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Cost Estimation for Engineering Projects CIVE 4312 Hanadi Rifai

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Cost Estimation When choosing between options for designing a project the overall cost is a major factor When choosing between options for designing a project the overall cost is a major factor A cost estimation analysis must be performed in order to make an informed decision on the most economic option A cost estimation analysis must be performed in order to make an informed decision on the most economic option Options that may be the most cost efficient in the beginning may be more costly in the long run once yearly fees, interest, and lifetime are factored in Options that may be the most cost efficient in the beginning may be more costly in the long run once yearly fees, interest, and lifetime are factored in Two methods of analysis will be discussed: present value and future value Two methods of analysis will be discussed: present value and future value

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Time Value of Money Why can’t the initial costs, yearly costs, and final value be added together to give the estimated cost of the project? Why can’t the initial costs, yearly costs, and final value be added together to give the estimated cost of the project? Money invested today is worth more 10 years from now due to the interest accrued. Money invested today is worth more 10 years from now due to the interest accrued. On the other hand, a loan taken out today will be more costly in the future due to interest on the unpaid balance. On the other hand, a loan taken out today will be more costly in the future due to interest on the unpaid balance. For example, if you buy a car, the amount paid for the care will be higher if it is paid off in 10 years versus 5. For example, if you buy a car, the amount paid for the care will be higher if it is paid off in 10 years versus 5.

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Determining the Present Value In this analysis the cost of the project is determined in today’s dollar value. In this analysis the cost of the project is determined in today’s dollar value. The formula for computing the present values is: The formula for computing the present values is: PV = - first cost – annual operating costs + annual revenue + salvage value However, the annual operating costs (AOC), annual revenue, and the salvage value must be calculated taking the time value of money into account. However, the annual operating costs (AOC), annual revenue, and the salvage value must be calculated taking the time value of money into account. These values can be found by using Compound Interest Factor Tables or in Excel These values can be found by using Compound Interest Factor Tables or in Excel Note: if you are comparing options with different lifetimes, choose the least common multiple between the two lifetimes and carry out the analysis for that many years (i.e. if option 1 has a lifetime of 3 years and option 2 is 5 years, carry out the analysis over 15 years) Note: if you are comparing options with different lifetimes, choose the least common multiple between the two lifetimes and carry out the analysis for that many years (i.e. if option 1 has a lifetime of 3 years and option 2 is 5 years, carry out the analysis over 15 years)

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Present Value Using Tables EX: Determine the present value for three machines using a minimum acceptable rate of return (MARR) of 10% and the information below. 1 PV E = -2500 – 900(P/A,10%,5)* + 200(P/F,10%,5)* * These values are found by looking up the number on the table for 10% at 5 years in the P/A or P/F column and then multiplying it by the given value. PV E = -2500 – 900(3.7908) + 200(0.6209) = $-5788 This is repeated for the two other alternatives: PV G = -3500 – 700(P/A,10%,5) + 350(P/F,10%,5) = $-5936 PV S = -6000 – 50(P/A,10%,5) + 100(P/F,10%,5) = $-6127 _________________ 1 Example taken from: Blank, L. and Tarquin, A. Engineering Economy. 6 ed. Electric-PoweredGas-PoweredSolar-Powered First Cost Annual Operating Cost Salvage Value Lifetime (years) $2500 $900 $200 5 $3500 $700 $350 5 $6000 $50 $100 5

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Present Value in Excel Using the previous example we can setup an Excel spreadsheet to calculate these values. The first cost will be at year 0, annual costs will be in years 1-5, and the salvage value will be at year 5. Using the excel function: =NPV(rate, values) The present value for the annual costs and the salvage value are calculated. ** The electric-powered machine is chosen since it has the least negative present value.

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Determining the Future Value The future value is the value of the project at the end of its lifetime or at a certain point in the future The future value is the value of the project at the end of its lifetime or at a certain point in the future Future value can be easily calculated from the present value using the Compound Interest Factor tables or Excel Future value can be easily calculated from the present value using the Compound Interest Factor tables or Excel Future value is useful if the asset might be sold or traded before its expected lifetime Future value is useful if the asset might be sold or traded before its expected lifetime The most economic option will have the highest future value The most economic option will have the highest future value

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Calculating the Future Value Using the previous example, the electric powered machine had a lifetime of 5 years and a present value of $-5788. To find the future value by using the table: FV = PV(F/P, %, # of years) = -5788(F/P, 0.1, 5) FV = -5788 * 1.6105 = $-9322 To find the future value by using Excel: =FV(%, # of years,,PV)

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