ENGINEERING

MANAGEMENT
MGMT 3000

FINAL EXAMINATION
FOCUS
 Question 1 [20 Marks]
A company wants to start a major project in three years time. They
have decided to deposit a sum of $10,000 every three months into
a fund that offers an annual interest of 9% but compounded
monthly. In addition to regular savings, a lump sum of $30,000 is
deposited at the end of the first year, and $50,000 is deposited at
the end of the second year.
a) What is the balance in three years, before the project starts? [10
Marks]
b) What is the value of the balance in today’s dollars? [5 Marks]
c) How can the company organize its workforce and what should
they do to make a full start with the project when the time
comes? [5 Marks]
 Question 1a - Solution
Important Factors
Future value, F = ???
Quarterly Deposit, A = $10,000
Interest Rate, in =9%
Number of years = 3
Compound interest = monthly = 12
M = 12; K = 4; C = 3

Effective Interest Rate, EAR – Every Three months

C 3 3
 in _ pa   9%   0.09 
EAR  1    1  1    1  1    1  0.02267  2.267%
 CK   12   12 

Balance at the end of three years based on my quarterly deposit

Fquat _ dep A
1  i 1
N
 10,000
1  0.02267  1
4*3
 $136,152.66
i 0.02267
 Question 1a - Solution
Effective Interest Rate, EAR – on Annual basis
n 12 12
 in _ pa   9%   0.09 
EAR  1    1  1    1  1    1  0.0938  9.38%
 N   12   12 

Balance at the end of three years based $30,000 deposited in the end of 1 st Year

F30 K  P 1  i 
N
 30,0001  0.0938  $35,892
2

Balance at the end of three years based $50,000 deposited in the end of 2 nd Year


F50 K  P 1  i 
N
 50,0001  0.0938  $54,690
1

Total Sum available at the end of three years

FTotal  $136,152  $35,892  $54,690
 $226,735
 Question 1b - Solution
Balance in today’s value
F 226,735
P   $173,262
1  i  1  0.0938
N 3

Question 1c - Solution
 Company should organize the workforce for the
project in Matrix form to set up the basic teams.
 They can also do feasibility studies, market search,
risk analysis, work out the scope of the project even
pre [pare drawings and do R&D.
 Question 2
• As a manufacturer of highly sensitive electronic
motion sensing equipment, you need to decide if
you should build a totally new next generation
product or upgrade the existing platform. There is
uncertainty as to how the market will react and
expected demand level of the product. Designing a
product from scratch has a much higher start-up
cost as opposed to upgrading the existing platform.
However you need to make a decision before the
demand level is known.
 Table of expected probabilities of
market demand and costs.
  New New Fast Major Upgrade of Minor Upgrade of
Market Demand Comprehensive Track Product existing Product existing Product
Product
High $1.0m (0.4) $1.0m (0.2) $0.6m (0.3) $0.1m (0.6)
Medium $0.1m (0.4) $0.1m (0.3) $0.2m (0.4) $0.05m (0.2)
Low $0.05m (0.2) $0.05m (0.5) $0.1m (0.3) $0.02m (0.2)
RETURNS ($m) $3.0m $1.2m $1.5m $0.4m

EXPECTED SUNK COSTS ASSOCIATED

  New New Fast Major Upgrade Minor Upgrade of

  Comprehensive Track Product of existing existing Product
Product Product
Sunk Cost $0.6m $0.2m $0.09m $0.05m
         
 Question 2b – Solution
Draw a decision tree – Option Analysis
Option 1 - New Comprehensive Product
Probability Investment Outcome Tree Value Returns Expected Profit
0.4 $ 1,000,000.00 $ 400,000.00
0.4 $ 100,000.00 $ 40,000.00 $ 450,000.00 $ 3,000,000.00 $ 2,550,000.00
0.2 $ 50,000.00 $ 10,000.00

Option 2 - New Fast Track Product

Probability Investment Outcome Tree Value Returns Expected Profit
0.2 $ 1,000,000.00 $ 200,000.00
0.3 $ 100,000.00 $ 30,000.00 $ 255,000.00 $ 1,200,000.00 $ 945,000.00
0.5 $ 50,000.00 $ 25,000.00

Option 3 - Major Upgrade of existing Product

Probability Investment Outcome Tree Value Returns Expected Profit
0.3 $ 600,000.00 $ 180,000.00
0.4 $ 200,000.00 $ 80,000.00 $ 290,000.00 $ 1,500,000.00 $ 1,210,000.00
0.3 $ 100,000.00 $ 30,000.00

Option 4 - Minor Upgrade of existing Product

Probability Investment Outcome Tree Value Returns Expected Profit
0.6 $ 100,000.00 $ 60,000.00
0.2 $ 50,000.00 $ 10,000.00 $ 74,000.00 $ 400,000.00 $ 326,000.00
0.2 $ 20,000.00 $ 4,000.00
 Question 2b – Solution
Draw a decision tree – Tree Diagram
m
.55
of
it=
2
0.4 $1,000,000
r
1
P
0.4 $100,000 $450,000.00
n m
it o 0.6 0.2
Profit=1.95m Op =$
nk
Return=
3 m
$50,000
Su
ew 45
m
N ct O it=
0.
9
0.2
$1,000,000
d
il du Su pti f
u
B ro
nk on
=$ 2
0.2
P ro
0.3 $100,000 $255,000.00
P m 0.5
Return=
1.2m $50,000
m
.21 .3 $600,000
Up P

= 0
1
fit
gr ro

ro
P 0.4 $200,000 $290,000.00
ad du

3 m
n 0.3
e

tio 0.09
ex ct

p
O =$ Return= $100,000
is

n k 1 .5 m
Su
tin

6m
g

Su Op 0 .3 2 .6
0 $100,000
it=
Profit=1.12m t
nk io
=$ n 4
0.
Pr
of
0.2 $50,000 $74,000.00
05 0.2
m
Return=
0 .4 m
$20,000
 Question 2c – Solution
Which would be the better option?
• Option 1 (Build Comprehensive New Product ) =
$2.55m - $0.6m = $1.95m
• Option 2 (Build Fast Track New Product ) = $0.945m -
$0.2m = $0.745m
• Option 3 (Major Upgrade of Existing Product) =
$1.21m - $0.09m = $1.12m
• Option 4 (Minor Upgrade of Existing Product) =
$0.326m – $0.05m = $0.321m

Building a new product (option 1) offers the

largest return for the investor
 Question 3
A medical equipment production company (Can Save Lives Co) is
considering producing three different products. The products are
A - Heart Monitor,
B – Respiratory Nebulizer, and
C - Blood Sugar Monitor.
Their market research shows the expected returns and the
probabilities of uncertainties are shown in Table below.
EQUIPMENT TYPE Good Medium Poor COST

HEART MONITOR $2.2m $1.5m $600,000 $1,300,000

(0.4) (0.3) (0.3)
RESPIRATORY $3.1m $1.3m $1.0m
NEBULISER (0.3) (0.3) (0.4) $1,600,000

BLOOD SUGAR $1.8m $900,000 $500,000

MONITOR (0.3) (0.4) (0.3) $1,100,000
 Question 3: Solution
Products Economic Status
Product A -Heart Monitor
Probability Investment Outcome Tree Value Cost Net Profit
0.4 $ 2,200,000.00 $ 880,000.00
0.3 $ 1,500,000.00 $ 450,000.00 $ 1,510,000.00 $ 1,300,000.00 $ 210,000.00
0.3 $ 600,000.00 $ 180,000.00

Product B - Respiratory Nebulizer

Probability Investment Outcome Tree Value Cost Net Profit
0.3 $ 3,100,000.00 $ 930,000.00
0.3 $ 1,300,000.00 $ 390,000.00 $ 1,720,000.00 $ 1,600,000.00 $ 120,000.00
0.4 $ 1,000,000.00 $ 400,000.00

Product C - Blood Sugar Monitor

Probability Investment Outcome Tree Value Cost Net Profit
0.3 $ 1,800,000.00 $ 540,000.00
0.4 $ 900,000.00 $ 360,000.00 $ 1,050,000.00 $ 1,100,000.00 $ (50,000.00)
0.3 $ 500,000.00 $ 150,000.00

The best choice for the company is Heart Monitor with Net Profit of S210,000.00
Question 3 – Solution: Decision Tree
$ 210,000.00

$ 120,000.00

-$50,000.00
 Question 4
The following information is supplied to compare Desalination
Plant project with the Kimberley Perth Water Canal Project. Use
Capital recovery analysis to select the project which gives
better cost per kilolitre of water.

New Desalination Plant Kimberley to Perth Water Canal

Supplies 50GL water pa
25 year life
$400m CAPEX to build
$30m OPEX pa
Assume interest rate of 5.5%
Assume salvage value = $50m
Supplies 200GL water pa
50 year life
$2.2b CAPEX to build
$70m OPEX pa
Assume interest rate of 5.5%
Assume salvage value = $200m
 Question 4 – Solution
New Desalination Plant
0.055 *1.05525
CAPEX _ Re cov ery  $400  $50m * 25
 0.055 * $50m
1.055  1
0.055 *1.05525
 $350m * 25
 0.055 * $50m
1.055  1
 $28.84m

AE  CAPEX _ Re cov ery  AnnualOPEX

 $28.84m  $30m
 $58.84m
$58,840,000
Cost / Kiloliter 
50,000,000kiloliter
 $1.17 / kiloliter
 Question 4 – Solution
Kimberley to Perth Water Canal
0.055 *1.05550
CAPEX _ Re cov ery  $2,200  $200m * 50
 0.055 * $200m
1.055  1
0.055 *1.05550
 $2,200m * 50
 0.055 * $200m
1.055  1
 $129.1m

AE  CAPEX _ Re cov ery  AnnualOPEX

 $129.1m  $70m
 $199.1m
$199,100,000
Cost / Kiloliter 
200,000,000kiloliter
 $0.995 / kiloliter
 Question 5
A steel Printing Power Pty. Ltd. has borrowed $4m at a compounded interest rate of 9% p.a. The
company had also borrowed $6m two years ago and $5m last year with an annual compound interest
rate of 7% and 8% respectively. The total debt of the company now stands at $15m. The company is
listed on the stock exchange with a β value of 1.3 and now has a debt ratio of 60%. The company
expects to maintain the existing capital structure at a risk free rate of 7% and a risk premium of 7.4%.
The corporate tax rate is 30%. Calculate the following: 

a) Cost of Equity

b) Cost of pre tax Debt

c) The WACC

The company hopes that the new expansion will increase revenues by $7m p.a. However this will
cause annual increases in labour costs of $3m, material costs of $2.0m and overheads by $1.0m p.a.
Land for the expansion was purchased 4 years ago for $9m. Upfront equipment development cost is
$5m and is to be depreciated using the straight line method to zero salvage value as the equipment is
expected to operate for 10 years. Funding cost of raising new equity is 10%. The funding cost of new
debt is 2%.

(d) By calculating the “Operating Net Cashflow” use NPV analysis to show if the company should go
ahead with the expansion.
 Question 5 - Solution
(a) Ke = Rf +β(Rm-Rf) = 7% + 1.3 (7.4%) = 16.62%
(b) Kd = (L1 / LT )K1 + (L2 / LT )K2 + (L3 / LT )K3
= (4 /15 ) 9% + ( 6/15) 7% + (5/15) 8%
= 2.4 + 2.8 + 2.67= 7.867%
(c) WACC = (E/V) × Ke + (D/V) Kd (1-Tc)
=(0.4) × 16.62% + (0.6)(7.867%)(1–30%)
= 9.952 %
 Question 5d - Solution
Depreciation Expense = [I – S ] / n = [$5m - $0 ] / 10 = $0.5m per year for 10 years. 
Revenue = $7m
Expenses = Labour + Materials + O/H = $3m + $2m + $1m = $6m
Taxable Income = Revenue – Expenses - Depreciation
= $7m - $6m - $0.5m = $0.5m p.a
Net Income = $0.5m ( 1 – 30%) = $0.35 m p.a. (After Tax)
Net Operating Cash Flow = Net Income + Non Cash Expenses ( i.e. Depreciation)
= $0.35 m + $ 0.5m (from depreciation) = $0.85m p.a 
Thus total income after 10 years using present value annuity:

P = 0.85 [(1+0.09952)^10-1]/[(0.09952) (1 + 0.09952)^10]

P= $5.234m
Funding Cost = (E/V)× Fe + (D/V) Fd = (0.4)10% + (0.6) 2% = 5.2%

True Cost of Funding = $5m / [1 - 5.2%] = $5.27m 

Thus NPV total = Total Outlay – Total Income = $5.234m - $5.27m = - $0.036m
 Question 6 [20 Marks]
A government organization has hired you to make a
recommendation on the cost of a high tech sports
complex that they are going to build. You estimate that
the complex will cost $500m in today’s money. You
also estimate that the complex will need renovation
every 10 years at a cost of $10m. The annual repairs
and maintenance is estimated to be $2m per year. For
an interest rate of 8%, calculate:
a) The capitalized equivalent cost of the complex; [10
Marks]
b) The dollar value of costs at the end of year 10 and
year 20. [10 Mark]
 Question 6a – Solution
The capitalized equivalent cost of the complex
 Question 6b – Solution
The dollar value of costs at the end of year 10 and year 20
 Question 7
A team of employees are preparing a new proposal for an expansion project.
Answer the following:
(a) Computer workstation for process control cost $200,000 with a salvage
value of $15,000 at the end of five years. Calculate the annual depreciation
allowances and the resulting book values using the double-declining
balance method. [5 Marks]
(b) A packaging machine costs $190,000 with a salvage value of $10,000. In its
lifetime, it will package 300,000 items. Calculate the allowed depreciation
amount on the day that it packs the 110,000th item. [5 Marks]
(c) A backup diesel generator costs $120,000 and has a useful operating life of
100,000 hours or 15 years. The expected salvage value of the generator is
$20,000. The generator operated for 4,000 hours in the first year and
6,000 hours in the second year. Determine the depreciation using the
straight-line method for the first year and for the second year based on the
operating hours. Explain the financial implications if the company adopted
the double-declining balance method to calculate depreciation on a yearly
basis. [10 Marks]
 Question 7a – Solution
Computer workstation for process control cost $200,000 with a salvage value of $15,000 at the end of
five years. Calculate the annual depreciation allowances and the resulting book values using the
double-declining balance method. [5 Marks]

Double-declining balance method

B0= $200k
B1= $200k - 2×$200k/5 = $120k
B2= $120k - 2×$120k/5 = $72k
B3= $72k - 2×$72k/5 = $43.2.6k
B4= $43.2k - 2×$43.2k/5 = $25.84k
B5= $25.84k - 2×$25.84k/5 = $15.5k
Since the salvation value is $15,000 maximum
depreciation in year five is $0.5k
 Question 7b – Solution
A packaging machine costs $190,000 with a salvage value of $10,000. In its lifetime, it will package
300,000 items. Calculate the allowed depreciation amount on the day that it packs the 110,000th
item. [5 Marks]

Depreciation expense
D1= (190k-10k)/300k = $0.60 per item
D110k = $0.6×110,000 = $66,000
 Question 7c – Solution
A backup diesel generator costs $120,000 and has a useful operating life of 100,000 hours or 15
years. The expected salvage value of the generator is $20,000. The generator operated for 4,000
hours in the first year and 6,000 hours in the second year. Determine the depreciation using the
straight-line method for the first year and for the second year based on the operating hours.
Explain the financial implications if the company adopted the double-declining balance method
to calculate depreciation on a yearly basis. [10 Marks]

Straight-line method based on operating hours

D1h= (120k-20k)/100k = $1.00 per hour
D4k-h = $1.00×4,000 = $4,000
D6k-h = $1.00×6,000 = $6,000
Double decline balance method
Byear0 = $120k
Byear1 = $120k - (2×$120/15) = $104,000
Dy1= $120k-$104k=$16k
Byear2 = $104k - (2×$104/15) = $90,133.3
Dy1= $104k-$90,133.3=$13.667k
Machine is inefficiently used in the first two years therefore it may better to adopt
depreciation based on items produced to reserve savings for the later years.
 ou
Y
Than
k