Estimating Project Costs &

Benefits
Project Financial Management

Ata ul Musawir
 Outline

1. Types of Costs

2. Estimating Project Costs

3. Estimating Models

4. Estimating Project Benefits

5. Estimating Project Cash Flows

 1. Types of Costs
• Fixed Costs • Sunk Costs

• Variable Costs • Opportunity Costs

• Mixed Costs • Recurring vs. Non-recurring

Costs
• Step-wise Costs
• Incremental Costs
• Marginal Costs
• Life-Cycle Costs
• Average Costs
 1. Types of Costs
• Fixed costs are constant or unchanging regardless of the
level of output or activity (e.g. rent of factory/premises,
management salaries, interest payments, depreciation of
machinery, etc.).

• Fixed Costs and Economies of Scale – Fixed costs per unit

decrease with an increase in production. Thus, a company
can achieve economies of scale when it produces enough
goods to spread the same amount of fixed costs over a larger
number of units produced and sold.

• For example, a Rs. 1,000,000 factory rent spread out over

100,000 product units means that each unit carries with it
Rs. 10 in fixed costs. If the factory produces 200,000 units,
the fixed cost per unit drops to Rs. 5.
1. Types of Costs
 1. Types of Costs
• Variable costs depend on the level of output or activity. They
increase as the number of units produced/sold increase (e.g.
materials, labor wages, shipping & delivery costs, etc.).

• Mixed costs (or semi-variable costs) are those that are partially
fixed and partially variable (e.g. salespersons’ salaries, vehicle
operations, electricity bill, landline bill, etc.).

• Some mixed costs are fixed over a certain range of output but become
variable if that range is exceeded (e.g. staff overtime charges, mobile phone
packages, any arrangement where a ‘flat’ rate is charged up to a certain
number of units and then charged on per unit basis on further use).

• Some mixed costs are variable over a certain range of output but become
fixed if that range is exceeded (e.g. software subscriptions, any arrangement
where per unit charges apply until a ‘cap’ is reached, after which point
additional units become free of charge).
 1. Types of Costs
• Step-wise costs/step-variable costs are those that are fixed
over a certain range of production/sales. If the range is
exceeded, then there is a spike in the costs (e.g. factory
supervisor salaries, servers at a restaurant, cost of
equipment & vehicles, etc.).

• The range where the costs are stable is known as the

relevant range.
 1. Types of Costs

c1. Mixed: fixed then c2. Mixed: variable then

variable fixed
 1. Types of Costs
• So far, we have looked at examples of costs with a linear
relationship with number of units.

• However, in reality not all costs follow this linear pattern.

• When costs of different types are aggregated or combined,

they tend to take on a non-linear/curvilinear shape.

• For example, labor costs may include a fixed portion

(basic/minimum pay, health insurance), a variable portion
(hourly wages, safety equipment), and a mixed portion
(overtime).
 1. Types of Costs

Examples of Some Possible Non-linear/Curvilinear Costs Shapes

 1. Types of Costs: Activity
• Calculating the break-even point for a training course project

• Example 2-1 in Newnan et al. (2012) Engineering Economic

Analysis, 11th ed., p. 37
 1. Types of Costs
• Marginal cost is the variable cost for one additional unit
produced/served/etc.

• Marginal cost is used to decide whether an additional unit should be

made or purchased.

• For example, if producing one additional unit is within our plant’s

capacity, then marginal cost = variable cost.

• However, if we are operating at capacity, producing one additional unit

may require us to pay overtime, hire additional staff, and/or start-up
another machinery. In this case, marginal cost > variable cost.

• Average cost is the total cost (fixed, marginal, mixed, stepwise, etc.)
divided by some number of units (may be over time, over production
units, for a specific cost category such as fuel expenses, etc.).
 1. Types of Costs
• Sunk costs are those already spent as a result of a past decision.

• Sunk costs must be ignored in cost-benefit analysis because current

decisions cannot change the past. We must only consider present and future
opportunities in making financial decisions.

• For example:
• Resources spent conducting a feasibility study is sunk. It should not be considered
when deciding whether or not to proceed.
• Costs already spent in a failing project are sunk (but future costs are not).
• Non-refundable fees paid for university admission are sunk.

• When we consider sunk costs in financial decisions, we commit the sunk

cost fallacy. This fallacy can lead to an escalation of commitment in
projects.

• Escalation of commitment is a behavior pattern in which an individual or

group facing increasingly negative outcomes from some decision, action, or
investment continues the same behavior rather than change course.
 1. Types of Costs

Sunk Cost Fallacy and the Escalation of Commitment in the Concorde project
 1. Types of Costs: Activity
• Determining the relevant selling price

• Example 2-2 in Newnan et al. (2012) Engineering Economic

Analysis, 11th ed., p. 40
 1. Types of Costs
• An opportunity cost is associated with using a resource in one
activity instead of another.

• Every time we use a business resource (equipment, money,

people, etc.) in one activity, we give up the opportunity to use the
same resources at that time in some other activity.

• Therefore, an opportunity cost is the benefit that is forgone by

engaging a business resource in a chosen activity instead of
engaging that same resource in the forgone activity.

• For example:
• Using a building for office space means foregoing potential revenue from
renting it out.
• Choosing a job opportunity at Company X means foregoing the next best
opportunity at Company Y.
• Engaging your best staff to one activity/project means losing out on their
services on another activity/project.
 1. Types of Costs
• Recurring costs refer to any expense that is known and
anticipated, and that occurs at regular intervals (e.g. annual
maintenance expenses, insurance premiums, interest payments,
rent, etc.).

• Non-recurring costs are one-of-a-kind expenses that occur at

irregular intervals and thus are sometimes difficult to plan for or
anticipate from a budgeting perspective (rework, machinery
repair, factory renovations, foreign exchange rate fluctuations,
etc.).

• When choosing between competing alternatives (including

choosing between conducting a project vs. doing nothing), the
focus is on the differences between those alternatives. This is the
concept of incremental costs.
 1. Types of Costs: Activity
• Determining the incremental costs between two alternatives

• Example 2-3 in Newnan et al. (2012) Engineering Economic

Analysis, 11th ed., p. 42
 1. Types of Costs
• Life-cycle costing refers to the concept of designing
products, goods, and services with a full and explicit
recognition of the associated costs over the various phases
of their life cycles.

• Two key concepts in life-cycle costing are:

1. Decisions made early in the life cycle tend to ‘lock in’ costs that
will be incurred later
2. The later design changes are made, the higher the costs

• Figure 2-4 illustrates how costs are committed early in the

product life cycle – nearly 70-90% of all costs are committed
during the design phases. However, at this time, typically
only 10-30% of cumulative life-cycle costs have been spent.
1. Types of Costs
1. Types of Costs
1. Types of Costs
 2. Estimating Project Costs
• Rough estimates: Order-of-magnitude estimates used for
high-level planning, for determining project feasibility, and in
a project’s initial planning and evaluation phases.

• Rough estimates tend to involve back-of-the-envelope

numbers with little detail or accuracy.

• The intent is to quantify and consider the order of

magnitude of the numbers involved.

• These estimates require minimum resources to develop, and

their accuracy is generally −30 to +60%.
 2. Estimating Project Costs
• Semi-detailed estimates: Used for budgeting purposes at a
project’s conceptual or preliminary design stages.

• These estimates are more detailed, and they require

additional time and resources.

• Greater sophistication is used in developing semi-detailed

estimates than the rough-order type, and their accuracy is
generally −15 to +20%.
 2. Estimating Project Costs
• Detailed estimates: Used during a project’s detailed design and
contract bidding phases.

• These estimates are made from detailed quantitative models,

blueprints, product specification sheets, and vendor quotes.

• Detailed estimates involve the most time and resources to

develop and thus are much more accurate than rough or semi-
detailed estimates. The accuracy of these estimates is generally −3
to +5%.

• Note: The upper limits of +60% for rough order, +20% for semi-
detailed, and +5% for detailed estimates are based on
construction data for plants and infrastructure. Final costs for
software, research and development, and new military weapons,
etc. often have much higher corresponding percentages.
2. Estimating Project Costs
 2. Estimating Project Costs
• Estimates for First-time Projects – Estimated parameters can be for
one-of-a-kind or first-run projects. The first time something is done, it
is difficult to estimate costs required to design, produce, and maintain
a product over its life cycle (e.g. the first NASA mission).

• Time and Effort Available – Our ability to develop estimates is

constrained by time and effort availability. Constraints on time and
effort can make the overall estimating task more difficult. If the
estimate does not require as much detail (such as when a rough
estimate is the goal), then time and personnel constraints may not be a
factor. When detail is necessary and critical (such as in legal contracts),
requirements must be anticipated and resource use planned.

• Estimator Expertise – The more experienced and knowledgeable the

estimator is, the less difficult the estimating process will be, the more
accurate the estimate will be, the less likely it is that a major error will
occur, and the more likely it is that the estimate will be of high quality.
 3. Estimation Models
• This section discusses several estimating models that can be
used at the rough, semi-detailed, or detailed design levels.

• For rough estimates the models are used with rough data,
likewise for detailed design estimates they are used with
detailed data.

• There are many types of estimating models but this section

will focus on two of the most common ones:
• The per-unit model (or parametric estimating)
• The segmenting model (or bottom-up estimating)
 3. Estimation Models
• The per-unit model (or parametric estimating) uses a ‘per unit’
factor, such as cost per square foot/meter, to develop the
estimate desired.

• This is a very simplistic yet useful technique, especially for

developing estimates of the rough or order-of-magnitude type.

• The per-unit model is commonly used in the construction industry.

For example, a contractor may quote the cost of a house at Rs.
2,500 per square foot.

• The per unit model does not take into account economies of scale
(the fact that higher quantities usually cost less on a per-unit
basis).

• However, in most cases, the model can be effective in getting an

approximation of expected costs.
 3. Estimation Models: Activity
• Project cost estimation using the parametric model

• Example 2-4 in Newnan et al. (2012) Engineering Economic

Analysis, 11th ed., p. 49
 3. Estimation Models
• The segmenting model (or bottom-up estimating) involves
decomposing an activity or product into its individual
components.

• The scheme they used of decomposing cost items and

numbering the material components (A.1, A.1, A.2, etc.) is
known as a work breakdown structure (WBS).

• Estimates are made at the lowest levels of the WBS, and

then the estimates are aggregated (added) back together.

• It is much easier to estimate at the lower levels because they

are more readily understood.
3. Estimation Models
3. Estimation Models
 3. Estimation Models: Activity
• Project cost estimation using the segmenting model

• Example 2-5 in Newnan et al. (2012) Engineering Economic

Analysis, 11th ed., p. 50
 3. Estimation Models
• Triangulation using different sources of data or using different
quantitative models can give us more accurate cost estimates.

• We should approach our economic estimate from different

perspectives because such varied perspectives add richness,
confidence, and quality to the estimate.

• A similar technique is to use three-point estimates of costs: an

optimistic estimate (cO), a most likely estimate (cM), and a
pessimistic estimate (cP).

• The estimated costs can then be calculated using the Beta

Distribution formula (from the traditional PERT technique):
Expected Cost (cE) = (cO + 4cM + cP) / 6
 4. Estimating Project Benefits
• Benefits include sales of products, revenues from bridge tolls and
electric power sales, cost reductions from reduced material or
labor costs, less time spent in traffic jams, reduced risk of
flooding, etc. Projects are undertaken to secure such benefits.

• The cost concepts and cost-estimating models can also be applied

to economic benefits. Fixed and variable benefits, recurring and
nonrecurring benefits, incremental benefits, and life-cycle benefits
all have meaning. Also, issues regarding the type of estimate
(rough, semi-detailed, and detailed), as well as difficulties in
estimation (one of a kind, time and effort, and estimator
expertise), all apply directly to estimating benefits.

• Benefits are more likely to be overestimated than

underestimated. The concept of triangulation is particularly
important for estimating benefits in a realistic manner.
 Estimating Project Costs & Benefits
Readings – Optimism Bias and the Planning Fallacy:

1. Lovallo, D. & Kahneman, D. (2003) Delusions of Success: How

Optimism Undermines Executives’ Decisions, Harvard Business
Review, July.

2. Flyvbjerg, B. (2008). Curbing optimism bias and strategic

misrepresentation in planning: Reference class forecasting in
practice. European Planning Studies, 16(1), 3-21.

3. Buehler, R., Griffin, D., & Ross, M. (1994). Exploring the

"planning fallacy": Why people underestimate their task
completion times. Journal of Personality and Social Psychology,
67(3), 366.
 5. Estimating Project Cash Flows
• Capital budgeting is the process of identifying, analyzing, and
selecting investment projects whose returns (cash flows) are
expected to extend beyond one year. Investment project
proposals (capital expenditure) can stem from a variety of sources.
For example:

• New products or expansion of existing products

• Replacement of equipment or buildings

• Research and development

• Exploration (especially in oil and gas industries)

• Other (for example, safety-related or pollution-control devices)

• The estimation techniques herein are discussed in the context of

internal projects but can also be applied to external projects.
 5. Estimating Project Cash Flows
• One of the most important tasks in capital budgeting is
estimating future cash flows for a project. These estimates
are then used for project valuation and selection.

• Because cash, not accounting income, is central to all

decisions of the firm, we express whatever benefits we
expect from a project in terms of cash flows rather than
income and cost flows.

• Project valuation and selection decisions rely on the

accuracy of cash flow estimates. However, trade-offs need to
be considered between improving accuracy and cost of
acquiring additional information.
 5. Estimating Project Cash Flows
Note:
• For each project investment proposal, we need to consider
information on operating cash flows only.

• Financing cash flows, such as interest payments, principal

payments, and cash dividends, are excluded from the cash-flow
analysis.

• However, the need for a project investment’s return to cover

financing/capital costs is not ignored. The use of a discount rate
(or hurdle rate) equal to the required rate of return of capital
providers will capture the financing cost dimension.

• Discount rates will be used in the project valuation topic. We will

also look at how discount rates are calculated in the financing
topic.
 5. Estimating Project Cash Flows
• Cash flow information regarding costs and benefits must be presented
on an incremental basis, so that we analyze only the difference between
the cash flows of the firm with and without the project.
• E.g. 1: If a firm is planning to develop a new product that is likely to compete
with its own existing products, it is not appropriate to express cash flows in
terms of estimated total sales of the new product. We must also take into
account the potential loss of sales of existing products (cannibalization) and
make our cash flow estimates on the basis of incremental sales.
• E.g. 2: If a firm decides to upgrade its IT system, we must only consider the
cost savings provided beyond those of the existing system.

• The above describes some factors to consider if we do undertake the

project. We also need to consider what would happen if we don’t
undertake the project.
• E.g. 1: If the firm does not develop the new product, it may lose market share
to a competitor.
• E.g. 2: If the firms decides not to upgrade the system, it may face delays in its
data processing system, which would lead to customer dissatisfaction.
 5. Estimating Project Cash Flows
• When choosing between competing alternatives (including choosing between
conducting a project vs. doing nothing), the focus is on the differences between
those alternatives, i.e. the incremental costs.

• In project cash flow estimation, only incremental costs matter and sunk costs
(those costs already spent due to past decisions) must be ignored.

• However, opportunity costs of employing fixed assets for the project should be
considered in the cash flow estimates.
• For example, if a currently unused building is needed for a project, we should include
the opportunity cost of lost rent per year (during the life of the project) in our cash
flow analysis. If it will be delivered as part of the project, the cost of the building needs
to be considered as a cash outflow at the start of the project.

• When a project investment contains a current asset component, this component

(net of any spontaneous changes in current liabilities) is treated as part of the
project investment and not as a separate working capital decision. Hence, cash
flow estimates should consider changes in working capital that may arise due to
the project.
• For example, with the acceptance of a new project it is sometimes necessary to carry
additional cash, receivables, or inventories. This investment in working capital should
be treated as a cash outflow at the time it occurs.
 5. Estimating Project Cash Flows
• Furthermore, in estimating cash flows, anticipated inflation
must be taken into account. Often there is a tendency to
assume erroneously that price levels will remain unchanged
throughout the life of a project.

• Cash flows are affected in several ways. For example, if cash

inflows ultimately arise from the sale of a product, expected
future prices affect these inflows.

• As for cash outflows, inflation affects both expected future

wages and material costs.

• Finally, cash flows should be determined on an after-tax

basis.
5. Estimating Project Cash Flows
 5. Estimating Project Cash Flows
• We will now identify the specific components that
determine a project’s relevant cash flows. In doing so, we
need to keep in mind the concerns mentioned in our ‘cash-
flow checklist’ (Table 12.1).

• It is helpful to place project cash flows into three categories

based on timing:
i. Initial cash outflow: the initial net cash investment.
ii. Interim incremental net cash flows: those net cash flows
occurring after the initial cash investment but not including the
final period’s cash flow.
iii. Terminal-year incremental net cash flow: the final period’s net
cash flow. (This period’s cash flow is singled out for special
attention because a particular set of cash flows often occurs at
project termination.)
5. Estimating Project Cash Flows
(i) Initial Cash Outflow
 5. Estimating Project Cash Flows
(ii) Interim incremental net cash flows
 5. Estimating Project Cash Flows
(iii) Terminal-year incremental net cash flow
Depreciation & Tax Guidelines in Pakistan

Source: https://taxsummaries.pwc.com/pakistan/corporate/deductions#
Also see: https://fbr.gov.pk/Categ/Income-Tax-Brochure/380
 Common Depreciation Methods

• Note: residual value and salvage value have the same meaning in this context.
 Common Depreciation Methods

• Note 1: Regular refers to straight line depreciation rate.

• Note 2: Unlike straight line depreciation, salvage value is not deducted at the start. Instead,
depreciation in the last year is adjusted (Year 5 in this example) so that the book value = the
salvage value. If there is no salvage value, companies may prefer to use straight line depreciation
instead or switch to straight line depreciation during the second half of the asset’s useful life.
 Common Depreciation Methods

• Note: Unlike the double declining method, the depreciation rate does not need to be based on
the straight line rate. However, like the double declining method, depreciation in the last year is
adjusted (Year 5 in this example) so that the book value = the salvage value. If there is no salvage
value, companies may prefer to use straight line depreciation instead or switch to straight line
depreciation during the second half of the asset’s useful life.
 Exercises
1. Develop the depreciation schedules for an asset with an initial cost of Rs.
900,000, a useful life of 8 years, and a salvage value of Rs. 84,000:
i. Using the straight line depreciation method
ii. Using the double-declining depreciation method
iii. Using the diminishing balance depreciation method assuming a
depreciation rate of 18%

2. Using the double-declining depreciation method, develop the

depreciation schedule for an asset with an initial cost of Rs. 14,00,000, a
useful life of 10 years, and a salvage value of Rs. 850,000.

3. Using the diminishing balance depreciation method, develop the

depreciation schedule for an asset with an initial cost of Rs. 620,000, a
useful life of 4 years, and a salvage value of Rs. 45,000. The relevant
depreciation rate is 35%.
Depreciation Method used in Examples & Exercises

• MACRS: Modified Accelerated Cost Recovery System

• Half-year convention: Half-year depreciation of asset in the year that
the asset is acquired and in the final year of depreciation.
 5. Estimating Project Cash Flows
E.g. Asset Expansion
• The Faversham Fish Farm is considering the introduction of a
new fish processing facility.

• To launch the facility, it will need to spend $90,000 for

special equipment. The equipment has a useful life of four
years.

• Shipping and installation expenditures equal $10,000, and

the machinery has an expected final salvage value, four
years from now, of $16,500.

• The machinery is to be housed in an abandoned warehouse

next to the main processing plant. The old warehouse has no
alternative economic use. No additional net working capital
is needed.
 5. Estimating Project Cash Flows
E.g. Asset Expansion
• You are also told that the capitalized cost of the asset is to be
depreciated according to the following schedule (MACRS 3-
year asset class):
• Year 1: 33.33%
• Year 2: 44.45%
• Year 3: 14.81%
• Year 4: 7.41%
• Total: 100.00%

• Furthermore, assume that the tax rate is 40%.

 5. Estimating Project Cash Flows
E.g. Asset Expansion
• The marketing department envisions that use of the new
facility will generate additional net operating revenue cash
flows, before consideration of depreciation and taxes, as
follows:

• We now need to estimate the project’s relevant incremental

cash flows.
 5. Estimating Project Cash Flows
E.g. Asset Expansion

• The expenditures incurred to bring an asset into use need to be

‘capitalized’, i.e. they are considered as part of the asset’s cost.
 5. Estimating Project Cash Flows
E.g. Asset Expansion
• The next steps involve calculating the incremental future cash
flows for the remaining years of the project.

• We will start by calculating the depreciation charges per year.

• Note that the capitalized cost of the asset is $90,000 + $10,000 =

$100,000. This is the figure to be used during depreciation
calculations.

• Hence the depreciation charges per year can be calculated as

follows:
• Year 1: 33.33% * 100,000 = $33,330
• Year 2: 44.45% * 100,000 = $44,450
• Year 3: 14.81% * 100,000 = $14,810
• Year 4: 7.41% * 100,000 = $7,410
• Total: 100.00%
5. Estimating Project Cash Flows
E.g. Asset Expansion
 5. Estimating Project Cash Flows
E.g. Asset Expansion
• Cash flow calculations (Year 1 example):

• Step 1 – Tax is charged on income after deducting depreciation charges:

• Year 1 income after deducting depreciation: 35,167 – 33,330 = $1,837
• Tax charges on the income (if applicable): $1,837 * 0.40 = $735

• Step 2 – We then deduct the tax charges from the income:

• Income after deducting tax: 1,837 – 735 = $1,102

• Step 3 – Since depreciation is a non-cash expense, it is added back to the

calculation to get the incremental net cash flow for the year:
• Incremental net cash flow = 1,102 + 33,330 = $34,432
 5. Estimating Project Cash Flows
E.g. Asset Expansion
• Tax on disposal calculations (in terminal year, i.e. Year 4):

• Note: An asset’s book value is equal to its cost minus its accumulated
depreciation.

• If the salvage value > book value of the asset at the time of sale or
disposal, then realize a capital gain on sale or disposal of asset.
• Since the capital gain is a source of income, we have to pay tax on the
amount gained.

• If the salvage value < book value of the asset at the time of sale or
disposal, then we realize a capital loss on sale or disposal of asset.
• In this case, we can deduct the loss from our net income, which will reduce
the income tax to be paid (if any).

• In this case, our asset will be fully depreciated and hence will have a
book value of 0 in Year 4. Therefore, the entire salvage value is a capital
gain. Hence, we need to pay tax charges on the disposal in Year 4 as
follows:
• Tax charges on disposal = 16,500 * 0.40 = $6,600
 5. Estimating Project Cash Flows
E.g. Asset Expansion

• Thus, for an initial cash outflow of $100,000, the firm expects to

generate net cash flows of $34,432, $39,530, $39,359, and $32,219 over
the next four years.

• These data represent the relevant cash flow information that we need to
judge the attractiveness of the project (to be continued…).
 5. Estimating Project Cash Flows
E.g. Asset Replacement

• Suppose that we are considering the purchase of a new

machine to replace an machine and that we need to obtain
cash flow information to evaluate the attractiveness of this
project.

• The purchase price of the new machine is $18,500, and it

will require an additional $1,500 to install, bringing the total
cost to $20,000.

• The old machine, which has a remaining useful life of two

years, can be sold for its depreciated book value of $2,000.
The old machine would have no salvage value if held to the
end of its useful life.
 5. Estimating Project Cash Flows
E.g. Asset Replacement
• The initial cash outflow for the investment project,
therefore, is $18,000 as follows:
 5. Estimating Project Cash Flows
E.g. Asset Replacement
• Remember, we are concerned with the differences in the
cash flows resulting from continuing to use the old machine
versus replacing it with a new one.

• Compared to the old machine, the new machine should cut

labor and maintenance costs and produce other cash savings
totaling $7,100 a year before taxes for each of the next four
years, after which it will probably not provide any savings
nor have a salvage value.

• These savings represent the net operating revenue savings

to the firm if it replaces the old machine with the new one.
 5. Estimating Project Cash Flows
E.g. Asset Replacement
• Calculating the depreciation costs. Assume that:
• The old machine had a capitalized cost of $9,000
• The old machine had a remaining useful life of 2 years
• Depreciation percentages for both machines are calculated using MACRS
 5. Estimating Project Cash Flows
E.g. Asset Replacement
• We can now calculate the future incremental cash flows as follows:
 5. Estimating Project Cash Flows
E.g. Asset Replacement
• Therefore, the expected incremental net cash flows from the project are:

• Thus, for an initial cash outflow of $18,000, we are able to replace the
old machine with a new one that is expected to result in net cash flows
of $6,393, $7,549, $5,445, and $4,853 over the next four years.

• These data represent the relevant cash flow information that we need to
judge the attractiveness of the project (to be continued…).
 Exercise
• In project cash flow estimation, should the following be ignored,
or added to, or subtracted from the new machine’s purchase
price when estimating initial cash outflow?

a. The market value of the old machine is $500, the old machine has a
remaining useful life, and the investment is a replacement decision.

b. The old machine provided a benefit of $1,500 per year.

c. An additional investment in inventory of $2,000 is required.

d. $200 is required to ship the new machine to the plant site.

e. The new machine has a salvage value of $25,000 at the end of its
useful life.

f. Training of the machine operator will cost $300.

Exercise
 Exercise
a. Relevant cash flows – first three columns
b. Differential cash flows – fourth column

Year Rock Bull Diff. (Rock - Bull)

0 -74,000 -59,000 -15,000
1 -2,000 -3,000 1,000
2 -2,000 -4,500 2,500
3 -2,000 -6,000 4,000
4 -2,000 -7,500 5,500
5 -13,000 -24,000 11,000
6 -4,000 -10,500 6,500
7 -4,000 -12,000 8,000
8 5,000 -8,500 13,500
Exercise
Exercise
Exercise
Exercise