ECONOMIC ASPECTS AND ANALYSIS

Energy Economic Analysis –

Economic concepts
Computation of economic aspects
calculation of simple payback method
 The time value of money concept.
 Cash flow models,
 payback analysis,
 depreciation,
 taxes and tax credit
 Numerical problems.
Objectives
• To understand the time value of money concept
• To study the different cash flow models
• To develop a cash flow model for uniform series
compound amount factor & single compound
amount factor
• To learn about payback analysis
• To understand about depreciation
• To explain the meaning of life cycle cost analysis
• To learn about tax & credits

2
Common Terminology In Energy Economics
1. Fixed capital
• Cost spent for purchase land, plant & equipment
• Capital cost of generating equipment
• Capital cost of transmission system
• Capital cost of distribution system
2.Running capital
• Capital for purchase of raw material
• Payment of salary
• Wages
• Fuel cost
• Maintaing and repairing cost
• Cost of water
• Cost of lubricating oil
Common Terminology In Energy Economics
3. Taxes
• Property of taxes levied on generating station building and substation
building.
• Tax should be paid to municipal corporation for the use of street
road
• Income tax from employees
4. Insurance charges
• To cover the risk of fire to the building
• To cover accidental breakdown
• Workers compensation
5.Depreciation & sinking fund
• After a certain time the equipment is to be replaced because of
physical & functional reasons
• Eg. Plant has worn out & become unfit for further use (physical
reason) , capacity of the plant become inadequate due to load
growth (functional reason)
Interest
• Interest is the earning power of money.
• It represents the growth of capital per unit period.
• The period may be a month, a qurter, semi annual or a year.
• Interest is the income produced by money that is lent or loaned.
• Simple interest & Compound interest are the type of interest.

• Simple interest
F= Total sum realized after n years
n= no. of periods
i= Interest, i= PnR
F=P(1+ni)
• Compound interest
Fn= P*(1+i)^n
Capital budgeting Techniques:
The capital budgeting appraisal methods are techniques of
evaluation of investment proposal will help the company to
decide upon the desirability of an investment proposal depending
upon their;
 Relative income generating capacity and
 Rank them in order of their desirability.
These methods provide the company a set of norms on the basis
of which either it has to accept or reject the investment proposal.
The most widely accepted techniques used in estimating the cost-
returns of investment projects can be grouped under two
categories.
,

1. Traditional methods
2. Discounted Cash flow methods
Capital budgeting Techniques:
1. Traditional methods
• Pay-back period method: - even cash flow
• Average rate of return method (ARR):-uneven cash flow
2. Discounted Cash flow methods
 The traditional method does not take into consideration the time
value of money.
 They give equal weight age to the present and future flow of
incomes. The DCF methods are based on the concept that a rupee
earned today is more worth than a rupee earned tomorrow.
These methods take into consideration the profitability and also
time value of money.
Time value of money (TVM) is a financial principle that asserts that
money available in the present is worth more than the same amount
of money in the future because of its potential earning capacity so
long as the money earned in the present is able to earn interest.
Usually a percentage of the principal amount borrowed for interest can
be either simple or compound.
Traditional methods
 These methods are based on the principles to
determine the desirability of an investment
project on the basis of its useful life and
expected returns.
 These methods depend upon the accounting
information available from the books of
accounts of the company.
 These will not take into account the concept of
‘time value of money’, which is a significant
factor to determine the desirability of a
project in terms of present value.
Pay-back period method: - Even cash flow
It is the most popular and widely recognized traditional method of
evaluating the investment proposals.
It can be defined, as ‘the number of years required to recover the
original cash out lay invested in a project’.
The pay back period is also called payout or payoff period.
This period is calculated by dividing the cost of the project by the
annual earnings after tax but before depreciation.
Under this method the projects are ranked on the basis of the
length of the payback period.
A project with the shortest payback period will be given the
highest rank and taken as the best investment.
The shorter the payback period, the less risky the investment is
the formula for payback period is

The payback period is expressed in years and fractions of years.

Merits:
1. It is one of the earliest methods of evaluating the investment
projects.
2. It is simple to understand and to compute.
3. It dose not involve any cost for computation of the payback period.
4. It is one of the widely used methods in small scale industry sector.
5. It can be computed on the basis of accounting information available
from the books.
Demerits:
1.This method fails to take into account the cash flows received by the
company after the pay back period.
2.It doesn’t take into account the interest factor involved in an
investment outlay.
3.It is not consistent with the objective of maximizing the market
value of the company’s share.
4. It fails to consider the pattern of cash inflows
i. e., the magnitude and timing of cash in flows.
Example 1:
The Delta company is planning to purchase a machine known as
machine X. Machine X would cost $25,000 and would have a useful life
of 10 years with zero salvage value. The expected annual cash inflow of
the machine is $10,000.

According to payback period analysis, the purchase of

machine X is desirable because its payback period is 2.5
years which is shorter than the maximum payback period
of the company.
Example 2:
The management of Rani Beverage Company is considering to purchase
a new equipment to increase the production and revenues, due to
increased demand . The useful life of the equipment is 10 years and the
company’s maximum desired payback period is 4 years. The inflow
and outflow of cash associated with the new equipment is given below:
Initial cost of equipment: $37,500
Annual cash inflows: Sales: $75,000
Annual cash Outflows: Cost of ingredients: $45,000
Salaries expenses: $13,500
Maintenance expenses: $1,500
Non cash expenses: Depreciation expense: $5,000
Computation of net annual cash inflow: =
$75,000–($45,000+$13,500+$1,500) = $15,000
Payback period of the equipment. = $37,500/$15,000 =2.5 years
Depreciation is a non-cash expense and has therefore been ignored
while calculating the payback period of the project. 2.5 years which is
shorter than the maximum desired payback period of 4 years.
Example 3:
The management of Health Supplement Inc. wants to reduce its labor
cost by installing a new machine. Two types of machines are available in
the market – machine X and machine Y. Machine X would cost $18,000
where as machine Y would cost $15,000. Both the machines can reduce
annual labor cost by $3,000.
Which is the best machine to purchase according to payback method?

Payback period of machine X: $18,000/$3,000 = 6 years

Payback period of machine y: $15,000/$3,000 = 5 years

According to payback method, machine Y is more desirable than

machine X because it has a shorter payback period than machine X.
Accounting (or) Average Rate of Return Method (ARR):
 In the above examples we have assumed that the projects generate
even cash inflow but many projects usually generate uneven cash
flow.
 When projects generate inconsistent or uneven cash inflow
(different cash inflow in different periods), the simple formula
given above cannot be used to compute payback period.
 In such situations, we need to compute the cumulative cash inflow
and then apply the following formula:
Accounting Rate of Return (ARR)
It is an accounting method, which uses the accounting information
repeated by the financial statements to measure the probability of
an investment proposal.
It can be determine by dividing the average income after taxes by the
average investment i.e., the average book value after “depreciation”.
accounting rate of return on an investment can be calculated as the
ratio of accounting net income to the initial investment

Average income after taxes= / .

Average investment = T /2

On the basis of this method, the company can select projects, who’s
ARR is higher than the minimum rate established by the company.
It can reject the projects with an ARR lower than the expected rate of
return.
This method can also help the management to rank the proposal on the basis of
ARR.

A highest rank will be given to a project with highest ARR,

where as a lowest rank to a project with lowest ARR.

Merits
1. It is very simple to understand and calculate.
2. It can be readily computed with the help of the available accounting data.
3. It uses the entire stream of earning to calculate the ARR.

Demerits:
1. It is not based on cash flows generated by a project.
2. This method does not consider the objective of wealth maximization
3. IT ignores the length of the projects useful life.
4. It does not take into account the fact that the profits can be re-invested.
Example 1:
Julie Miller is evaluating a new project for her firm, Basket Wonders
(BW). She has determined that the after-tax cash flows for the
project will be $10,000; $12,000; $15,000; $10,000; and $7,000,
respectively, for each of the Years 1 through 5. The initial cash outlay
will be $40,000.
Capital budgeting Techniques:
1. Traditional methods
• Pay-back period method: - even cash flow
• Average rate of return method (ARR):-uneven cash flow
2. Discounted Cash flow methods
 The traditional method does not take into consideration the time
value of money.
 They give equal weight age to the present and future flow of
incomes. The DCF methods are based on the concept that a rupee
earned today is more worth than a rupee earned tomorrow.
These methods take into consideration the profitability and also
time value of money.
Time value of money (TVM) is a financial principle that asserts that
money available in the present is worth more than the same amount
of money in the future because of its potential earning capacity so
long as the money earned in the present is able to earn interest.
Usually a percentage of the principal amount borrowed for interest can
be either simple or compound.
Discounted payback method of capital budgeting is a financial
measure which is used to measure the profitability of a project based upon
the inflows and outflows of cash for that project.
Under this method, all cash flows related to the project are discounted to
their present values using a certain discount rate set by the management.
The discounted payback method takes into account the time value of
money and is therefore an upgraded version of the simple payback period
method.
Companies use this method to assess the potential benefit of undertaking a
particular business project.
The discounted payback method tells companies about the time period in
which the initially invested funds to start a project would be recovered by
the discounted value of total cash inflow.
Additionally, it indicates towards the potential profitability of a certain
business venture.
For example, if a project indicates that the funds or initial investment will
never be recovered by the discounted value of related cash inflow, it means
the project would not be profitable and the company should refrain from
investing in it.
Example
The following example illustrates how a discounted payback method
differs from a traditional or simple payback method.

An opportunity arises for a company which requires an initial

investment of $800,000 now. The management’s discount rate is 12%.
The amount of cash inflows expected from the new opportunity are:

Year-1 cash Inflow: $250,000

Year-2 cash Inflow: $400,000
Year-3 cash Inflow: $300,000
Year-4 cash Inflow: $450,000

Required: Compute the simple and discounted payback periods of the

new investment opportunity. Is this investment opportunity acceptable
under two methods if the maximum desired payback period of the
management is 3 years?
Simple payback period
The simple payback method dos not take into account the present value of cash
flows.

Simple payback period =

Years before full recovery + (Unrecovered cost at start of the year/Cash flow during the year)
= 2 + *150,000/300,000
= 2.5 years
= $800,000 – $650,000
We see that in year 3, the investment is not just recovered but the remaining cash inflow is
surplus. The initial investment of the company would be recovered in 2.5 years. So the project is
acceptable according to simple payback period method because the recovery period under this
method (2.5 years) is less than the maximum desired payback period of the
management (3 years).
Discounted payback period
The discounted payback method takes into account the present value of cash flows.

Present value factor at 12%: (1/1.12)^1 = 0.893;

(1/1.12)^2 = 0.797;
(1/1.12)^3 = 0.712;
(1/1.12)^4 = 0.636; or
use present value of $1 table to obtain these factors. The rest of the computations are similar
to simple payback period
Discounted payback period =
Years before full recovery + (Unrecovered cost at start of the year/Cash flow during the year)
= 3 + *44,350/2,86,200
= 3.15 years
* $800,000 – $755,650
We observe that the outcome with discounted payback method is less favorable than with the
simple payback method and according to this method the initial investment would be
ecovered in 3.15 years.
The project is not acceptable according to discounted payback period method because the
recovery period under this method (3.15 years) is more than the maximum desired payback
period of the management (3 years).
Advantages and disadvantages of discounted payback method
Advantages/benefits:
 It takes into account the time value of money by deflating the cash flows
using cost of capital of the company.
The concept backing the method is easy to understand.
Limitations/disadvantages:
Both simple and discounted payback method do not take into account the
full life of the project.
The overall benefit and profitability of a project cannot be measured under
these methods because any cash flows beyond the payback period is ignored.
It may become a relative measure.
In some situations the discounted payback period of the project may be
longer than the maximum desired payback period of the management but
other measures like accounting rate of return (ARR) and internal rate of
return (IRR) etc. may favor the project.
The accuracy of the output only depends upon the accuracy of the input
provided, like cash flows, the estimation of the timing of cash flows which
affects their present values, and the accuracy of the discount rate to be used
etc
The TVM can break it down a bit more for easy way ……….
you need to bear 4 things to be remember in mind:
Present Value - the amount you start with or your pocket, or your
wallet, and the amount you can invest for the future.
 Future Value - the amount you end up with at some point in the
future. Ideally it ends up being more than what you started out with
and has been earning some form of interest for the time period where
you invested it and left it alone to mature.
Time scale - how long are you going to leave this invested money to
earn interest?
 In a negative context, it could also mean a debt - how long are you
going to leave it before you start paying it off? This is most often
measured in months or years, but can sometimes be weeks. Some
investment accounts will have certain requirements. where you have
to leave the money in the account for a longer period of time to get a
better rate of return.
The interest rate - how much your money will earn for the length of
time you invest it.
Time value of money (TVM) means……..
In the scenario of calculating a payback period, we are looking at
projected returns on the investment over a number of months or
years, and therefore disregarding what amount of interest could
be made.
Therefore, this might not give an accurate overall picture of what
cash flows will actually be earned for the project.
The basic TVM formula is as shown in the image.

where,
FV = Future value of money,
PV = Present value of money,
i = Rate of interest or current yield on similar investment,
t = Number of years and
n = Number of compounding periods of interest per year
Time Value of Money Calculation (Step by Step)
Step 1: Firstly, try to figure out the rate of interest or the rate of return
expected from a similar kind of investment based on the market
situation. Please note that the rate of interest mentioned here is not
the effective rate of interest but the annualized rate of interest. It is
denoted by ‘i’.
Step 2: Now, the tenure of the investment in terms of number years
has to be determined i.e. for how long the money is going to remain
invested. The number of years is denoted by ‘t’.
Step 3: Now, the number of compounding periods of interest per year
has to be determined i.e. how many times in a year the interest will be
charged. The interest compounding can be quarterly, half-yearly,
annually, etc. The number of compounding periods of interest per
year is denoted by ‘n’.
Step 4: Finally, if the present value of money (PV) is available, then
the future value of money (FV) after ‘t’ number of year can be
calculated using the following formula as,
 Time value of money concept
• The change in the amount of money over a given
time period is called time value of money
• Money can “make” money if invested.
• Money made depends upon interest rate
• Money has a time value
• Money can be spent, money to be borrowed,
money to be kept as a depreciation
Time value of money
• To compare the various option or alternatives it is necessary to
convert all cash flows for each measures or scheme into equivalent
base.
• This is based on the guiding principle that money in hand today is
more valuable than money received at some time in future.
• To convert cash from one time into another different techniques are
to be used.
Different techniques for time value of money are
1. Single Payment Compound Amount (SPCA)
2. Single Payment Present Worth (SPPW)
3. Uniform Series Compound Amount (USCA)
4. Sinking Fund Payment (SFP)
5. Uniform Series Present Worth (USPW)
6. Capital Recovery (CR)
7. Gradient Present Worth (GPW)
1. Single Payment Compound Amount (SPCA)
• This formula simply gives the future value (S) of an amount
of money with present value (P) after n periods at an
interest rate i.
S= P* SPCA at i,n Where SPCA= (1+i)n

given data :
n  3 i  20 % P  100 doller
SPCA  ( 1  i ) n  ( 1  0 . 2 ) 3  1 . 728

Future Value ( S )  P * SPCA

 100 * 1 . 728  172 . 8 dollers
2. Single Payment Present Worth (SPPW)
• This gives the present value P in terms of future value S
after n periods at an interest rate i and is just opposite of
SPCA.
present value ( P )  future Value ( S ) X ( SPPW at i , n )
1
where SPPW 
(1  i ) n

Given data : i  20 % n 3 P ? S  100 dollers

1 1
SPPW  n
 3
 0 . 5787
(1  i ) (1  0 . 2 )
present value ( P )  future Value ( S ) X ( SPPW at i , n )
 100 X 0 . 5787  57 . 87
3. Uniform Series Compound Amount (USCA)
• This will determine the amount S that an equal annual
payment R will total in n years at i interest
S  R X (USCA at i , n )
(1  i ) n  1
where USCA 
i

Given data : annual payment ( R )  100, n  3 years , i  20%

(1  i ) n  1 (1  0.2) 3  1
then USCA    3.64
i 0. 2
S  R X (USCA at i, n )
 100 X 3.64  364 dollers
4.Sinking Fund Payment (SFP)
• This will determine the equal annual amount R that must be invested
for n years at i interest to accumulate a specified future amount.
• This is opposite of Uniform Series Compound Amount (USCA)
5. Uniform Series Present Worth (USPW)
• This will determine the present amount P that can be paid by equal
payment of R at i interest over n years

• USPW= USCA*SPPW P= R* USPW at i ,n

USCA- Uniform Series Compound Amount
SPPW- Single Payment Present Worth
6. Capital Recovery (CR)
• This will determine an annual payment R required to
pay off a present amount P at i interest for n years
• Capital Recovery technique is also opposite of Uniform
Series Present Worth (USPW)

Where
7.Gradient Present Worth (GPW)
• This will determine the present amount P that can
be paid by annual amounts R which escalates at e%
at i interest for n years

Percentage at which an annual change in the price levels of the

goods and services occurs or is expected to occur is called
escalation rate.
Eg. Inflation & deflation of money will influence on escalation
rate.
For instance, if you invest Rs. 1 lakh for 5 years at 10% interest, the
future value of this one lakh will be Rs. 1,61,051 as per the formula.
This formula can help you to analyze different investments over
different time periods, enabling you to make optimal and informed
financial decisions.
TVM and Compounding Periods
Monthly: Rs. 1,64,530.89
Quarterly: Rs. 1,63,861.64
Half Yearly or Semi-annually: Rs. 1,62,889.46
Annually: Rs. 1,61,051
This is where the Power of compounding works.
It proves that TVM is dependent on interest rate, tenure as
well as the number of compounding periods per financial
year.
 ECONOMIC ASPECTS AND ANALYSIS
Economic concepts, Computation of economic aspects based on
simple payback method,

1. Traditional methods
• Pay-back period method: - even cash flow
• Average rate of return method (ARR):-uneven cash flow

2. Discounted Cash flow methods :

The discounted cash flow method is designed to establish the present

value of a series of future cash flows.
 Time value of money concept
 Discounted payback method
 other methods etc.
Common Terminology used in Energy Economics
1.Fixed capital
Cost spent for purchase land, plant & equipment
Capital cost of generating equipment
Capital cost of transmission system
Capital cost of distribution system
2.Running capital
Capital for purchase of raw material
Payment of salary, Wages and Fuel cost
Maintenance and repairing cost and Cost of water
Cost of lubricating oil
3. Taxes
Property of taxes levied on generating station building and substation building.
Tax should be paid to municipal corporation for the use of street road.
Income tax from employees.
4. Insurance charges
To cover the risk of fire to the building
To cover accidental breakdown and Workers compensation
5.Depreciation & sinking fund
After a certain time the equipment is to be replaced because of physical & functional
reasons Eg. Plant has worn out & become unfit for further use (physical reason) ,
capacity of the plant become inadequate due to load growth (functional reason)
Interest
Interest is the earning power of money.
It represents the growth of capital per unit period.
The period may be a month, a quarter, semi annual or a year.
Interest is the income produced by money that is lent or loaned.
Simple interest & Compound interest are the type of interest.

Cash flow model

What is cash flow???????

In financial accounting, a cash flow statement, also known as

statement of cash flows, is a financial statement that shows how
changes in balance sheet accounts and income affect cash and
cash equivalents, and breaks the analysis down to operating,
investing and financing activities.
Cash flow model
Examples of cash flow
Cash flow model
• In evaluating energy investing opportunities, the timing
of cash receipts & expenditure are the – Objectives of
cash flow model
• Different cash flow models are available (Three types)
1. End of period convention
2. Mid period convention
3. Continuous period convention
1.End of period convention

• All cash flow which occur at any time interval assumed

to occur at the end of each interval.
• Simplify the computation & errors.
• The above diagram illustrates 3 years of duration.
Cash flow model
2.Mid period convention

• Cash flow can be assumed to occur at midperiod

• Fig illustrate 3 year duration of mid period convention.
3. Continuous flow convention
• Cash flow for any period are received at a continues rate
• The following diagram shows this for 8 cash flows per year
again over three year period.
Net present value method (NPV)
• The NPV takes into consideration the time value of money.
• This is done by equating future cash flow to its current value today, in
other words determining the present value of any future cash flow.
• NPV is the differentiates between the present value of cash inflows of a
project and the initial cost of the project.
• It is a present value of future returns, discounted at the required rate of
return minus the present value of the cost of the investment.
• The present value is determined by using an assumed interest rate, usually
referred to as a discount rate.
• Discounting is the opposite process to compounding.
• Compounding determines the future value of present cash flows, whereas
discounting determines the present value of future cash flows.
• The net present value method calculates the present value of all the yearly
cash flows incurred or accrued throughout the life of a project and
summates them.
• Costs are represented as negative value and savings as a positive value.

• The sum of all the present value is known as the Net Present Value (NPV). The
higher the net present value, the more attractive the proposed project.

• The cash flows of different years and are valued differently and made
comparable in terms of present values for this the net cash inflows of
various period are discounted using required rate of return which is
predetermined.

NPV is the present value of an investment project’s net

cash flows minus the project’s initial cash outflow.

Co- investment
CF1, CF2, CF3… CFn= cash flows in different years.
k= Discounting rate
n= Years, ICO= Cashinflow
Julie Miller is evaluating a new project for her firm, Basket Wonders (BW). She has
determined that the after-tax cash flows for the project will be $10,000; $12,000;
$15,000; $10,000; and $7,000, respectively, for each of the Years 1 through 5. The
initial cash outlay will be $40,000. Basket Wonders has determined that the
appropriate discount rate (k) for this project is 13%.
Net present value method (NPV)
Merits:
1. It recognizes the time value of money.
2.It is based on the entire cash flows generated during the useful life of
the asset.
3.It is consistent with the objective of maximization of wealth of the
owners.
4. The ranking of projects is independent of the discount rate used for
determining the present value.
Demerits:
1. It is different to understand and use.
2. The NPV is calculated by using the cost of capital as a discount rate. But
the concept of cost of capital. If self is difficult to understood and
determine.
3. It does not give solutions when the comparable projects are involved
in different amounts of investment.
4. It does not give correct answer to a question whether alternative
projects or limited funds are available with unequal lines.
PI(Profitability index method)
• PI is the ratio of the present value of a project’s future net cash flows to
the project’s initial cash outflow.
• The method is also called benefit cost ration.
• This method is obtained from NPV with slight modification.
• In case of NPV the present value of cash out flows are profitability index
(PI), the present value of cash inflows are divide by the present value of
cash out flows, while NPV is a absolute measure, the PI is a relative
measure.
• It the PI is more than one (>1), the proposal is accepted else rejected.
• If there are more than one investment proposal with the more than one
PI the one with the highest PI will be selected.
• This method is more useful incase of projects with different cash outlays
and hence is superior to the NPV method.
The formula for PI is
The formula for PI

Merits:
1. It is one of the earliest methods of evaluating the investment projects.
2. It is simple to understand and to compute.
3. It dose not involve any cost for computation of the payback period.
4. It is one of the widely used methods in small scale industry sector
Demerits
1. This method fails to take into account the cash flows received by the company
after the pay back period.
2. It does not take into account the interest factor involved in an investment
outlay.
3. It is not consistent with the objective of maximizing the market value of the
company’s share.
4. It fails to consider the pattern of cash inflows due to the magnitude and timing
of cash in flows.
Julie Miller is evaluating a new project for her firm, Basket Wonders (BW). She has
determined that the after-tax cash flows for the project will be $10,000; $12,000;
$15,000; $10,000; and $7,000, respectively, for each of the Years 1 through 5. The
initial cash outlay will be $40,000. Determined the PI for that the required rate is
13% for project.
Cash PV Factors PV of Cash PV Factors PV of Cash PV Factors PV of Cash
Year
Flows ($) @15% Flows ($) @13% Flows ($) @10% Flows ($)
1 10,000 .870 8,700 .884 8849 .909 9,090
2 12,000 .756 9,072 .783 9397 .826 9,912
3 15,000 .658 9,870 0.693 10395 .751 11,265
4 10,000 .572 5,720 0.613 6133 .683 6,830
5 7,000 .497 3,479 .542 3799 .621 4,347

Total Cash Inflow 36,841 38,573 41,444

Less Cash Outflows 40,000 40,000 40,000

NPV -3,159 -1427 1,444

Profitability Index 0.921 0.9643 1.036
No! The PI is less than 1.00. This means that the project is not profitable.
[Reject as PI < 1.00 ]
Depreciation …
Please note that all fixed assets are subject to depreciation except
freehold land.
Gradually decrease in the value of assets is Known as
Depeciation
Objectives of Depreciation …
To calculate proper profits.
• To show the asset at its reasonable value.
• To provide of replacement of an asset.
• Depreciation is permitted to be deducted from profits for tax
purposes.
Causes of Depreciation …
• Wear and Tear
• Disuse and Maintenance
• Change in production
• Restriction of production
• Reduced demand
Julie Miller is evaluating a new project for her firm, Basket Wonders (BW). She has
determined that the after-tax cash flows for the project will be $10,000; $12,000;
$15,000; $10,000; and $7,000, respectively, for each of the Years 1 through 5. The
initial cash outlay will be $40,000. Basket Wonders has determined that the
appropriate discount rate (k) for this project is 13%.
B. Internal Rate of Return Method (IRR)
The IRR for an investment proposal is that discount rate which equates the
present value of cash inflows with the present value of cash out flows of an
investment.
The IRR is also known as cutoff or handle rate. It is usually the concern’s
cost of capital.
The internal rate is the interest rate that equates the present value of the
expected future receipts to the cost of the investment outlay.
The IRR is not a predetermine rate, rather it is to be trial and error
method.
It implies that one has to start with a discounting rate to calculate the
present value of cash inflows.
If the obtained present value is higher than the initial cost of the project
one has to try with a higher rate.
Like wise if the present value of expected cash inflows obtained is lower
than the present value of cash flow. Lower rate is to be taken up.
The process is continued till the net present value becomes Zero. As this
discount rate is determined internally, this method is called internal rate of
return method.
IRR is the discount rate that equates the present value of the future
net cash flows from an investment project with the project’s initial
cash outflow(ICO), IRR Solution for the above problem

Find the interest rate (IRR) that causes the discounted cash flows to equal $40,000.
IRR Solution (Try 10%)
Merits:
1.It consider the time value of money
2.It takes into account the cash flows over the entire useful life of the
asset.
3.It has a psychological appear to the user because when the highest rate
of return projects are selected, it satisfies the investors in terms of the
rate of return an capital
4.It always suggests accepting to projects with maximum rate of return.
5.It is inconformity with the firm’s objective of maximum owner’s welfare.

Demerits:
1. It is very difficult to understand and use.
2. It involves a very complicated computational work.
3. It may not give unique answer in all situations.
IRR Solution (Try 15%)

Cash PV Factors PV of Cash PV Factors PV of Cash

Year
Flows ($) @15% Flows ($) @10% Flows ($)
1 10,000 .870 8,700 .909 9,090
2 12,000 .756 9,072 .826 9,912
3 15,000 .658 9,870 .751 11,265
4 10,000 .572 5,720 .683 6,830
5 7,000 .497 3,479 .621 4,347
Total Cash Inflow 36,841 41,444

Less Cash Outflows 40,000 40,000

Profitability Index -3,159 1,444
IRR = 15 – ( (3,159/4,603)*(5))
= 15-0.6862*5
= 11.57.
The management of Basket Wonders
has determined that the hurdle rate is 13% for projects
of this type.

No! The firm will receive 11.57% for

each dollar invested in this project at
a cost of 13%. [ IRR < Hurdle Rate ]
 ECONOMIC ASPECTS AND ANALYSIS
Economic concepts, Computation of economic aspects
based on
1. Traditional methods
• Pay-back period method: - even cash flow
• Average rate of return method (ARR):-uneven cash flow
2. Discounted Cash flow methods : The discounted cash flow method
is designed to establish the present value of a series of future cash
flows.
 Time value of money concept
 Discounted payback method
 NPV and IRR methods
 Internal and Average Rate of return method.
 PI(Profitability index method)
 Depreciation and its methods
 Present worth method
 PWA DEPRECIATION

Present Worth Analysis

Depreciation.
 Please note that all fixed assets are subject to depreciation except
freehold land.
 Gradually decrease in the value of assets is Known as Depreciation.
 After a certain time the equipment is to be replaced because of
physical & functional reasons.
 Depreciation has been defined as 'the diminution in the utility or
value of an asset, due to
 natural wear and tear,
 exhaustion of the subject-matter,
 efflux ion of time accident,
 obsolescence or similar causes.
Exp. Plant has worn out & become unfit for further use (physical
reason), capacity of the plant become inadequate due to
load growth& plant has become absolute due to new
technical improvement (functional reason).
 Fixed assets like plant and machinery etc. are used in the business for the purpose of
production of goods or for providing useful services in the course of production.
 These fixed assets are utilized during operations of a business for a number of successive
accounting periods.
 Value of such fixed assets decreases with passage of time and its utilization i.e. wear and
tear.
 Value of portion of fixed asset utilized for generating revenue must be recovered during a
particular accounting year to ascertain true income.
 This portion of cost of fixed asset allocated to a particular accounting year is called
depreciation.
Objectives of Depreciation … To calculate proper profits.
• To show the asset at its reasonable value.
• To provide of replacement of an asset.
• Depreciation is permitted to be deducted from profits for tax purposes.

Causes of Depreciation …
• Wear and Tear
• Disuse and Maintenance
• Change in production
• Restriction of production
• Reduced demand.
Bath tub curve
Depreciation methods
9 methods are present
1. Straight line depreciation
2. Sum of years digits depreciation
3. Declining balance depreciation
4. Diminishing value method
5. Sinking fund depreciation
6. Production units method
7. Machine hour method
8. Annuity method
9. Depletion method
1.Straight line depreciation
• There is reduction in value of equipment & other property of the
plant every year due to depreciation.
• A constant depreciation charge is made every year on the basis of
total depreciation and the useful life of the property.
• The annual depreciation charge equals to the total depreciation
divided by the useful life of the property.

Example: If the initial cost of the equipment is Rs 1,00,000 and its

scrap value is 10,000 after the useful life of 20 years. Calculate annual
depreciation charges?
Straight line depreciation
Annual depreciation= Total depreciation/ Useful life
Straight line depreciation
100000 – 10000/20 = Rs. 4500/-
1.Straight line depreciation
Drawbacks
• Assumption of constant depreciation charge is not correct.
• It does not account for the interest which may be drawn during
accumulation.
Exp2: On Jan, 2011, a Company purchased an equipment at a cost of
Rs 1,40,000, having a life span of 5 years. At the end of the 5th year
the scrap value will be Rs 20,000. Calculate the depreciation for 2011
& 2012 using straight line depreciation method.
Original Cost= Rs 1,40,000.00 ,
Estimated Life in years = 5.
Estimated Residual Value = 20,000.
Straight-Line Method
Annual depreciation = (1,40,000 – 20,000) / 5 = 24,000
Annual depreciation rate =((24,000/1,40,000)*100) =17.14%
Year Amount of Depreciation Book value
0 0 1,40,000
1 24,000 1,16,000
2 24,000 92,000
3 24,000 68,000
4 24,000 44,000
5 24,000 20,000

The straight-line method is widely used by firms because

it is simple and it provides a reasonable transfer of cost to
periodic expenses
if the asset is used about the same from
period to period.
2. Sum of years digit depreciation
In this method depreciation is determined by finding the sum of
digits using the following formulae
N= n(n+1)/ 2
n= life of equipment
N= Sum of digit
Annual depreciation charge= (P – S)/n
P= initial cost of the equipment
n = useful life of the equipment in years
S= scrap value or salvage value after the useful life of the plant.
First year, D= (n/N) *(P-S)
Second year, D= ((n-1)/N)*(P-S)
Third year, D= ((n-2)/N)* (P-S)
Fourth year D=((n-3)/N)*(P-S)
Fifth year D=((n-4)/N)*(P-S)
The following formula is used to calculate depreciation
expense under sum of years’ digits method
 In this method, the calculated depreciation is accelerated
depreciation for an asset.
 The method takes into account the original cost of the asset, the salvage
value it can be sold for, and the useful life of the asset in years.
 It takes the total number of years the asset can be depreciated, adds up
those years, and uses that number as a base to weight the depreciation
amounts in an accelerated way.
 For example, if an asset can be depreciated over four years, the sum-of-
digits method adds together 4 + 3 + 2 + 1 to get 10 years total.
 In the first year, the asset’s depreciation percent is 4/10 or 40%
 in the second year it’s 3/10 or 30%,
 in the third its 2/10 or 20%
 and the next year so on.
Example: assume an asset has an original cost of 1,00,000. It has a useful
life of four years and a salvage value of 15,000.
Depreciable value of the asset is 100,000- 15,000= 85,000.
The sum-of-digits depreciation schedule is as follows:
Year 1: Starting book value is 1,00,000 the depreciation amount is
40%, or 34,000. The ending book value is 66,000.

Year 2: Starting book value is 66,000 and the depreciation amount is

30%, or 25,500. The ending book value is 40,500.

Year 3: Starting book value is 40,500 and the depreciation amount is

20%, or $17,000. The ending book value is 23,500.

Year 4: Starting book value is 23,500 and the depreciation amount is

10%, or 8,500. The ending book value is 15,000.
Q1. Calculate the depreciation rate using the i)straight line & ii) sum of year’s digit for the
data given below: Salvage value L is Rs 0, Life of equipment , n=5 years, Initial expenditure
P=Rs 1,50,000, for a declining balance method use a 200% rate.
Sol:

ii)Sum of year’s digit method

N= n(n+1)/2
i) Straight line method 5(5+1)/2
N= 15
D= (P – L)/n D1= (n/N)*P = 50,000/-
=(1,50,000 – 0)/5 D2= ((n-1)/N)*P = 40,000/-
= 30,000 per year D3= ((n-2)/N)*P = 30,000/-
D4= ((n-3)/N)*P = 20,000/-
D5=((n-4)/N)*P = 10,000/-
Example:
The Monster company purchased a machine on January 1, 2015. The
relevant information is given below:
Cost of the machine: $250,000 , Expected useful life of machine: 5 years,
Salvage value: $25,000
Required: Prepare a schedule showing the depreciation expense of each
year of the useful life of the machine using sum of years’ digits method

 Depreciable cost : $250,000 – $25,000 = $225,000

 Depreciation t the end of the first year: $225,000 × (5/15) = $75,000
 Book value at the end of the first year: $250,000 – $75,000 = $175,000
Declining-Balance Depreciation Method
Compared to other methods, declining-balance depreciation results in a
larger amount expensed in the earlier years as opposed to the later years
of an asset’s useful life.
 This method reflects that, the assets are typically more productive in
their early years than in their later years – also, the practical fact that any
asset (think of buying a car) loses more of its value in the first few years of
its use.
In This method, the depreciation factor is 2 x The straight-line method.
• In this method Depreciation rate can be reestablished

Periodic Depreciation Expense = Book value x Rate of depreciation

Book Value = Initial Cost – Accumulated Depreciation
D= 1- (S/P)^(1/N) D- Annual depreciation rate
S- Salvage value or scrap value
P- Initial investment
N- Duration / Useful life
On January, 2011, a Company purchased an equipment at a cost of
Rs 1, 40,000, having a useful life of 5 years. The depreciation rate is
20%. Calculate the depreciation from 2011 to 2015 using Reducing
Balance Depreciation method. Also calculate the scrap value of the
equipment at the end of the year 2015.
Example 2:
Methods of Depreciation
Diminishing value Depreciation
Diminishing value Depreciation
• It is also similar to Declining balance method, Using this method the
assets do not depreciate by an equal amount each year. Rather,
depreciation is recalculated each year based on the assets
depreciated value or ‘book value’.

• Depreciation charge is fixed for every year

• More rational than straight line method

Depreciation value D= 1- (S/P)^(1/N)

Depreciation after ‘n’ years= P*(1- D)^n
Example 2:
5.Sinking Fund Depreciation
If a large sum of money is required for replacement of an asset at the end of its
effective life, it may not be advisable to leave in the amount of depreciation set
apart annually, for it may or may not be available in the form of the readily realisable
assets to the concern at the time it is required.
• Fixed depreciation charge is made every year & interest
compounded on it annually.
• Interest is considered.
• Depreciation charge implies cost of replacement of equipment after
its useful life.
• Depreciation charge= total annual installment + interest accumulations.
“Total fund must be equal to the cost of replacement of equipment”.
• Cost of replacement= P – S (a)
P= Initial investment or Capital
S= Scrap value or Salvage value
Total fund= q(1+r)^n – 1/r (b)
According to sinking fund method , total fund equals to cost of
replacement. Equate (a) and (b)
 (P – S) = q((1+r)^n – 1)/ r
Sinking fund q= (P-S)* (r/(1+r)^n – 1))
Where r/(1+r)^n -1 is called sinking fund factor.
P - Initial value of equipment
n – Useful life of equipment in years
S - Scrap value after useful life
r – Annual rate of interest expressed as a decimal
Advantages
• Interest is considered and Economically sound
• Provide cash for replacement
• Enable drawing up of balance sheet
Disadvantages
• Calculation is difficult
• Accounting is rather difficult
• Sinking Fund Method will provide us with
an amount of depreciation as well as
provide funds for the replacement of this
asset when an asset need replacement like
the end of life of an asset.
• Under this method, we charged
depreciation on the value of the asset but
will not be credited to the asset account
instead we will credit to sinking fund
account.
• It is also called Depreciation fund account.
Numerical Problems
Q2. The equipment in a power station costs Rs 15,60,000/-
and has a salvage value of Rs 60,000/- at the end of 25
years. Determine the depreciation value of equipment at
the end of 20years by the following methods. i)straight
line method
ii) Diminishing value method
iii)Sinking fund method at 5% compounded annually.
Numerical Problems
Q2. Solution
P= 15,60,000/-
Salvage value (S )= 60,000/-
N = 25 years,
n=20
i) Straight line method

( total investment  salvage value )

Annual depreciati on 
no . of years
15 , 60 , 000  60 , 000
  60 , 000 / 
25
Depreciati on value at the end of 20 years
 total investment ( P )  ( annual depreciati on * 20 )
 15 , 60 , 000  ( 20 * 60 , 000 )  Rs 3, 60 , 000 / 
Numerical Problems
Q2. Solution
ii) Diminishing value method
1
L (N)
D  1[ ] where L  S  Salvage value
P
1
60 ,000 25 )
(
D  1[ ]  0.122
1560000
Depreciati on after 20 years  P * (1  D ) n
 1560000 * (1  0.122 ) 20
 Rs 1,15,615 / 
Numerical Problems
Q2. Solution
iii) Sinking fund
rate of int rest  5%
r
Sinking fund (q )  (P  L ) * ( 1
)
[1  r ] N
0 . 05
 (15 , 60 , 000  60 , 000 ) * ( 25  1
)
[1  0 . 05 ]
q  31 , 433 / 
P (1  r ) n  1
Sinking fund after 20 years   Rs 10 , 39 , 362 / 
r
( USCA  Time Value money calculatio n)
The value of the plant after 20 years is
 Rs (15 , 60 , 000  10 , 39 , 362 )
 Rs 5 , 20 , 638 / 
Numerical Problems
Q3. A transformer costing Rs 90,000 has an useful
life of 20 years .Determine the annual
depreciation charge using straight line method.
Assume the salvage value of the equipment to
be Rs 10,000/-.
P= 90,000/-
S = 10,000/-
N= 20 years
Q3. Solution
Annual depreciation charge =( P – S) /n
= (90,000 – 10,000)/20
= Rs.4000/-
Numerical Problems
Q4. A distribution transformer costs Rs 2,00,000 and has
a useful life of 20 years. If the salvage value is Rs
10,000 & the rate of annual compound interest is 8%,
calculate the amount to be saved annually for
replacement of the transformer after the end of 20
years by sinking fund method.
Q4. Solution Q4. Solution
P= 2,00,000/- q = (P – S) ( r/ (1+r)^n -1)
n= 20 years
S= 10,000/- r = 8% Rs 4153/-
Numerical Problems
Q5.You have accumulated Rs 5000/- in credit card debit. The
credit card company charges 18% nominal annual interest
compounded monthly. You can offered to pay only Rs.100
per month. How many months will it take you to pay off
debit?
Present Worth Analysis
 LEARNING OUTCOMES

1. Formulate Alternatives
2. PW of equal-life alternatives
3.PW of different-life alternatives
4. Future Worth analysis

5. Capitalized Cost analysis

Introduction Present Worth
 A future amount of money converted to its equivalent value now has a present
worth (PW) value. This present value is always less than that of the actual
future cash flow, for any interest rate greater than zero, all P/F factors have a
value less than 1.0.

 For this reason, present worth values are often referred to as Discounted
Cash Flows (DCF), Similarly, the interest rate may be referred to as the
discount rate. Besides PW, equivalent terms frequently used are present
value (PV) and net present value (NPV).
 The goal of this PRESENT WORTH ANALYSIS is to continue the introduction of
some basic concepts of engineering economics. The concepts that will be
discussed include:
 Minimum Attractive Rate of Return (MARR).
 Present Worth Method or Present Value.
 Capitalized Worth Method or Capitalized Equivalency.

These concepts are used to evaluate the economic feasibility of an

engineered solution.
 Formulating Alternatives
 Alternatives are developed from project proposals to accomplish a
stated purpose.
 Some projects are economically and technologically viable, and others
are not. Once the viable projects are defined, it is possible to formulate
the alternatives.
 Alternatives are one of two types:
 mutually exclusive or independent.
 Each type is evaluated differently
Two types of cash flow estimates
Revenue: Alternatives include estimates of costs (cash
outflows) and revenues (cash inflows)

Cost: Alternatives include only costs; revenues and savings

assumed equal for all alternatives; also called service
alternatives
 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved
1-7
Minimum Attractive Rate of Return:
• The minimum attractive rate of return (MARR), also called the target
rate, hurdle rate, cut-off rate or valuation rate, is the rate by which a
project is evaluated when an interest rate is not known.
• It is usually chosen to maximize the economic viability of an
organization when considering a project, and accounts for various risk
factors.
• The MARR is typically established based on company policy and may
be project specific.
The MARR may take into account some of the following:
 The amount of money available for investment, and the source and
cost of these funds
 The number of good projects available for investment and their
purpose
 The amount of perceived risk associated with investment
opportunities available The type of organization involved (e.g.,
government, public utility, private industry).
Present Worth Analysis
 Present worth (PW) is the concept of the equivalent worth of
all cash flows at the end of year 0 – or, another way to look
at it, at the beginning of year 1.
 All cash inflows and outflows are discounted to the present
point in time at an interest rate (typically chosen as the
MARR).
 Present worth as a function of interest rate for a series of
cash flows is found as follows:

Where:
i = effective interest rate, or MARR, per compounding period
k = index for each compounding period (0≤k≤N)
Fk = future cash flow at end of period k
n = number of compounding periods in the study period
 This equation assumes there is a constant
interest rate throughout the life of the project.
 This would have to be adjusted if the interest rate
varied throughout the course of the project.
 To apply the present worth method to determine
a project’s economic worthiness,
 use the following:

If PW (i = MARR) ≥ 0, the project is economically

justified
PW Analysis of Alternatives
 Convert all cash flows to PW using MARR
 Precede costs by minus sign; receipts by plus sign

EVALUATION
• For one project, if PW > 0, it is justified
• For mutually exclusive alternatives, select one with
numerically largest PW
• For independent projects, select all with PW >0
Selection of Alternatives by PW

Project ID Present Worth

A $30,000
B $12,500
C $-4,000
D $ 2,000

Solution: (a) Select numerically largest PW; alternative A

(b) Select all with PW > 0; projects A, B & D
Problem 1: A piece of new equipment has been proposed to increase the
productivity of a manual process. The investment cost is $50,000, and the
equipment will have a market value of $15,000 at the end of five years.
Increased productivity attributable to the equipment will amount to $12,000 per
year after extra operating costs have been subtracted from the revenue
generated by the additional production. If the company’s MARR is 18% per year,
is this proposal a good one?
 Example: PW Evaluation of Equal-Life ME Alts.
Alternative X has a first cost of $20,000, an operating cost of $9,000 per year,
and a $5,000 salvage value after 5 years. Alternative Y will cost $35,000 with
an operating cost of $4,000 per year and a salvage value of $7,000 after 5
years. At an MARR of 12% per year, which should be selected?

Solution: Find PW at MARR and select numerically larger PW value

PWX = -20,000 - 9000(P/A,12%,5) + 5000(P/F,12%,5)

= -$49,606

PWY = -35,000 - 4000(P/A,12%,5) + 7000(P/F,12%,5)

= -$45,447

Select alternative Y
Example: PW Evaluation of Equal-Life
Example: PW Evaluation of Equal-Life
Taxes & Tax credits
What is tax?
• A compulsory contribution to state revenue,
levied by the government on workers' income
and business profits, or added to the cost of
some goods, services, and transactions is
termed as tax.
• A fee charged ("levied") by a government on a
product, income, or activity.
• Two types of taxes- direct tax & indirect tax
12
8
Taxes & Tax credits
What is tax?
• If tax is levied directly on personal or
corporate income, then it is a direct tax.
• If tax is levied on the price of a good or
service, then it is called an indirect tax.

12
9
Taxes & Tax credits
What is tax?
• A tax is a financial charge
• Tax imposed upon a taxpayer by a state or the
functional equivalent of a state to fund
various public expenditures.
• A failure to pay is usually punishable by law.
• Taxes are also imposed by many
administrative divisions.
13
0
Taxes & Tax credits
Why Tax?
• The purpose of taxation is to finance
government expenditure.
• One of the most important uses of taxes is to
finance public goods and services, such as
street lighting and street cleaning.

13
1
Taxes & Tax credits
Why Tax?
• Tax deductable expenses such as maintenance ,
energy, operating cost, insurance & property
taxes reduce the income subject to taxes.

AS= (1-i)*E+ i*D- Equation for finding tax saving

AS= Yearly annual after tax saving
E = Yearly annual energy saving
D = Annual depreciation rate
i = Income tax
13
2
Taxes & Tax credits
Tax credit
• A tax credit is a tax incentive which allows
certain taxpayers to subtract the amount of the
credit from the total they owe(liable) the state.
• Tax credit encourages the capital investments.
• encourage behaviors like investment.
• The tax credit lowers the income tax.
• Increases the investment merit.

13
3
Taxes & Tax credits
Tax credit
• A credit directly reduces tax bills, unlike tax
deductions and tax exemptions , which indirectly
reduce tax bills by reducing the size of the base.
• Most tax credits are nonrefundable tax credits.
Meaning that they can only be used to the point
at which no more taxes are owed (liable).
• Some tax credits are refundable tax credits.
Meaning if the credit exceeds the amount of
taxes owed, the excess is given to the taxpayer.
13
4
Numerical Problems

13
5
Q1. Calculate the depreciation rate using the i)straight line & ii) sum of year’s digit for
the data given below: Salvage value L is Rs 0, Life of equipment , n=5 years, Initial
expenditure ,
P=Rs 1,50,000, for a declining balance method use a 200% rate.

Sol:

i) Straight line method ii)Sum of year’s digit method

D= (P – L)/n N= n(n+1)/2
5(5+1)/2
=(1,50,000 – 0)/5
N= 15
= 30,000 per year D1= (n/N)*P = 50,000/-
D2= ((n-1)/N)*P = 40,000/-
D3= ((n-2)/N)*P = 30,000/-
D4= ((n-3)/N)*P = 20,000/-
D5=((n-4)/N)*P = 10,000/-

1
3
6
Numerical Problems
Q2. The equipment in a power station costs Rs
15,60,000/- and has a salvage value of Rs
60,000/- at the end of 25 years. Determine
the depreciation value of equipment at the
end of 20years by the following methods.
i)straight line method
ii) Diminishing value method
iii)Sinking fund method at 5% compounded
annually.
13
7
Numerical Problems
Q2. Solution
P= 15,60,000/- Salvage value (S )= 60,000/-
N= 25 years, n=20
i) Straight line method
(total investment  salvage value )
Annual depreciati on 
no . of years
15 ,60 ,000  60 ,000
  60 ,000 / 
25
Depreciati on value at the end of 20 years
 total investment ( P )  ( annual depreciati on * 20 )
 15 ,60 ,000  ( 20 * 60 ,000 )  Rs 3,60 ,000 / 

13
8
Numerical Problems
Q2. Solution
ii) Diminishing value method
1
L (N)
D  1[ ] where L  S  Salvage value
P
1
60 ,000 ( 25 )
D  1[ ]  0.122
1560000
Depreciati on after 20 years  P * (1  D ) n
 1560000 * (1  0.122 ) 20
 Rs 1,15,615 / 
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Numerical Problems
Q2. Solution
iii) Sinking fund
rate of int rest  5%
r
Sinking fund ( q )  ( P  L ) * ( N 1
)
[1  r ]
0.05
 (15,60,000  60,000 ) * ( 25 1
)
[1  0.05]
q  31,433 / 
P (1  r ) n 1
Sinking fund after 20 years   Rs 10,39,362 / 
r
(USCA  Time Value money calculatio n)
The value of the plant after 20 years is
 Rs (15,60,000  10,39,362 )
 Rs 5,20,638 /  14
0
Numerical Problems
Q3. A transformer costing Rs 90,000 has an
useful life of 20 years .Determine the annual
depreciation charge using straight line
method. Assume the salvage value of the
equipment to be Rs 10,000/-.

P= 90,000/-
S= 10,000/-
N= 20 years
14
1
Numerical Problems
Q3. Solution
Annual depreciation charge =( P – S) /n
= (90,000 – 10,000)/20
= Rs.4000/-

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Numerical Problems
Q4. A distribution transformer costs Rs 2,00,000
and has a useful life of 20 years. If the salvage
value is Rs 10,000 & the rate of annual
compound interest is 8%, calculate the
amount to be saved annually for replacement
of the transformer after the end of 20 years
by sinking fund method.

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Numerical Problems
Q4. Solution
P= 2,00,000/-
n= 20 years
S= 10,000/-
r = 8%

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Numerical Problems
Q4. Solution
q = (P – S) ( r/ (1+r)^n -1)

Rs 4153/-

14
5
Numerical Problems
Q5. You have accumulated Rs 5000/- in credit
card debit. The credit card company charges
18% nominal annual interest compounded
monthly. You can offered to pay only Rs 100
per month. How many months will it take you
to pay off debit?

14
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Numerical Problems
Q5. Solution
P= 5000/-
A or R= 100
i or r = 0.18
c = 12
n =?

14
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Thank you