Fourth Year Mechanical Power

MEP 416 - Energy Conservation

Lecture (1} - Concise

Review of:
• Units of Energy
• Energy Efficiency and Energy Conservation
• Financial Analysis of Engineering Project

Prof. Dr. Abdelhafez Hassanein

Professor of Heat Engines and Combustion
Mechanical Power Department
Faculty of Engineering
Cairo University
 Fourth Year Mechanical Power
MEP 41 6 - Energy Conservation
Prof. Dr. Abdelhafez Hassanein
Lecture (1) - Concise

Units of Energy:
• Kilowatt-hour (kWh) 1 kWh = 3.6 x 103 kJ
• British thermal units (Btu) 1 Btu = 1.055 kJ
• Therme 1 therme = 100,000 Btu = 1.055 x 105 kJ
• Calorie 1 kcal = 4.2 kJ
• Barrel 1 barrel = 6 x 106 kJ
• Ton of oil equivalent (toe) 1 toe= 7.5 barrel= 4.5 x 107 kJ

Barrel of Oil Equivalent (BOE)

The barrel of oil equivalent (BOE) is a unit of energy based on the
approximate energy released by burning one barrel (42 U.S. gallons or
159 liters) of crude oil. One barrel of oil equivalent (BOE) approximately
equals to 5.8 x 106 BTU. The value is necessarily approximate as various
grades of oil have slightly different heating values.

BOE~ 5.8 x 106 BTU ~ 6 GJ (based on HHV of crude oil)

Energy Efficiency and Energy Conservation:

• Energy Efficiency
Energy efficiency is the reduction in energy consumption in a facility by
improving the energy utilization technology. Or: "using less energy to
provide the same service".

• Energy Conservation
Energy conservation is the reduction in energy consumption of
engineering systems through reducing the number of energy
consuming centers or facilities.

A facility here may be stationary (e.g., an industrial plant or a house),

or mobile (e.g., bus, or train).

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1)

Examples on Energy Efficiency:

• When you replace an appliance, such as a refrigerator or washing

machine, with a more energy-efficient model, the new equipment
provides the same service, but uses less energy

• Replacing an incandescent lamp with a compact fluorescent lamp

(which uses much less energy to produce the same amount of
light) is energy efficiency

Energy efficiency saves money on energy bill, and reduces the

amount of greenhouse gases going into the atmosphere.

• Delamping or turning off part of light is energy conservation

• A block of diesel-generator sets are used to supply the electric

energy for an industrial plant, the energy conservation would
require either reduction of the number of operating hours of the
diesel engines~ or reduction of the number of load centers in the
plant

On the other hand, improving the efficiency of the engines, and/or the
generators are considered energy efficiency measures

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1) 2

Review of Financial Analysis of Engineering Projects

Simple Payback Period (SPP):

Simple payback period is the time in which the initial cash outflow of
an investment is expected to be recovered from the cash inflows
generated by the investment. It is one of the simplest investment
appraisal techniques.

Formula
The formula to calculate the simple payback period of a project
depends on whether the cash flow per period from the project is even
or uneven. In case they are even, the formula to calculate the simple
payback period is:

S.imp 1e Pay b ac k Peno

. d =--Initial
- -Investment
-----
Cash Inflow per Period

Example: Even Cash Flows

A company is planning to undertake a project requmng initial

investment of $105 million. The project is expected to generate $25
million per year for 7 years. Calculate the payback period of the
project.

Solution

S.imp 1e Pay b ac k Peno

. d Initial Investment
= ---------
Cash Inflow per Period

. . $105 000 000

Simple Payback Period = $ 25 ,~00,~00 = 4.2 years

When cash inflows are uneven, we need to calculate the cumulative

net cash flow for each period and then use the following formula for
payback period:

Energy Conservation-Prof. Dr. Abdelhafez Hassanein Lecture (1) 3

Simple Payback Period =A + ~

In the above formula,

A is the last period with a negative cumulative cash flow;

B is the absolute value of cumulative cash flow at the end of the

period A;

C is the total cash flow during the period after A

Example: Uneven Cash Flows

Company is planning to undertake another project requiring initial

investment of $50 million and is expected to generate $10 million in
Year 1, $13 million in Year 2, $16 million in year 3, $19 million in Year 4
and $22 million in Year 5. Calculate the simple payback value of the
project.

Solution

Cumulative
Year Cash Flow
Cash Flow
0 - $50,000,000 -$50,000,000
1 $10,000,000 -$40,000,000
2 $13,000,000 - $27,000,000
$16,000,000
$8,000,000
5 $30,000,000

.
Simple Payback Penod
. =3 +
1- $$11,000,000 I ~ 3.58 years
- 19,000,000

Energy Conservation-Prof. Dr. Abdelhafez Hassanein Lecture (1) 4

Example: Uneven Cash Flows

The initial investment in a pollution prevention project is $10,000. The

projected savings is $4,000 for the first year, $4,000 for the second year,
$2,500 for the third year, $2,000 in the fourth year, and $2,000 for the
fifth year. Estimate the simple payback period.

Solution

Cumulative
Year Cash Flow
Cash Flow
0 -$10,000 -$10,000
1 $4,000 -$6,000
$4,000
$500
4 $2,500
5 $2,000 $4,500

. . . l-$2,0001
Simple Payback Period =2 + $ = 2.8 years
- 2,500

Advantages of SPP

1. It is easy to use and anybody who is having limited financial

knowledge can apply it.

2. It is also beneficial for those investors who want to know the time
frame in which they would recover their original investment and do
not want to take risk and want quick return on their investments.

Disadvantages of SPP

1. It ignores the time value of money and therefore may not present
true picture when it comes to evaluating cash flows of a project.

2. It does not reflect changing in energy or raw material prices and

usually ignores the effect of taxation.

3. It also ignores cash flows beyond the payback period

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture {l} 5

Discounted Payback Period {DPP}:

One of the major disadvantages of simple payback period is that it

ignores the time value of money. To counter this limitation, an
alternative procedure called discounted payback period may be
followed, which accounts for time value of money by discounting the
cash inflows of a project.

In discounted payback period we have to calculate the present value

of each cash inflow taking the start of the first period as zero point. For
this purpose the management has to set a suitable discount rate. The
discounted cash inflow for each period is calculated using the formula:

D.1scount e d C as h.1n fl ow= Actual(Cash

.)n Inflow
1+1

Where, i is the discount rate and n is the period to which the cash
inflow relates.

Usually the above formula is split into two components which are
actual cash inflow and present value factor {i.e. 1/{l + i)An). Thus
discounted cash flow is the product of actual cash flow and present
value factor.

The rest of the procedure is similar to the calculation of simple

payback period except that we have to use the discounted cash
flows as calculated above instead of actual cash flows. The
cumulative cash flow is replaced by cumulative discounted cash flow.

Discounted Payback Period = A + !

c
Where,

A = Last period with a negative discounted cumulative cash flow;

B= Absolute value of discounted cumulative cash flow at the end of
the period A;
C= Discounted cash flow during the period after A

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1) 6

Example

A project with an initial cost of-$100,000 is expected to collect cash

inflow for the first four years is shown in the table. Calculate the
discounted payback period at an interest rate of r = 103.

Year 1 2 3 4
Cash Inflow $20,000 $40,000 $70,000 $30,000

The cash flow 1s first discounted by the interest rate and then
cumulated:

Cash Factor for PY Present Value Cumulative

Year
inflow of Cash Flow of Cash flow discounted Cash Flow
1 $20,000 0.9091 $18, 182 $18, 182
2 $40,000 0.8264 $33,058 $51,240
3 $70,000 0.7513 $52,592 $103,832
4 $30,000 0.6830 $20,490 $124,322

~ $140,000
0
u:
.s:::. $120,000
V')

0
u
"'O
$100,000 --- -- -- - --- -- --
-CD
c
::J
0
$80,000
u $60,000
.~
"'O
CD
> $40,000
:.;::::
0
::J $20,000
E
::J
u $0
2 Year 3 4

The payback can be obtained by interpolation from the results. It is the

time where the cumulative cash-flow is equal to the initial investment
(i.e., $100,000). It is slightly below 3 years and is equal to 2.926 years.

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1) 7

Example

An initial investment of $2,324,000 is expected to generate $600,000

per year for 6 years. Calculate the discounted payback period of the
investment if the discount rate is 113.

Solution

Step 1:
Prepare a table to calculate discounted cash flow of each period by
multiplying the actual cash flows by present value factor. Create a
cumulative discounted cash flow column.

Present Value Discounted Cumulative

Year Cash Flow
Factor Cash Flow Discounted
n CF
PV$1 =1 /(1 +i)n CFxPV$1 Cash Flow
0 -$2,324,000 1.0000 -$2,324,000 -$2,324,000
1 $600,000 0.9009 $540,541 - $1,783,459
2 $600,000 0.8116 $486,973 - $1,296,486
3 $600,000 0.7312 $438,715 -$ 857,771
4 $600,000 0.6587 $395,239 -$ 462,533
$600,000 0.5935
$600,000 0.5346
Step 2:
. l-10~4621
Discounted Payback Penod =5 + ~ 5.32 years
-320,785

Energy Conservation- Prof. Dr. Abdelhafez Hassanein Lecture (1) 8

Example

The boiler in a facility will be equipped with an economizer to improve

its efficiency. The investment is EGP5000. The results are estimated to
gain net cash inflows in the first five years as given in the table.

Year 1 2 3 4 5
Cash Inflow 2000 2000 2000 1000 1000

At an interest rate of 103, estimate the discounted payback period.

Solution

Present Value Discounted Cumulative

Year Cash Flow
Factor Cash Flow Discounted
n CF
PV$1 =1 /(1 +i)n CFxPV$1 Cash Flow
0 -5,000 1.0000 -5000.00 -5000.00
1 2,000 0.9091 1818.18 -3181.82
2 2,000 0.8264 1652.89 -1528.93
2,000 0.7513
4 1,000 0.6830
5 1,000 0.6209 1277.64

Discounted Payback Period = 3 + I- 26 ·30 I ~ 3.04 years

683.01

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (l) 9

Example
The production manager in a company
suggested to the Board of Directors to add a Year Cash Inflow
new production line on the base of $1,000,000 1 $300,000
investment. The expected·· increase in cash 2 $300,000
inflows through the next five years are given in 3 $400,000
the table. What will be the simple payback
4 $300,000
period? Is it correct or expressive? For an
interest rate of 93, what will be the discounted 5 $300,000
payback periods?

Solution:
Consider first the simple payback:
Year Cash Inflow Cumulative Cash Inflow
1 $300,000 300,000
2 $300,000 $600,000
3 $400,000
4 300,000 1,300,000
5 $300,000 $1,600,000

The invested money will be paid back after 3 years. The answer is not
true or expressive as the financial value of money will be reduced by
time.
Consider the discounted payback:
Cumulative
Present Discounted
Year Cash Inflow Discounted
Value Factor Cash Inflow
Cash Inflow
0 -1,000,000 1.0000 -1,000,000 -$ l ,000,000
1 300,000 0.9174 275,229 -$724,771
2 300,000 0.8417 252,504 -$472,267
3 400,000 0.7T?2 308,873 -$163,393
4 300,000 0.70f 4 212,528 $49, 134
5 300,000 0.64S i9 194,979 $244, 114

OPP = 3 + 1- 1633931~ 3.77 years

212528
This answer is more expressive.

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1) 10

Example

This year the owner of a Hospital allocated a total of $18 million to add
an emergency modern and sophisticated department. The results are
estimated to positively impact net cash inflow starting 6 years from
now and for the expected future at an average level of $6 million per
year. At an interest rate of 103, estimate the discounted payback
periods.

Solution:

Factor for PY
Present Value Cumulative
Year Cash inflow of Cash Flow
of Cash flow discounted Cash
(n) CF PV$1 =
CF* PV$1 Flow
l/(l+i)n
0 -$18,000,000 1.0000 -$18,000,000 -$18,000,000
1 $0 0.9091 $0 -$18,000,000
2 $0 0.8264 $0 -$18,000,000
3 $0 0.7513 $0 -$18,000,000
4 $0 0.6830 $0 -$18,000,000
5 $0 0.6209 $0 -$18,000,000
6 $6,000,000 0.5645 $3,386,844 -$14,613, 156
7 $6,000,000 0.5132 $3,078,949 -$11,534,208
8 $6,000,000 0.4665 . $2, 799 ,044 -$8,735, 163
9 $6,000,000 0.4241 $2,544,586 -$6, 190,578
10 $6,000,000 0.3855 $2,313,260 -$3,877,318
$6,000,000 0.3505 $2, 102,963
12 $6,000,000 0.3186 $137,430
13 $6,000,000 0.2897 $1,875,417

OPP= 11 + l 774355 1= 11.928 ~ 12

I-1911785 years

Energy Conservation- Prof. Dr. Abdelhafez Hassanein Lecture (1) 11

Net Present Value (NPV):

• The net present value (NPV) method quantify the impact of time on
any porticular future cash flow. This is done by equating each
future cash flow to its current value today, in other words
determining the present value of any future cash flow

• This is done by an assumed interest rate, usually referred to as a

discount rate

• Discounting is the opposite process of compounding

• Compounding determines the future value of present cash flow,

whereas discounting determines the present value of future cash
flow

• The NPV rule is to accept a project if its NPV is positive (+) and
decline a project if its NPV is negative

• If two projects are mutually exclusive (both projects have +ve NPV),
pick the one with the higher positive NPV

• NPV is calculated by calculating the PY of the future cash flows

and then subtracting the cost

Future NCF
N PV = - Initial investment +
(1 + r)t

Where NPV is the net present value, NCF is the net cash flow, ( r) is
the interest rate, and ( t) is the time.

Energy Conservation- Prof. Dr. Abdelhafez Hassanein Lecture (1) 12

Example:
Two proposed projects each has capital cost of U$30,000.00. The net annual
savings of each project ore shown in the table below. Using the net present value
technique, evaluate the financial merits of each project assuming an annual
discount rate of 83 for each.

Project (1) Project {2)

Year
Net annual savings {U$) Net annual savings {U$)
1 6,000.00 6,600.00
2 6,000.00 6,600.00
3 6,000.00 6,300.00
4 6,000.00 6,300.00
5 6,000.00 6,000.00
6 6,000.00 6,000.00
7 6,000.00 5,700.00
8 6,000.00 5,700.00
9 6,000.00 5,400.00
10 6,000.00 5,400.00

Solution:
To determine the annual present values, the annual cash flows should be
multiplied by the annual discount factors for a rate of 83 as shown in the table
below.

Discount Project (1) Project (2}

Year factor for 83 Savings (U$) Present value Savings (U$) Present value
(a) (b} (ax b} (c) (ax c}
0 1.000 -30,000.00 -30,000.00 -30,000.00 -30,000.00
1 0.926 6,000.00 5,555.56 6,600.00 6, 111.11
2 0.857 6,000.00 5,144.03 6,600.00 5,658.44
3 0.794 6,000.00 4,762.99 6,300.00 5,001.14
4 0.735 6,000.00 4,410.18 6,300.00 4,630.69
5 0.681 6,000.00 4,083.50 6,000.00 4,083.50
6 0.630 6,000.00 3,781.02 6,000.00 3,781.02
7 0.583 6,000.00 3,500.94 5,700.00 3,325.90
8 0.540 6,000.00 3,241.61 5,700.00 3,079.53
9 0.500 6,000.00 3,001.49 5,400.00 2,701.34
10 0.463 6,000.00 2,779.16 5,400.00 2,501.24
10,260.49 10,873.91

Project (2) should be the choice.

Energy Conservation- Prof. Dr. Abdelhafez Hassanein Lecture (l} 13

Example

Consider two proposed projects A and B. Their capital cost and

projected cash flows are shown in the table below. Using the net
present value technique, evaluate the financial merits of each project
for a cost of capital of 103 for each.

·Project (A) Project (B)

Year
After-tax cash flows (U$) After-tax cash flows (U$)
0 (today) ($10,000) {$10,000)
1 5000 1000
2 4000 3000
3 3000 4000
4 1000 6000

Solution:

Project !Al r=103

0 1 2 3 4
I I I I I
-10000 5000 4000 3000 1000
-10000 .oo 111 I (1 + r) 0 I

4545.45 • /(l + r)
1
I
/(1 + r) 2
3305.79 +---'-----"-----------'
/(1 + r) 3
2253.94 - - ' - - - - - - - - - - - - - - - - - - - '
/(1 + r) 4
683.01 + - - - = - - - - - - - - - - - - - - - - - - - - - - - '

NPV=788.19

Energy Conservation - Prof. Dr. Abdelhafez Hassanein Lecture (1) 14

Project (B) r=103

0 1 2 3 4
I I I I I
0 -10000 1000 3000 4000 6000
-10000.00 ... /(l + r) I

909.09 "' /(l + r)

1
I
/(1 + r) 2
2479 .34 4--.!-~---------'

/( 1 + r) 3
3005.26 +---'-~-------------'
4
4098.08 4--/..:.....(l_+_r..:.....)_ _ _ _ _ _ _ _ _ _ _ ______.

NPV=491.77

NPV for project (A) = $788.19 > 0

NPV for project (B) = $491.77 > 0

Both projects are accepted but project (A) should be the choice.

Energy Conservation- Prof. Dr. Abdelhafez Hassanein Lecture (1) 15