WRD720S - 2022

TASK 01 – EE: Engineering Economics

MODEL ANSWER

1.
A project requires loan finance of N$ 5000 now and N$ 3000 in 3 years’ time.

Determine repayment of the loan with the following two options:

• Option 1:
Loan repayment: Over 5 years In five (5) equal annual instalments, if the interest rate is 5%
p.a.
• Option 2:
Capitalization of the loan present value (equal to the loan repayment calculated for
Option 1), as a single payment in 5 years’ time with interest being 7% p.a.

Structure the answer to provide the following:

1.1 cash flow diagrams for each repayment option considered

1.2 financial repayment value determination for both options

Both options must be carried out by:

(a) hand calculations, aided with interest factors, and

(b) using MS Excel spreadsheet built-in financial functions

[28]

Model answer

1.1

i = 5%

Annuity A = ?

0 3 5
Years
P = N$ 5000 F = N$ 3000

(3)
(a) By hand:

The repayment schedule requires an equivalent annual amount A.

1. Discount the future expense, F @ yr 3, to a present value, P @ yr 0:
F = N$ 3000; i = 5% pa; n = 3 years
P=?
P = F (P/F, 5%, 3) = N$ 3000 (0.86384) = N$ 2591.52 (3)

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 Then
Total present value of loan, PT @ yr 0:
PT = N$ 5000 + N$ 2591.52 = N$7591.52 (1)

2. Covert the total present loan value, PT , to an equivalent annuity, A, over a 5 yr period:
PT = N$ 7591.52; i = 5% p a; n = 5 years
A=?
A = PT (A/P, 5%, 5) = N$ 7591.52 (0.23097) = N$ 1753.41 (2)

(9)
(b) MS Excel spreadsheet financial functions
1. Discount future expense @ yr 3 to a present value @ yr 0:
1.1 Copy the example data in a table of a new Excel worksheet.

1.2. Select a cell you want the function result to be displayed in.
(for example the cell selected was C28)
1.3. Type PMT in the function selection bar & click on “ ꝭx ” function in toolbar
1.4. Next the function selection table comes up
Click GO and then OK
1.5. Next the fractions arguments table comes up
Populate this with the relevant data.

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 1.6. Select “OK” for the answer to be displayed in spreadsheet (cell C28)
(table below shows initial data capture & MS Excel spreadsheet value for the “Fv” fn)
Note:
Built-in function “i” is expressed as a fraction, ie RATE of 5% p.a. is populated as 5/100
(4)

2. Covert the total present loan value, PT , to an equivalent annuity, A, over a 5 yr period:
1.1 Copy the example data in a table of a new Excel worksheet.

Annuity required, ie PMT

Same procedure followed as before

(4)
(8)
1.2
(a) By hand

i = 7%
F=?

0 Years 5

P = N$ 7591.52

(3)
As before:
Total present value of loan, PT @ yr 0:
PT = N$7591.52 (1)
then
Repayment requires a single future amount, F @ yr 5.
PT = N$ 7591.52; i = 7% pa; n = 5 years
F=?

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 F = PT (F/P, 7%, 5) = N$ 7591.52 (1.4026) = N$ 10647.87 (2)

(6)

(b) MS Excel spreadsheet financial functions

Follow the same procedure as before, but

(4)
[28]

2.
A lump-sum deposit of $7000 is made now into an investment account that pays 5% pa. interest.

Withdrawal of the moneys deposited will be as follows:

• An equal amount end-of-year of N$ 1200 for 5 years, starting next year (end of yer 1).
• At the end of the sixth year, the account will be closed, and the remaining balance be
withdrawn.

2.1 Draw a cash flow diagram indicating the investment and withdrawals

2.2 Determine the final account balance using calculation by hand aided with interest factors.

[10]

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Model answer

2.1

Note: Withdrawal is Equal amount end-of-year of N$ 1200 for 5 years, starting next year
(= end of year 1).

(3)

2.2

Final balance FB at year 6 = N$ 7000 (F/P, 5%, 6) – [1200 (F/A, 5%, 5) (F/P, 5%, 1)]

= N$ 7000 (1.3401) – [ 1200 (5.5256) (1.0500) ]

= N$ 9380.70 – [6962.26]

= N$ 2418.44 (7)

(10)
OR

A = N$ 1200

P = N$ 7000

Final balance FB at year 6 = N$ [7000 – 1200 (P/A, 5%, 5)] (F/P, 5%, 6)
= N$ [7000 – 1200 (4.3295)] (1.3401)

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 = N$ 1804.60 (1.3401)
= N$ 2418.34

3.
An energy utility company requires that for each of power generators annual investments be placed
into a capital reserve fund to ensure funds being available for unexpected major refurbishment of
equipment.

For this purpose, N$5000 was deposited annually for a period of 15 years which made N$ 100000
available for refurbishments.

What rate of return did this practice provide to the company?

(Solve both by hand calculation and MS Excel Spreadsheet financial function application.)

[14]

Model Answer

1. Analysis by hand

(3)

From
A = F (A/F, i%, 15)
then
N$ 5000 = 100000 (A/F, i%, 15)

(A/F, i%, 15) = 5000/100000 = 0.05 (2)

Consider the interest tables where the factor (A/F, i%, 15) approximate a value of 0.05:

For i = 4% → (A/F, i%, 15) = 0.04994

i = 3% = 0.05377 (2)

Draw a diagram graphically representing the results

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By interpolation
X /(0.05377-0.05) = (1-X) /(0.05 – 0.04994)
then
X = 0.984%
Therefore
i = 3.984% (3)
(10)

2. MS Excel spreadsheet financial function use

1. Copy the example data in table of a new Excel worksheet.

2. Select a cell you want the function result to be displayed in.

(for example the cell selected was G72 – see final Excel table)

3. Type RATE in the function selection bar & click on “ ꝭx ” function in toolbar

4. Next the function selection table comes up

Click GO and then OK

5. Next the fractions arguments table comes up

Populate this with the relevant data.

Function inputs

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 6. Select “OK” for the answer to be displayed
(table below shows initial data capture & Microsoft Exel spreadsheet return value for
RATE function)
Note:
The built-in function for I is expressed as a fraction
To express this as % then the value must be multiplied by a 100 .

(2 x 2 = 4)

[14]

4.
The cost of a pump set for a sewer pump station is expected to amount to N$ 80000 and to have a
life of 5 years. Maintenance costs are estimated to be 2% of the initial cost and the latter will
increase linearly at 10% annually.

4.1 Draw a cash-flow timeline for each system option, indicating all cost components.

4.2 For a rate of return of 10% p.a., what is the:

(a) total present cost of the pump set over its life of 5 years?

(b) from the total present cost in (a), determine the EUAC over the life of the pump set.

[12]

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Model Answer

4.1

O&M = 2% x N$ 80000 = N$ 1600

N$ 80000

G = 10% x N$ 1600 = N$ 160

(3)

4.2
(a)
P = 80000 + 1600 (P/A, 10%, 5) + 160 (A/G, 10%, 5) (P/A, 10%, 5)
= 80000 + 1600 (3.7908) + 160 (1.8101) (3.7908)
= N$ 87163.16

OR

P = 80000 + [1600 + 160 (A/G, 10%, 5)] (P/A, 10%, 5)

= 75000 + [1500 + 150 (1.8101)] (3.7908)
= N$ 87163.16
(6)

(b) EUAC = N$ 87163.16 (A/P, 10%, 5) = 87163.16 (0.2638) = N$ 22993.64 (3)

[12]

5.
The supply from a treatment plant is required to meet growth in water demand for a particular
region. The existing facility has reached the end of its economic operational life and design

capacity, requiring a new larger facility to be constructed.

Three (3) different locations for constructing the new facility has been identified and related cost
and benefit data are given below.

Location 1 Location 2 Location 3

1. Initial land cost (N$ million) 19.3 28.5 35.0

2. Facility initial construction cost:
(N$ million) 460.0 446.0 446.0
3. Project benefits:
(N$ million per year) 23.0 19.0 14.0

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 Based on a 50-year project life and a rate of return of 3% p.a.:

5.1 Determine the economic feasibility of construction of the facility at any of

the three locations identified, using a EUAC benefit-cost ratio analysis. (6)

5.2 Rank the economically feasible construction locations for the new facility
from least to most beneficial, based on economics alone using an
incremental EUAC benefit-cost analysis. (4)

Do all calculations in N$ millions (in accordance with the monetary data given).

[10]

Model Answer

5.1 In N$1 million units:

Location 1: UEAC = (land cost + facility first cost)(A/P, 3%, 50)

= (19.3 + 460.0)(0.0389) = N$ 18.645 M per year (1)

Location 2: UEAC = (28.5 + 446.0)(0.0389) = N$ 18.458 M per year (1)

Location 3: UEAC = (35.0 + 446.0)(0.0389) = N$ 18.711 M per year (1)

The overall B/C ratios based on EUAC are:

B/C

Location 1 23/18.645 = 1.233 Economical

2 19/18.458 = 1.029 Economical
3 14/18.711 = 0.748 NOT economical (3 x 1)
(6)
5.2
Consider an incremental B/C analysis for determining the best location.
Rank the two economical locations from lowest to highest cost:
In N$ millions:
Cost Benefit ∆B/∆C

Location 2 18.458 (least) 19 B/C = 1.029 > 1 makes it economical

1 18.645 23 (23 – 19) / (18.645 – 18.458)
= 4/0.187 = 21.39 (2)

Then
Ranking:
Location 1 – BEST economically
2 – 2ND BEST (2) (4)

[10]

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6.
A choice must be made between two operational systems for a new sewerage pump station.

Both systems have an estimated life of 30 years.

The economic data for the two alternative systems are as follows:

System 1:
Initial installation cost = N$ 1.8 Million.
Retrofit of installation every 15 years = N$ 1.2 Million
Estimated energy costs per year = N$ 50000.
Estimated operation & maintenance cost per year = N$ 36000.
Estimated salvage value at end of life = N$ 20000.

System 2:
Initial installation cost = N$ 2.0 Million.
Refurbishment every 15 years = N$ 450000.
Estimated energy costs per year = N$ 25000.
Estimated annual O & M cost = N$ 32000.
Estimated salvage value at end of life = N$ 35000.

6.1 Draw a cash-flow timeline for each system option, indicating all cost components.
6.2 Do a comparative economic analysis of the system options assuming a rate of return of
10% p.a. and select the best system based on economics alone.
Do calculations by hand aided by interest factors using a EUACF approach . [26]

Model Answer

6.1

System 1 Salvage = N$ 20000

0 15 30
yr yr
Energy + O&M = N$ 86000

N$ 1.2 M
N$ 1.80 M

Salvage = N$ 35000
System 2 15
0 0 30

Energy + O&Myr = N$ 57000

N$ 0.45 M
N$ 2.0 M

2 x (4)

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EUACSYSTEM 1 = [1.8M + 1.2 M (P/F, 10%, 15) – 0.020 M (P/F, 10%, 30) ] (A/P, 10%, 30) + 0.086 M
= [1.8M + 1.2 M (0.23939) – 0.020 M (0.05731)] (0.10608) + 0.086 M
= N$ 0.30729580 M
= N$ 307295.80 (8)

EUACSYSTEM 2 = [2.0M + 0.45 M (P/F, 10%, 15) – 0.035 M (P/F, 10%, 30) ] (A/P, 10%, 30) + 0.057 M
= [2.0M + 0.45 M (0.23939) – 0.035 M (0.05731)] (0.10608) + 0.057 M
= N$ 0.28037474 M
= N$ 280374.74 (8)

EUAC for System 2 < System 1

Therefore System 2 is best based on economy aspects alone (2)

[26]

TOTAL MARK = 100

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