Example 1.

A proposed manufacturing plant requires an initial fixed-capital

investment of Rs. 900,000 and Rs. 100,000 of working capital.
It is estimated that the annual income will be Rs. 800,000 and the
annual expenses including depreciation will be Rs. 520,000 before
income taxes.
A minimum annual return of 15 percent before income taxes is
required before the investment will be worthwhile.
Income taxes amount to 34 percent of all pre-tax profits.
Determine the following:
(a) The annual percent return on the total initial investment before
income taxes.
(b) The annual percent return on the total initial investment after
income taxes.
(c) The annual percent return on the total initial investment before
income taxes
based on capital recovery with minimum profit.
(d) The annual percent return on the average investment before income
taxes
assuming straight-line depreciation and zero salvage value.

Solution:
(a) Annual profit before income taxes =
Rs. 800,000 – Rs. 520,000 = Rs. 280,000.
Annual percent return on the total initial investment before income taxes =
[280,000/(900,000 + lOO,OOO)] X (lOO) = 28 percent.

(b) Annual profit after income taxes = [ 280,000 X 0.66] = Rs.184,800.

Annual percent return on the total initial investment after income taxes =
[184,800/(900,000 + lOO,OOO)] X lOO) = 18.5 percent.

(c) Minimum profit required per year before income taxes =

[900,000 +l00,000 X 0.15] = Rs.150,000.
Fictitious expenses based on capital recovery with minimum profit =
Rs.520,000 + Rs.150,000 = Rs. 670,OOO/year.
Annual percent return on the total investment based on capital recovery with
minimum annual rate of return of 15 percent before income taxes =
[800,000 - 670,000] / [900,000 +lOO,OOO] X lOO = 13 percent.

(d) Average investment assuming straight-line depreciation and zero salvage

value
= Rs. 900,000/2 + Rs.100,000 = Rs.550,000.
Annual percent return on average investment before income taxes =
[280,000/550,000X100] = 51 percent.

Example 2.

A piece of equipment has an initial installed value of $12,000. It is

estimated that its useful life period will be 10 years and its scrap value
at the end of the useful life will be $2000.
The depreciation will be charged as a cost by making equal charges
each year, the first payment being made at the end of the first year. The
depreciation fund will be accumulated at an annual interest rate of 6
percent. At the end of the life period, enough money must have been
accumulated to account for the decrease in equipment value. Determine
the yearly cost due to depreciation under these conditions.

This problem is a typical case of an ordinary annuity. Over a period of 10

years, equal payments must be made each year at an interest rate of 6 percent.
After 10 years, the amount of the annuity must be equal to the total amount of
depreciation.
Amount of annuity = S
Total amount of depreciation = $12,000 - $2000 = $10,000 = S
Equal payments per year = R = yearly cost due to depreciation
Number of payments = n = 10
Annual interest rate = i = 0.06.

• S = {R[(1 + i)n – 1] / i }
• R = {S . i / [(1 + i)n – 1] }

R = $759/year
Yearly cost due to depreciation = $759
 COST ESTIMATION EXAMPLE

Problem 1.
The purchased cost of shell and tube exchanger with 10m2 of heating surface
was Rs.100,000 in 1980. What will be the purchased cost of a similar heat
exchange with 20m2of heating area in 1980. The purchase cost capacity exponent
is 0.6 for surface area ranging from 10m2 to 40m2

Solution:

cost of heat exchanger A= cost of H.E B(capacity of A/capacity of B)^0.6

=100,000(20/10)^0.6
=151,571.
cost of heat exchanger = 151,571.

Problem 2.
The purchased cost of 1400 gallon stainless steel tank in 1970 was Rs.20,000.
What will be the cost of 2500 gallon tank in 1970.

Solution:

cost of tank A = cost of tank B(2500/1400)^0.6

=20,000(25/14)^0.6
=28,321.560