgeting and
investment planning to analyze the profitability of a projected investment or project.

The following formula is used to calculate NPV:

n
Rt
NPV =∑
t=1 (1+i)t

Where:

Rt = Net cash inflow - outflows during a single period t

i = Discount rate or return that could be earned in alternative investments

t= number of time period

NPV=TVECF−TVIC

Where:

TVECF=Today’s value of the expected cash flows

TVIC=Today’s value of invested cash
 o Benefit-Cost Ratio (BRC)
A benefit-cost ratio (BCR) is a ratio used in a cost-benefit analysis to summarize the overall
relationship between the relative costs and benefits of a proposed project. BCR can be expressed
in monetary or qualitative terms. If a project has a BCR greater than 1.0, the project is expected
to deliver a positive net present value to a firm and its investors.

 A benefit-cost ratio (BCR) is an indicator showing the relationship between the relative
costs and benefits of a proposed project, expressed in monetary or qualitative terms.
 If a project has a BCR greater than 1.0, the project is expected to deliver a positive net
present value to a firm and its investors.
 If a project's BCR is less than 1.0, the project's costs outweigh the benefits, and it should
not be considered.

How Benefit-Cost Ratio Works ?

Benefit-cost ratios (BCRs) are most often used in capital budgeting to analyze the overall value
for money of undertaking a new project. However, the cost-benefit analyses for large projects
can be hard to get right, because there are so many assumptions and uncertainties that are hard to
quantify. This is why there is usually a wide range of potential BCR outcomes.

The BCR also does not provide any sense of how much economic value will be created, and so
the BCR is usually used to get a rough idea about the viability of a project and how much the
internal rate of return (IRR) exceeds the discount rate, which is the company’s weighted-average
cost of capital (WACC) – the opportunity cost of that capital.

The BCR is calculated by dividing the proposed total cash benefit of a project by the proposed
total cash cost of the project. Prior to dividing the numbers, the net present value of the
respective cash flows over the proposed lifetime of the project – taking into account the terminal
values, including salvage/remediation costs – are calculated.
Q no.2

A series of cash inflows at the end of each of the next four years as $7000, $5000, $3000 and

$1000. Assuming the initial cash outlay for this proposal is $15,000. Find the payback period.

Year Cash Flows Cumulative Cash Flows

0 -$15,000(q)

1 $7,000 $7,000

2(p) $5,000 $12,000(r)

3 $3,000 $15,000

4 $1,000 $16,000

Payback Period Step by Step

1. We add up the cash inflows beginning after the initial cash outlay in the cumulative cash
nflows column

2. We keep an eye on this last column and track the last year for which the cumulative total
does not exceed the initial cash outlay

3. We compute the part or fraction of the next years cash inflow need to payback the initial cash
outlay by taking the initial cash outlay less the cumulative total in the last step then divide this
amount by the next year cash inflow.

E.g., ( $15,000 - $12,000 ) / $3,000 = 1.00

4. Since we said these were annual cash flows thus to obtain the payback period in years , we
take the figure from the last step and add it to the year from the step 2. Thus our payback period
is 2 + 1 = 3 years .Thus our payback period is 3 years.
Q no. 3

Suppose we like to make 10% profit on a 3 year project that will initially cost us $10,000.

a) In the first year, we expect to make $5000

b) In the second year, we expect to make $6000

c) In the third year, we expect to make $7000

Calculate the NPV

**Calculation step 1**

Right now, the project is going to cost us $10,000. So we won be making any money until at
least a year from now. What we need to do is calculate how much each of those future profit
amounts will be worth right here, today.This means we need to calculate the present value of
each of those 3 cash flows we be getting over the next three years. In other words:

a) How much is that $5000 one year from now worth today?

b) How much is that $6000 two years from now worth today?

c) How much is that $7000 worth three years from now worth today?

The answers to each of these three questions is the present value for that particular cash inflow.

**Calculation step 2**

In example I like to make a 10% profit. This is important because its the bare minimum well
need to make in order to say yes to this project. In corporate finance, we call this rate our
required rate of return (ROR).

To get our present values, we use this ROR!

In other words, we ask ourselves:
a) Earning 10%, $5000 one year from today would be worth how much right now?
b) Earning 10%, $6000 two years from today would be worth how much right now?
c) Earning 10%, $7000 three years from today would be worth how much right now?

**Calculation step 3**

Let's assume your using present value tables to get your answers.

a) We ll go over to 10% and down to 1 in the time period column to get your interest factor.
It ll be something like 0.9091. Multiply this factor by the $5000 we ll be getting in the
first year, and it gives us a present value of $4545.5.
b) Do the same thing for the $6000 we ll be getting in the second year. This time, you ll
go over to 10% and down to 2 in the time period column to get your interest factor. That
ll be 0.8264. Multiply this by the $6000 to get a present value of $4958.4.
c) Do the same thing for the $7000 we ll be getting in the third year. This time, we ll go
over to 10% and down to 3 in the time period column to get our interest factor.
That'll be 0.7513. Multiply this by the $5800 to get a present value of $5259.1.
**Calculation step 4**
Our next step is to add up all those present values we just calculated in step 6.
Adding $4545.5 + $4958.4 + $5259.1 gives us $14,763
 **Final step**
The last thing we need to do is subtract our original investment in the project from the result
in step 4.
Doing this gives us $14,763 - $10,000 or $4,763. This is our NPV!

Q no.4
Suppose you have a budgeted cost of a project at $600,000. The project is to be completed in
6 months. After a month, you have completed 15 % of the project at a total expense of
$300,000. The planned completion should have been 25 %. Calculate the CPI and SPI.
Discuss on result.
BAC=$600000
AC=$300000
Planned value(PV)= Planned completion (%)*BAC= 25$*600000= 150,000
Earned value (EV)= Actual completion(%)*BAC= 15%*600000= $90000
Compute the earned value variances:
Cost performance index =EV/AC = 90000/300000= 0.30
This means for every $1 spent, the project is producing only 30 cents in work.
Scheduled performance index = EV/PV= $90,000/$150,000= 0.60
This means for every estimated hour of work, the project team is completing only 0.6 hours
(36 minutes).

Q no. 5

NETWORK
Structurally, a network is a graphical model depicting the inter-relationship between the
various elements of the project work system. Through its graphical form, the network
provides visibility to all concerned not only about their inter-dependence but also what is
ahead of them and what may happen should there be a change in the desired relationship.
o CPM network
A CPM network is basically a deterministic network. The activities to be carried out and
the time each may consume are not likely to vary from what was reckoned at the time of
 development of the network Scenario it represents is quite realistic, the arithmetic
involved are complex.

o PERT network

In a PERT network the assumption is different. Activities in a PERT network are, of course,
deterministic but time is not. Time duration is considered probabilistic, and it is assumed, at
the time of development of network, that it will vary according to some known statistical
distribution.

o Decision network
A decision network, on the other hand, assumes that the activity itself may vary.
Accordingly, some probability is associated with each possible alternative activity; the sum
of the probabilities for the various alternatives, of course, equals 1.0. The time duration on
each alternative is, however, deterministic.
o GERT network
The most complex network is perhaps the GERT network. In a GERT network both activity
and time are considered probabilistic. Further, a GERT network for the first time provides for
repetition of an earlier activity based on feedback. Though the scenario it represents is quite
realistic, the arithmetic involved are complex.
Q no. 6
What Is Reimbursement?
Reimbursement is compensation paid by an organization for out-of-pocket expenses incurred or
overpayment made by an employee, customer, or another party. Reimbursement of business
expenses, insurance costs, and overpaid taxes are common examples. However, reimbursement
is not subject to taxation.

I. Reimbursement is money paid to an employee or customer, or another party, as

repayment for a business expense, insurance, taxes, or other costs. 
II. Business expense reimbursements include out-of-pocket expenses, such as those for
travel and food. 
III. Insurance reimbursement includes repayment for expenses repaid to the insured, such as
medication. Tax refunds are a form of reimbursement. 
IV. Per Diem rates are daily rates paid to employees as reimbursement for business trips. 

Lump sum contract

A lump sum contract (or stipulated sum contract) is the traditional means
of procuring construction, and still the most common form of construction contract. Under
a lump sum contract, a single ‘lump sum’ price for all the works is agreed before
the works begin.

It is defined in the CIOB Code of Estimating Practice as, ‘a fixed price

contract where contractors undertake to be responsible for executing
the complete contract work for a stated total sum of money.’

Mechanisms for varying the contract sum on a lump sum contract include:

I. Variations: These are changes in the nature of the works. Most contracts will contain

provision for the architect or contract administrator to issue instructions to vary
the design, quantities, quality, sequence or working conditions.
II. Relevant events: A relevant event may be caused by the client (for
example, failure to supply goods or instructions), or may be a neutral event (such
 as exceptionally adverse weather) and may result in a claim for loss and expense by
the contractor.
III. Provisional sums: An allowance for a specific element of the works that is not defined in
enough detail for tenderers to price.
IV. Fluctuations: A mechanism for dealing with inflation on projects that may last for several
years where the contractor tenders based on current prices and then the contract makes
provisions for the contractor to be reimbursed for price changes over the duration of
the project.
V. Payments to nominated sub-contractors or nominated suppliers.
VI. Statutory fees.
VII. Payments relating to the opening up works for inspection and testing.

The better defined the works are when the contract is agreed, the less likely it is that the contract
sum will change

o Cost-Plus Contract
A cost-plus contract is an agreement to reimburse a company for expenses incurred plus a
specific amount of profit, usually stated as a percentage of the contract’s full price. These type of
contracts are primarily used in construction where the buyer assumes some of the risk but also
provides a degree of flexibility to the contractor. In such a case, the party drawing up the contract
anticipates that the contractor will make good on his or her promises to deliver, and agrees to pay
extra so that the contractor can make additional profit upon completion.

Cost-plus contracts can be contrasted with fixed-cost contracts, in which two parties agree up
front to a specific cost regardless of the actual expenses incurred by the contractor. Cost-plus
contracts may also be known as cost-reimbursement contracts.

I. In a cost-plus contract, one party agrees to reimburse the contracting party for expenses
plus a specified profit proportional to the full value of the contract.
II. Cost-plus contracts are often used in construction when the budget is restricted or when
there is a high probability that actual costs might be less than anticipated.
III. Contractors must provide proof of all related expenses, including direct and indirect
costs.

o Item-rate contract
An item-rate contract is one in which the contractor agrees to carry out the work as per the
drawings, bills of quantities, and specifications in consideration of a payment to be made entirely
on measurements taken as the work proceeds, and at the unit-prices tendered by the contractor in
the bill of quantities

I. A bill of quantities is prepared, giving, as precisely as possible, the quantities of each

item of work to be carried out, and the contractor enters the unit rate against each item of
work.
II. The basis of the agreement is thus the unit rate of each item, certain practical and reason-
able variations in the quantities being accepted by both parties.

All the documents are invariably included in the agreement.

Convertible contracts:
Works on the cost-plus basis till scope of work can be defined and later converted to lumpsum.

Hybrid contracts:

o Lump sum + item rate- The contract in such cases may be divided into two parts. The parts
where design parameter and/or quantities are frozen are put on lump sum. For the balance parts where
quantities may change during detailed design, item rates are invited from the contractor against
schedule of item with no or very rough quantities.

o Lump sum + cost plus- Same as above except that where the details of the second part cannot
be even roughly estimated the same can be put on cost-plus .

o Lump sum + fixed rate-The lump sum portion may refer to supplies, design or for such scope
of work which can be fully defined. For services like commissioning or construction supervision or
for escalated period reimbursement may be at an agreed fixed rate.