CHAPTER 1

INTRODUCTION

As we know in Wikipedia sources engineering economics, previously known is a subset of economics for application to engineering projects. Engineers seek solutions to problems, and the economic viability of each potential solution is normally considered along with the technical aspects.

In some U.S. undergraduate engineering curricula, engineering economics is often a required course. It is a topic on the Fundamentals of Engineering examination, and questions might also be asked on the Principles and Practice of Engineering examination both are part of the Professional Engineering registration process.

Considering the time value of money is central to most engineering economic analyses. Cash flows are discounted using an interest rate, except in the most basic economic studies.

Figure 1.0 The full circular flow

For each problem, there are usually many possible alternatives. One option that must be considered in each analysis, and is often the choice, is the do nothing alternative. The opportunity cost of making one choice over another must also be considered. There are also noneconomic factors to be considered, like colour, style, public image, etc. such factors are termed attributes.

Costs as well as revenues are considered, for each alternative, for an analysis period that is either a fixed number of years or the estimated life of the project. The salvage value is often forgotten, but is important, and is either the net cost or revenue for decommissioning the project.

Some other topics that may be addressed in engineering economics are inflation, uncertainty, replacements, depreciation, resource depletion, taxes, tax credits, accounting, cost estimations, or capital financing. All these topics are primary skills and knowledge areas in the field of cost engineering.

Since engineering is an important part of the manufacturing sector of the economy, engineering industrial economics is an important part of industrial or business economics. Major topics in engineering industrial economics are: a) The economics of the management, operation, and growth and profitability of engineering firms. b) Macro-level engineering economic trends and issues. c) Engineering product markets and demand influences. d) The development, marketing, and financing of new engineering technologies and products. e) Benefit to cost ratio (B/C)

Ages ago, the most significant barriers to engineers were technological. The things that engineers wanted to do, they simply did not yet know how to do, or hadn't yet developed the tools to do. There are certainly many more challenges like this which face present-day engineers. However, we have reached the point in engineering where it is no longer possible, in most cases, simply to design and build things for the sake simply of designing and building them. Natural resources (from which we must build things) are becoming more scarce and more expensive. We are
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much more aware of negative side-effects of engineering innovations (such as air pollution from automobiles) than ever before.

For these reasons, engineers are tasked more and more to place their project ideas within the larger framework of the environment within a specific planet, country, or region. Engineers must ask themselves if a particular project will offer some net benefit to the people who will be affected by the project, after considering its inherent benefits, plus any negative side-effects (externalities), plus the cost of consuming natural resources, both in the price that must be paid for them and the realization that once they are used for that project, they will no longer be available for any other project(s).

Simply put, engineers must decide if the benefits of a project exceed its costs, and must make this comparison in a unified framework. The framework within which to make this comparison is the field of engineering economics, which strives to answer exactly these questions, and perhaps more. The Accreditation Board for Engineering and Technology (ABET) states that engineering "is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practice is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind".

It should be clear from this discussion that consideration of economic factors is as important as regard for the physical laws and science that determine what can be accomplished with engineering.

1.1

Project Brief

For our group, we must do the project about the topic Leased vs. Buy vs. Status Quo Decision. We must create something problem to solve the topic in practices for civil engineering application. First step to do when we get the project, we discuss to create the problem and also discuss to separate the part of project to solve the problem.

Other than that, our group also meet the lecture to give opinion and advice about the solution for our problem. We also surf the internet to give more information to solve our problem and get the example problem to guide our group.Finally, our group get the solution to solve the problem.

1.2

Objective

i) ii) iii)

To plan the project cost in the future. To apply the concept of engineering economy in daily life. To determine the risk for the project planning.

1.3

Learning Outcome

We must learn to apply the concept of engineering economy in daily life or in civil engineering. Other than that, we must know to planning the budget for future when we want to save money at bank or do investment. We also must know to do the comparison for three choices or more and choose the best solution when do comparison. Assess the strengths and weaknesses of alternative strategies for collecting, analysing and interpreting data from needs analyses and evaluations in direct practice, program and policy interventions also important. Finally, analyse problem data systematically by selecting appropriate interpretive or quantified content analysis strategies.

1.4

Company Background

BinaTeguh Sdn Bhd is registered with Pusat Khidmat Kontraktor (PKK) and the Construction Industry Development Board (CIDB) as a Class A and Grade 7 construction corporation respectively where BinaTeguhConstruction can tender for contracts of unlimited value.

At Bina Teguh Construction, we offer complete turnkey design and construction services, with prominent recognition in the fields of building construction, civil engineering and infrastructure. Recent additions to the BinaTeguh Construction Group including precast, piling and stone materials have further strengthened our capability as an integrated builder, in Malaysia and the region. We draw on the strengths of our diverse team, expertise and resources, and remain committed to building quality and innovation into our products and services. Since then, our story has been one of growth and achievement, becoming one of Malaysias largest construction companies, with interests throughout the region. As we climb the ranks of the design and build elite, we continue to build landmarks of achievement in our portfolio and help shape our nations progress.

1.5

Vision

To be the BEST in all we do.

1.6

Mission

We deliver innovative world-class infrastructure and homes for our customers through our core businesses in infrastructure development and construction, operation and maintenance of public infrastructure concessions, and large-scale urban property development.

1.7

Organizations

1.8

Responsibility

1.8.1

Board of Director

The role of a director comes with great responsibility. They can be held to account for the actions of the company which is why those who are offered directorships should not take them lightly as their personal wealth and reputation are put on the line as a result.

1.8.2

Project Director

A construction director is a person who is responsible for the planning, budgeting and coordinating of various construction projects. These projects will normally be spread out through different sectors: residential, commercial and industrial infrastructure. Depending on a directors expertise, skill level and

specialty, these people can either be adept at a specific field, or knowledgeable enough to lead a construction team in all.

1.8.3

General Manager

General Manager will independently supervise all projects including many mega projects through of each project. This role will include responsibility for management of the existing portfolio and the identification of new ventures, growth of the company across construction projects and contracts, overall management of all projects ensuring timely execution within budget.

1.8.4

Purchasing Executive Manager

The purchasing executive manager will increase company profitability and customer satisfaction by purchasing materials in a timely manner and at the lowest cost. The purchasing manager will coordinate vendor activity and negotiations, and analyse trends in vendor pricing and sales activity to determine the correct timing of purchases. They also will review stock purchase by monitoring market conditions, current stock levels, lead time required for manufacturing, potential price increase, anticipation of new orders from customers and suppliers conditions.

1.8.5 Accountant

Accountant is responsible for a variety of tasks within the accounting department. Duties vary depending on the size of the company. An accountant will prepare, examine, and analyse accounting records, financial statements, and other financial reports to assess accuracy, completeness, and conformance to reporting and procedural standards. They will compute taxes owed and prepare tax returns, ensuring compliance with payment, reporting and other tax requirements. And also analyse business operations, trends, costs, revenues, financial commitments, and obligations, to project future revenues and expenses or to provide advice.

1.8.6

QAQC Officer

Quality control during the construction process is extremely important in order to safeguard the value of the owner's investment. Process Technical Services QAQC personnel can perform checks and tests throughout the construction process, providing the project owner assurance that the project is being built according to specifications. QAQC Officer Supervise and coordinate all activities related to Quality Control and Quality Assurance. They work with craft foreman of workers engaged in construction, installation to ensure the Quality Control program is executed and clients quality requirements are achieved. They must inspect work to ensure conformance with specifications defined by the projects. The QA/QC Officer acts as a liaison between field supervision and client representative to ensure that quality issues are identified and corrected through the construction and repair process.

CHAPTER 2

LITERATURE VIEW

2.1

The Capital Budgeting Process

Capital budgeting is the process that companies use for decision making on capital project. The capital project lasts for longer time, usually more than one year. As the project is usually large and has important impact on the long term success of the business, it is crucial for the business to make the right decision.

2.1.1

Capital Budgeting Process

The specific capital budgeting procedures that the manager uses depend on the manger's level in the organization and the complexities of the organization and the size of the projects. The typical steps in the capital budgeting process are as follows:

Brainstorming. Investment ideas can come from anywhere, from the top or the bottom of the organization, from any department or functional area, or from outside the company. Generating good investment ideas to consider is the most important step in the process.

Project analysis. This step involves gathering the information to forecast cash flows for each project and then evaluating the project's profitability.

Capital budget planning. The company must organize the profitable proposals into a coordinated whole that fits within the company's overall strategies, and it also must consider the projects' timing. Some projects that look good when considered in isolation may be undesirable strategically. Because of financial and real resource issues, the scheduling and prioritizing of projects is important.
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Performance monitoring. In a post-audit, actual results are compared to planned or predicted results, and any differences must be explained. For example, how do the revenues, expenses, and cash flows realized from an investment compare to the predictions? Post-auditing capital projects is important for several reasons. First, it helps monitor the forecasts and analysis that underlie the capital budgeting process. Systematic errors, such as overly optimistic forecasts, become apparent. Second, it helps improve business operations. If sales or costs are out of line, it will focus attention on bringing performance closer to expectations if at all possible. Finally, monitoring and post-auditing recent capital investments will produce concrete ideas for future investments. Managers can decide to invest more heavily in profitable areas and scale down or cancel investments in areas that are disappointing.

2.1.2

Complexity of Capital Budgeting Process

The budgeting process needs the involvement of different departments in the business. Planning for capital investments can be very complex, often involving many persons inside and outside of the company. Information about marketing, science, engineering, regulation, taxation, finance, production, and behavioral issues must be systematically gathered and evaluated.

The authority to make capital decisions depends on the size and complexity of the project. Lower-level managers may have discretion to make decisions that involve less than a given amount of money, or that do not exceed a given capital budget. Larger and more complex decisions are reserved for top management, and some are so significant that the company's board of directors ultimately has the decision-making authority. Like everything else, capital budgeting is a cost-benefit exercise. At the margin, the benefits from the improved decision making should exceed the costs of the capital budgeting efforts.

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2.2

Minimum Attractive Rate of Return (MARR)

In business and engineering, the minimum acceptable rate of return, often abbreviated MARR, or hurdle rate is the minimum rate of return on a project a manager or company is willing to accept before starting a project, given its risk and the opportunity cost of forgoing other projects. A synonym seen in many contexts is minimum attractive rate of return. For example, suppose a manager knows that investing in a conservative project, such as a bond investment or another project with no risk, yields a known rate of return. When analyzing a new project, the manager may use the conservative project's rate of return as the MARR. The manager will only implement the new project if its anticipated return exceeds the MARR by at least the risk premium of the new project. The hurdle rate is usually determined by evaluating existing opportunities in operations expansion, rate of return for investments, and other factors deemed relevant by management. A risk premium can also be attached to the hurdle rate if management feels that specific opportunities inherently contain more risk than others that could be pursued with the same resources. A common method for evaluating a hurdle rate is to apply the discounted cash flow method to the project, which is used in net present value models. The hurdle rate determines how rapidly the value of the dollar decreases out in time, which, parenthetically, is a significant factor in determining the payback period for the capital project when discounting forecast savings and spending back to present-day terms. Most companies use a 12% hurdle rate, which is based on the fact that the S&P 500 typically yields returns somewhere between 8% and 11% (annualized). Companies operating in industries with more volatile markets might use a slightly higher rate in order to offset risk and attract investors. The hurdle rate is frequently used as synonym of cut off

rate, benchmark and cost of capital. Different organizations might have slightly different interpretations, so when multiple organizations (e.g., a start-ups company and a venture capital firm) are discussing the suitability of investing in a project, it is vital to make sure both sides' understanding of the term are compatible for this purpose.

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2.3

Capital Asset Pricing Model CAPM

In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that assets non-diversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta () in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

2.4

Cost of Equity

Cost of equity refers to a shareholder's required rate of return on an equity investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk.

Cost of equity is a key component of stock valuation. Because an investor expects his or her equity investment to grow by at least the cost of equity, cost of equity can be used as the discount rate used to calculate an equity investment's fair value. Both cost of equity calculation methods have advantages and disadvantages.

The dividend growth model is simple and straightforward, but it does not apply to companies that don't pay dividends, and it assumes that dividends grow at a constant rate over time. The dividend growth model also quite sensitive to changes in the dividend growth rate, and it does not explicitly consider the risk of the investment.

CAPM is useful because it explicitly accounts for an investment's riskiness and can be applied by any company, regardless of its dividend size or dividend growth rate. However, the components of CAPM are estimates, and they generally lead to a less concrete answer than the dividend growth model does. The CAPM method also implicitly relies on past performance to predict the future.

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The cost of equity is the rate of return required to persuade an investor to make a given equity investment. In general, there are two ways to determine cost of equity.

First is the dividend growth model: Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate

Second is the Capital Asset Pricing Model (CAPM): ra = rf + Ba (rm-rf) where: rf = the rate of return on risk-free securities (typically Treasuries) Ba = the beta of the investment in question rm = the market's overall expected rate of return

2.5

Weighted Average Cost Capital (WACC).

Weighted average cost of capital (WACC) is the average rate of return a company expects to compensate all its different investors. The weights are the fraction of each financing source in the company's target capital structure.

It's important for a company to know its weighted average cost of capital as a way to gauge the expense of funding future projects. The lower a company's WACC, the cheaper it is for a company to fund new projects.

A company looking to lower its WACC may decide to increase its use of cheaper financing sources. For instance, Corporation ABC may issue more bonds instead of stock because it can get the financing more cheaply. Because this would increase the proportion of debt to equity, and because the debt is cheaper than the equity, the company's weighted average cost of capital would decrease. Here is the basic formula for weighted average cost of capital:

WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)]

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E = Market value of the company's equity D = Market value of the company's debt V = Total Market Value of the company (E + D) Re = Cost of Equity Rd = Cost of Debt T= Tax Rate

A company is typically financed using a combination of debt (bonds) and equity (stocks). Because a company may receive more funding from one source than another, we calculate a weighted average to find out how expensive it is for a company to raise the funds needed to buy buildings, equipment, and inventory.

2.6

Leased Versus Buy Versus Status Quo.

2.6.1

Definition of Lease

A lease is a contractual arrangement calling for the lessee (user) to pay the less or (owner) for use of an asset. The narrower term rental agreement can be used to describe a lease in which the asset is tangible property. Language used is that the user rents the land or goods let or rented out by the owner. The verb to lease is less precise as it can refer to either of these actions. Examples of a lease for intangible property are use of a computer program (similar to a license, but with different provisions), or use of a radio frequency (such as a contract with a cell-phone provider).The term rental agreement is also sometimes used to describe a periodic lease agreement (most often a month-to-month lease) internationally and in some regions of the United States.

2.6.2

Definition of Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments.

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The lessee is the receiver of the services or the assets under he lease contract and the lessor is the owner of the assets. The relationship between the tenant and the landlord is called a tenancy, and can be for a fixed or an indefinite period of time (called the term of the lease). The consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers and washing machines to handbags and jewelry.

Under normal circumstances, a freehold owner of property is at liberty to do what they want with their property, including destroy it or hand over possession of the property to a tenant. However, if the owner has surrendered possession to another (the tenant) then any interference with the quiet enjoyment of the property by the tenant in lawful possession is unlawful.

Similar principles apply to real property as well as to personal property, though the terminology would be different. Similar principles apply to sub-leasing, that is the leasing by a tenant in possession to a sub-tenant. The right to sub-lease can be expressly prohibited by the main lease.

2.6.3

Advantages of leasing

For businesses, leasing property may have significant financial benefits:

Leasing is less capital-intensive than purchasing, so if a business has constraints on its capital, it can grow more rapidly by leasing property than by purchasing property.

Leasing can help businesses safeguard cash flow by paying for equipment as it generates revenue.

Capital assets may fluctuate in value. Leasing shifts risks to the lessor, but if the property market has shown steady growth over time, a business that depends on leased property is sacrificing capital gains.

Depreciation of capital assets has different tax and financial reporting treatment from ordinary business expenses. Lease payments are considered expenses rather than assets, which can be set off against revenue when calculating taxable profit at the end of the relevant tax accounting period.
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In some cases a lease may be the only practical option; for example, a small business may wish to open a location in a large office building within tight locational parameters.

Leasing may provide more flexibility to a business which expects to grow or move in the relatively short term, because a lessee is not usually obliged to renew a lease at the end of its term.

2.6.4

Disadvantages of leasing

For businesses, leasing property may have significant drawbacks:

A net lease may shift some or all of the maintenance costs onto the tenant. If circumstances dictate that a business must change its operations significantly, it may be expensive or otherwise difficult to terminate a lease before the end of the term. In some cases, a business may be able to sublet property no longer required, but this may not recoup the costs of the original lease, and, in any event, usually requires the consent of the original lessor. Tactical legal considerations usually make it expedient for lessees to default on their leases. The loss of book value is small and any litigation can usually be settled on advantageous terms. This is an improvement on the position for those companies owning their own property. Although it can be easier for a business to sell property if it has the time, forced sales frequently realise lower prices and can seriously affect book value.

If the business is successful, lessors may demand higher rental payments when leases come up for renewal. If the value of the business is tied to the use of that particular property, the lessor has a significant advantage over the lessee in negotiations.

2.6.5

Definition of Buy

A recommendation to purchase a specific security. A buy rating from an analyst or research firm is a recommendation to purchase the security, with the implied insistence that the security is undervalued in some fashion. To acquire an asset in exchange for currency. An investor would buy shares of a company by exchanging money or some form of monetary value for the shares.
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Exact definitions of a "buy" vary by brokerage, but in general a buy rating is better than neutral but worse than a strong buy, if the brokerage in question issues strong buy ratings. A sell rating on the other hand would be a recommendation to sell the security if currently held, and avoid purchasing it on the open market.

Like any buy-sell transaction, buying a security involves an active buyer and seller. While in most cases currency will be exchanged for the security, other forms of payment are also made, such as other securities or services.

2.6.6

Definition of 'Buy To Open'

A term used by many brokerages to represent the opening of a long call or put position in option transactions. A "buy to open" order has a distinguishing characteristic where the option position is not held short in the account during the transaction. The "sell to close" order is used to exit a position taken with a "buy to open" order.

The buy and sell terminology for options trading is not as straightforward as it is for stock trading. Instead of simply placing a "buy" or "sell" order as they would for stocks, options traders must choose among "buy to open," "buy to close," "sell to open," and "sell to close." Beginning options traders should ensure that they understand the terminology and that they place their orders carefully to avoid preventable mistakes.

2.6.7

Definition of 'Buying On Margin'

The purchase of an asset by paying the margin and borrowing the balance from a bank or broker. Buying on margin refers to the initial or down payment made to the broker for the asset being purchased. The collateral for the funds being borrowed is the marginable securities in the investor's account. Before buying on margin, an investor needs to open a margin account with the broker. In the U.S., the amount of margin that must be paid for a security is regulated by the Federal Reserve Board.

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Based on creditworthiness and other factors, the broker sets the minimum or initial margin and the maintenance margin that must exist in the account before the investor can begin buying on margin. Maintenance margin refers to the minimum amount of money that must exist in the account before the broker forces the investor to deposit more money. Let's say an investor deposits $10,000 and the maintenance margin is 50% ($5,000). As soon as the investor's equity dips so much as a dollar below $5000, the broker may call the investor and demand that he/she deposit additional money to bring the balance back to maintenance margin level.

2.6.8

Comparison of buying and leasing

There are many distinct differences between buying and leasing, regardless if such a transaction or agreement applies to property, machinery, equipment or other assets. The difference lies in that a lease is conceptually very similar to the principle of borrowing. The ownership of the leased property (be it land, equipment, merchandise, or etc.) is not transferred under the terms of the lease agreement. The lease gives the lessee the right to use the assets covered under the agreement for the duration of the contracted term, however, upon the completion of said term the lessee is required to return the assets in question to the lessor, thereby completing the terms of the agreement. In a general example having to do with an automobile lease, the vehicle is due back to the dealership at the conclusion of the lease term. Once the vehicle is returned, the automobile lease agreement is completed and the parties (lessor and lessee) separate with no further obligations to each other (assuming there is no damage on the vehicle entitling the dealer to some further compensation). The lessee has no further claim or right to use the vehicle and the lessor, or car dealer no longer collects any payment from the former lessee the previous driver.

Many lease agreements contain clauses and addendums that outline additional rights, or options for the lessee, to be exercised at will upon the conclusion of the lease (there are numerous equipment lease types with individual features). In automobile leases as a general example, a lessee may have an option to purchase the vehicle, thereby restructuring the agreement and ultimately obtain the ownership of the asset previously leased. In the example of a property lease, the renter (or lessee)
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may have the option to extend the lease, under pre-determined terms. Such scenarios are numerous and are typically pre-set during the initial creation and negotiation of the agreement between the parties.

Purchasing, on the other hand, involves an agreement that outlines the terms under which the purchaser acquires ownership of the desired item, property or asset. The purchase agreement delineates the purchase price and the terms under which it is to be paid for by the buyer. The overall purchase price can be amortized over a period of time as in the case of financing, or it can be paid in full, resulting in the instant transfer of ownership to the purchaser. In the event that the purchase is financed over a period of time, the ultimate price paid for the item or asset can be greater than the original price due to interest. For an individual deciding between buying or leasing, it is crucial to understand the pros and cons of each. Responsibility: In a scenario involving business entities that typically rely on functional equipment for ongoing operations and to stay ahead of competitors, responsibility is a key factor. In a purchase, the responsibility for the equipment falls solely on the shoulders of the business owner. While there are various insurance plans and warranties available to protect the owners, in case of damage or faulty manufacturing, the ultimate responsibility for the life of the equipment, after a purchase is complete, falls on the buyer. In a lease scenario, a lessee is only responsible for the equipment for the duration of the lease and while he or she remains in possession. Resale value: In case of a purchase, the full value of the asset is transferred to the purchaser, as the new owner. This means that in case of resale at a subsequent time, the full price for which the asset is resold can be collected by the new owner. In case of an automobile purchase, for example, an individual can, at a later date freely resell the vehicle and collect its value, albeit a depreciated amount from the original purchase price. In a lease, the lessor has no claim to the asset upon the conclusion of a lease, thereby the monies that were paid in the course of the lease cannot be, in part or in whole be recouped through a resale of the asset.

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Depreciation: Depreciation is a major consideration for individuals deciding between buying and leasing. For assets that suffer from significant depreciation, either as a result of regular wear and tear or through becoming obsolete upon the release of newer versions of the same materials (particularly applicable in the case of technology) leasing can prevent a significant loss of value. In business, there exists a basic rule of thumb: If it appreciates, buy it. If it depreciates, lease it. Leasing could permit the use of the equipment while it is new and upon the completion of the lease, it can be simple to upgrade by virtue of a new lease. In case of a purchase, however, an individual may be stuck with an obsolete asset with no means of recouping the cost of its acquisition.

Maintenance: Because in the instance of a lease the ultimate ownership is retained by the lessor, it is in the lessors best interest to maintain the asset in its best working order. Therefore, lessees can often benefit from comprehensive maintenance programs offered by lessors while still paying a discounted premium due to the fact that the asset is being leased, not purchased.

Cost: In the event of a purchase, the full value of the asset must be paid to the seller. In the event of a lease, however, only a portion of the full value is assessed, typically around 50%, however the figure varies based on the duration and type of lease. As a consequence, a lessor can gain the use of a much needed asset for a fraction of the full price of ownership. In many instances, this can better serve the lessee that an outright purchase would. As a corollary, a lessor could be granted the use of an asset that could otherwise be cost prohibitive.

3.5.9

Status Quo

Status quo is a Latin term meaning the existing state of affairs. It is a commonly used form of the original Latin "status quo" literally "the state in which". To maintain the status quo is to keep the things the way they presently are. The related phrase status quo ante, literally "the state in which before", means "the state of affairs that existed previously".

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A status quo pricing objective is one that maintains current price levels or meets the price levels of the competition. If the customer has many choices, and a small firm barely has the resources to stay in the market, then they should just charge the same price as the competition. They don't have the resources to survive a price war or the ability to claim better quality to charge a higher price. Price wars are intense competitive rivalries characterized by a multilateral series of price reductions.

In the short term, price wars are good for consumers, who can take advantage of lower prices. Often they are not good for the companies involved because the lower prices reduce profit margins and can threaten their survival. A small firm can avoid a price war by setting prices in line with its competition. It is best to respond to changes as quickly as possible or else it could signal to competitors that you are ready to engage in a price war. The slower it is done, the more it looks like the firm is attempting to steal back parts of the market share.

Charging what the competition is charging can be quite popular in cases where costs are difficult to measure or where the response of the competition is uncertain. Its major advantage is that it requires little planning, as it's a relatively passive policy. Sometimes companies will send managers or employees to a competitors store to check out prices and then adjust their prices accordingly. While status quo pricing ensures competition, it's still ultimately a better strategy than engaging in a price war.

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CHAPTER 3

PROBLEM ANALYSIS

3.1

Problem Statement Our company is a contractor involved in the construction work. Our company

has been recognized as an indigenous contractor by the government. Because of this recognition, our company has managed to get the construction of a hospital. Therefore, our company requires machinery tower crane to facilitate the work involving high ranking as lifting construction materials into high places and the concrete pouring work for difficult areas. For this problem, our company has to make a decision of whether we choose to buy or lease or maintain the status quo. 3.2 Problem Recognition, Definition, and evaluation The cost of buying a new Tower Crane is RM 180,000 and it would be used for 20 years after which the market value is zero. Alternatively, it could be leased for RM 18,600 every year. The effective Income tax rate for the company is 55% and straight line depreciation is used. The net before cash benefit of the Tower Crane is RM 20,000 while the after tax minimum attractive rate of return (MARR) for the company is 10%. The Present Worth (PW) is used to decide whether to buy or lease or status quo (do nothing).

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3.3

Development of the outcomes and cash flows for each alternatives.

Table 3.3 : Calculation of Buy Vs Lease Vs Status Quo

(A) Alternative Year Before tax Cash flow BUY 0 1 20 LEASE 0 1 19 STATUS QUO 1- 20 -RM 18,600 -RM 18,600 -RM 20,000 -RM 180,000 -RM 9,000 -RM 9,000 -RM 18,600 -RM 18,600 -RM 20,000 +RM 4,950 +RM 10,230 +RM 10,230 +RM 11,000 (B) Depreciation {c}=(A) (B)Taxable Income (D) = -0.55{C} Cash Flow for Income Taxes (E)=(A)+ (D) After-Tax Cash flow -RM 180,000 +RM 4,950 -RM 8,370 -RM 8,370 -RM 9,000

Calculation for Table 1

i.

Before tax cash flow (A) Cash flow is all of a rental property's cash inflows less all of its cash outflows. Think of it as all the money flowing in such as rent, loan proceeds, and interest on bank accounts less all the money flowing out like operating expenses, debt payment, and capital additions. Cash flow before taxes (CFBT) which doesn't take into consideration the owner's tax liability. Buy Leased Status Quo = - RM 180,000 = - RM 18,600 = - RM 20,000

*Note : negative sign (-ve) indicate cash outflows.

ii.

Depreciation - Straight Line Method (B) Straight line method depreciates cost evenly throughout the useful life of the fixed asset. Straight line depreciation is calculated as follows: Depreciation per annum = (Cost - Residual Value) / Useful Life

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Where:

Cost includes the initial and any subsequent capital expenditure. Residual Value is the estimated scrap value at the end of the useful life of the asset. As the residual value is expected to be recovered at the end of an asset's useful life, there does no need to charge the portion of cost equal the residual value.

Useful Life is the estimated time period an asset is expected to be used from the time it is available for use to the time of its disposal or termination of use. Useful life is normally calculated in units of years but it may be calculated based on an alternative basis. Useful life of an oil extraction company may for example be the estimated oil reserves.

Cost Residual Value Useful life

= RM 180,000 = 0 (the market value is zero) = 20 years.

Depreciation for buy = (-RM 180,000 0) / 20 years = - RM 9,000 iii.

Taxable Income (C)

The amount of income that is used to calculate an individual's or a company's income tax due. Taxable income is generally described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments that are allowable in that tax year.
Taxable Income = Before tax Cash flow (A) Depreciation (B)

Buy taxable income not exists in year 0 because no depreciation. It exists on year 1 to 20.
Taxable Income (1-20 years)

= 0- RM 9,000
= - RM 9,000

Leased taxable income exists in year 0 and year 1 to 20.

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Taxable Income (0 years)

= - RM 18,600 - 0
= - RM 18,600

Taxable Income (1-19 years)

= - RM 18,600 0
= - RM 18,600

Status Quo taxable income exists in year 1 to 10. Taxable Income (1-10 years)

= - RM 20,000 0
= - RM 20,000

iv.

Cash Flow For Income Tax (D) Statement of Cash Flows, classifies income tax payments as operating outflows in the cash flow statement, even though some income tax payments relate to gains and losses on investing and financing activities, such as gains and losses on plant asset disposals and early debt extinguishments.

Cash Flow For Income Tax (D) = The Effective Income Tax Rate Taxable Income (C)

Effective income tax rate

= 55 % 0.55

Buy Cash Flow for Income Tax not exists in year 0 because no taxable income. It exists on year 1 to 20. Cash Flow for Income Tax (1- 20 years) = -0.55 (-RM 9,000) = +RM 4,950

Leased Cash Flow for Income Tax exists in year 0 and year 1 to 10. Cash Flow for Income Tax (0 years) = -0.55 (-RM 18,600) = +RM 10,230 Cash Flow for Income Tax (1-19 years) = -0.55 (-RM 18,600) = +RM 10,230

Status Quo Cash Flow for Income Tax exists in year 1 to 20. Cash Flow for Income Tax (0 years) = -0.55 (-RM 20,000) = +RM 11,000

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v.

After Tax Cash Flow (E) After-tax cash flow from operations is the money a company generates from its core business operations after paying all of its operating expenses and income taxes. It's the money the company has available to pay interest payments on debt, pay dividends to owners and reinvest in the company. Cash flow after taxes (CFAT) which does account for tax liability (essentially the cash flow before tax less tax liability).

After Tax Cash Flow (E) = Before Tax Cash Flow(A) + Cash Flow For Income Tax (D)

Buy after Tax Cash Flow exists in year 0 and on year 1 to 20. After Tax Cash Flow (0 years) = - RM 180,000 + 0 = - RM 180,000 After Tax Cash Flow(1- 10 years) =0 + RM 4,950 = RM 4,950

Leased after Tax Cash Flow exists in year 0 and year 1 to 20. After Tax Cash Flow (0 years) = -RM 18,600 + RM 10,230 = -RM 8,370 After Tax Cash Flow (1-19 years) = - RM 18,600 + RM 10,230 = -RM 8,370

Status Quo After Tax Cash Flow exists in year 1 to 20. After Tax Cash Flow (0 years) = -RM 20,000 + RM 11,000 = - RM 9,000

3.4

Analysis and Comparison of the Alternatives The PW (after taxes) for the three alternatives are calculated below. Tax

minimum attractive rate of return (MARR) for the company is 10%.

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Table 3.4 : The PW (after taxes) for the three alternatives

= - RM180,000 + RM 4,950(P/A, 10%, 20) * From table 15 value for (P/A, 10%, 20) = 8.5136 Buy = - RM180,000 + RM 4,950 (8.5136) = - RM 137,857.68 -RM 137,858.00 = -RM 8,370 +( - RM 8,370)(P/A, 10%,19) * From table 15 value for (P/A, 10%, 19) = 8.3649 Leased = - RM 8,370 +(- RM 8,370) (8.3649) = - RM 78,384.21 -RM 78,384.00 = - RM 9,000 (P/A, 10%, 20) * From table 10 value for (P/A, 10%, 20) = 8.5136 Status Quo = -RM 9,000 (8.5136) = -RM 76,622.40 -RM 76,622.00

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CHAPTER 4

DISCUSSION

4.1

Selection of the Preferred Alternative If we compare Buy (PW= - RM 137.858) versus Status Quo (PW= - RM

76,622), we will find out that Status Quo is better because it has a lower PW value. But if we had compared Buy and Lease (PW= - RM 78,384) without considering Status Quo, Lease would have been a better alternative but that wouldnt have been a best final decision. But then comparing both Lease (PW= - RM 78,384) against Status Quo (PW= - RM 76,622), it clearly can be seen that Status Quo is better choice because it has a lower value comparing each of them. So, Status Quo is the Final Decision (best alternative). 4.2 Advantage of the decision (Status Quo) The obvious advantage to status quo is that it does not require any action done by the company. This passive action later will pay off the company by making the least money lost. Compared to a loan arrangement to purchase the same equipment, a status quo usually: Does not impact the financial state of the company Requires no restriction on a company's financial operations The company will not be losing a huge amount of money over the period of five years.
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Protects the company from making a big mistake an garnering a huge loss if decided to buy of lease the equipment. Finally, the action of status quo will not reflect on the financial state and the

budget can be used for another project. By implementing the status quo, the company will achieve a sound mind and focus on another project that needs their attention. The action of using status quo may seem passive but also is the indication that is a certain amount of self-protection by encouraging people to make safer choices. 4.3 Disadvantage of the Decision (Status Quo) The status-quo effect is a well known phenomenon in individual decision making. Most decisions include a status-quo alternative, i.e., doing nothing or maintaining ones current or previous situation. The strong desire to keep things the same can cause people to lose out by making conservative decisions. By making the decisions to stand by the status quo, causes the company to possibly lose out the opportunity for a great project. Choosing the status quo causes the project to come to a standstill and possibly halted. Status quo at times shows the company that they should not accept some projects or opportunity making their field of works to be somewhat limited. From this it shows that the company would need to strengthen their bonds with their clients and subsequently instill the clients faith in the company abilities .

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CHAPTER 5

CONCLUSION

From the results it can be seen that between the alternative of Leased and Status Quo, Status Quo is better option for the company. it does not let the company to lose any unnecessary monetary value in the process. There is some comfort in knowing that the company would not obtain any loss of monetary value. When opting for the Status Quo, the company would be able to make a fast decision and move on to another project. For the Status Quo alternative it showed that the company is able to make a snap decision and not waste any time for other alternatives. But if the company opt to still go through with the project, then the company would have to choose between two previous alternative of Buy versus Leased as stated above. Between the two, it is substantial that the difference were very big. With the difference of RM 1 762, it clearly shows that the Leased alternative is better option. Leasing does not produce any major downfall to the company. Using the Leased option, there is a result of saving money. Whilst when comparing the two alternatives Leased and Status Quo, there were only a small amount of difference between them; RM 59 474. Ultimately, the company would save with either of those alternatives, but to choose the best it is Status Quo as it does not require the company to lose any unnecessary funding and monetary savings. Considering all of this, it is a wise decision to opt for Status Quo alternative.

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