PROJECT MANAGEMENT & ECONOMICS

SESSIONS 14 & 15 Exercise

Working example: PsychoCeramic Sciences, Inc. project

PsychoCeramic Sciences, Inc. (PSI), a large producer of cracked pots and other cracked items, is considering the installation of a new manufacturing line that will, it is hoped, allow more precise quality control on the size, shape, and location of the cracks in its pots as well as in vases designed to hold artificial flowers. The plant engineering department has submitted a project proposal that estimates the investment requirements as follows: an initial investment of $125,000 to be paid up-front to the Pocketa-Pocketa Machine Corporation; an additional investment of $100,000 to install the machines; and another $90,000 to add new material handling systems and integrate the new equipment into the overall production system. Delivery and installation is estimated to take one year; integrating the entire system should require an additional year. Thereafter, the engineers predict that scheduled machine overhauls will require further expenditures of about $15,000 every second year, beginning in the fourth year of the projects life. They will not, however, overhaul the machinery in the last year of its life. The project schedule calls for production to begin in the third year, and to be up-to-speed by the end of that year. Projected manufacturing cost savings and added profits resulting from higher quality are estimated to be $50,000 in the first year of operation and are expected to peak at $120,000 in the second year of operation, and then to follow the gradually declining pattern of 115,000; 105,000; 97,000; 90,000; 82,000; and 65,000 in respective years. Project life is expected to be 10 years from project inception, at which time the proposed system will be obsolete and will have to be replaced. It is estimated that the machinery will have a salvage value of $35,000. PSI has a 15 percent opportunity cost for capital investments and expects the rate of inflation to be about 3 percent over the life of the project. Assuming that the initial expenditure occurs at the beginning of the year and all other receipts and expenditure occur as lump sums at the end of the year. 1. Prepare the Net Present Value analysis for the project. Repeat the analysis using 12% opportunity cost. 2. Make recommendation on the acceptability of the project.

Analysis Results
Year A
0 1 2 3 4 5 6 7 8 9 10 10

Inflow B
0 0 0 50000 120000 115000 105000 97000 90000 82000 65000 35000

Outflow C
125000 100000 90000 0 15000 0 15000 0 15000 0 0

Net Flow D=(B-C)

-125000 -100000 -90000 50000 105000 115000 90000 97000 75000 82000 65000 35000

Discount Factor E

NPV F=D*E

Total

759,000

360,000

399,000

Analysis Results
The payback analysis:
as the total inflow for the project is $759000 or $75,900 per year on average for the 10 year project. The required investment is $315,000 (ignoring the biennial overhaul charges}. Assuming 10 year, straight line depreciation or $31 ,500 per year, the payback period would be:

315000 Payback period 75900 31500

2.9 years

A project with this payback period would probably be considered quite desirable.

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA