KING FAHD UNIVERSITY OF PETROLEUM & MINERALS

Department of Systems Engineering

Final Exam

Summer 2015-2016 (153)

ISE 307 Engineering Economic Analysis

Name: _______________________________

ID: ______________

Section ______SN: ___

31stAugust2016

Question Points Marks

Q1 10
Q2 10
Q3 10
TOTAL 30
IMPORTANT, to get full credit in any question, you need to show your detailed work

Q1. (10 Marks)

A U.S. company buys an asset at a cost of (I) = $700,000, with salvage value (S) =$0. The useful
life of the asset is 7 years.

a. Compute the annual depreciation allowances and the resulting book values by using the DDB
method with switching to the SL method. Show that the book value at the end of 7 years will
be zero. (4 points)
b. Assume that the asset will be sold after 3 years at a price of $750,000 and that it would be
classified as 7-year MACRS property. Calculate ordinary gains, capital gains, and net proceeds
from sale if the ordinary gains and capital gains are taxed at 40% and 35%, respectively. (4
points)
c. If the company estimated its taxable income for the first year to be $18,000,000, find the
marginal and average tax rates in the first year using the U.S. Corporate Tax Schedule given
below. (2 points)

Taxable income Tax rate Tax computation

0- $15,000,000 34.33%

$15,000,000 - $18,333,333 38% $5,150,000 + 0.38 (D)

$18,333,333 and Up 35% $6,416,666 + 0.35 (D)

SOLUTION:

a.
SL Dep. Rate = 1/7 = 0.1143
DDB Rate = (200%) (SL Dep. Rate) = 2/7 = 0.286

n DDB method SL method Book Value

DDB Rate = 2/7 SL Dep. Rate = 1/7 BVn
0 $0 $0 $700,000
1 200,000 /7 100,000 500,000
2 142,857.143 /6 83,333 357,142.857
3 102,040.816 /5 71,428.57 255,102.041
4 72,886.2973 /4 63,775.5 182,215.744
5 52,061.641 shift to SL /3 60,738.58 121,477.164
6 60,738.58 60.738.58
7 60,738.58 0

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IMPORTANT, to get full credit in any question, you need to show your detailed work

b.

Total depreciation =700,000 (0.1429+0.2449+0.1749/2)=$332,675 (1 mark)

Book value=700,000-332,675=$367,325
Ordinary gains=700,000-367,325=$332,675 (1 mark)
Capital gains=750,000-700,000=$50,000 (1 mark)
Amount of tax paid=332,675(0.4)+50,000(0.35)=133,070+17,500=$150,570
The net proceeds from sale=750,000-150,570=$599,430 (1 mark)

c.

Marginal income rate =38% (1 mark)

Tax amount= 5,150,000 + 0.38 (18,000,000 – 15,000,000)=$6,290,000
Average tax rate =6,290,000/18,000,000=34.9% (1 mark)

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IMPORTANT, to get full credit in any question, you need to show your detailed work

Q2. (10 Marks)

A Computerized Machining Center (CMC) has been proposed for small tool manufacturing
company. If the new system, which costs $250,000, is installed, it will generate annual revenues
of $185,000 and will require $20,000 in annual labor, $12,000 in annual material expenses and
another $8,000 in annual overhead (power and utility) expenses. The CMC would be classified as
a 7-year MACRS property. The company expects to dispose out the facility at the end of year 3
and will be sold for $100,000. Assume a tax rate of 35%.

a. Develop the project’s cash flow over its project life by filling up the following Table.
b. Determine the net present worth (NPW) at the company’s MARR of 15%? Is this project
acceptable?

INCOME
0 1 2 3
STATEMENT
Revenues: 185000 185000 185000

Expenses:
Labor 20000 20000 20000
Material 12000 12000 12000
Overhead 8000 8000 8000
0.1429*250000= 0.2449*250000= (0.1749/2)*250000
Depreciation
35725 61225 =21852.5
185000-20000- 185000-20000- 185000-2000-
Taxable
12000-8000- 12000-8000- 12000-8000-
Income
35725=109275 61225=83757 21852.5=123137.5
109275*(1-0.35) 83757*(1-0.35) 123137.5*(1-0.35)
Net Income
=71028.75 =54453.75 =80039
CASH FLOW
STATEMENT
Net Income 71028.75 54453.75 80039
Depreciation 35725 61225 21852.5
Investment -250000
Salvage Val. 100000
Gain (loss) tax 10915.5

80039+21852.5+
NET CASH 71028.75+35725= 54453.75+61225=
-250000 100000+10915.5=
FLOW 106754 115679
212818

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IMPORTANT, to get full credit in any question, you need to show your detailed work

Please show your detailed calculations of the following elements:

Total depreciation:

35725+61225+21852.5=118812.5

Book Value:

250000-118812.5 = 131187.5

Gain (or loss):

100000-131187.5 = -31187.5

Gain tax (or credit):

-31187.5*0.35 = -10915.5

b.

NPV=-250000+106754/1.15+115679/1.15^2+212818/1.15^3=70230

Since NPV > 0, the project is acceptable.

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IMPORTANT, to get full credit in any question, you need to show your detailed work

Q3. (10 Marks)

(i) (5 Marks)

Higgins Machine Tools, Inc. is currently manufacturing one of its products on a hydraulic
stamping press machine. The machine has a current operating and maintenance cost of $50,000,
and this cost is expected to increase by $5,000 each year. The machine has a remaining useful life
of five years and could be sold on the open market now for $100,000. Its market value declines at
a rate of 17%. A new machine would cost $200,000, and its operating and maintenance cost is
expected to be $33,000 each year. The new machine has an expected service life of five years and
its market values reduces at a rate of 20%.

The required MARR is 15%. The firm does not expect a significant improvement in the machine's
technology to occur, and it needs the service of either machine for an indefinite period of time.

a) Fill the following table for the defender.

Defender
n Market Value O&M Cost
0
1
2
3
4
5

b) Find the economic service life for the defender and its cost.

Solution:

(i)
a)

Defender
n Market Value O&M Cost
0 $100,000
1 $83,000 $50,000
2 $68,890 $55,000
3 $57,179 $60,000
4 $47,458 $65,000
5 $39,390 $70,000

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IMPORTANT, to get full credit in any question, you need to show your detailed work

(1 mark)

b) Defender:

CR = (I-S)(A/P, 15%, N) + 0.15*S

AECO&M = 50,000 + 5000 (A/G, 15%, N)
AEC = CR + AECO&M

N=1:

CR = (100,000-83,000)*1.15 + 0.15*83,000 = 32,000

AECO&M = 50,000 + 5000*0 = 50,000
AEC = CR + AECO&M = 32,000 + 50,000 = 82,000 (1 mark)

N=2:

CR = (100,000-68,890)*0.6151 + 0.15*68,890 = 29,469

AECO&M = 50,000 + 5000*0.4651 = 52,326
AEC = CR + AECO&M = 29,469 + 52,326= 81,795 (1 mark)

N=3:

CR = (100,000-57,179)*0.4380 + 0.15*57,179 = 27,332

AECO&M = 50,000 + 5000*0.9071 = 54,536
AEC = CR + AECO&M = 27,332+ 54,536= 81,868 (1 mark)

Since AEC(N=3) > AEC(N=2), the economic service life of the defender is Nd*=2 and its
AECd*=$81,795. (1 mark)

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IMPORTANT, to get full credit in any question, you need to show your detailed work

(ii) (5 Marks)

The following data for a defender and a challenger in the tables given below show the market
value, operation and maintenance cost (O&M Cost), capital recovery cost (CR), annual operation
cost (AOC) and annual equivalent cost (AEC). Assuming 15% MARR and that the service of
either machine is needed for an indefinite period of time:

Defender
n Market Value O&M Cost CR(15%) AOC(15%) AEC(15%)
0 $200,000
1 $160,000 $100,000 $70,000 100000 $170,000
2 $128,000 $111,000 $63,488 105581.4 $169,070
3 $102,400 $122,000 $58,107 110885.5 $168,992
4 $81,920 $133,000 $53,647 115915.1 $169,562
5 $65,536 $144,000 $49,943 120673.8 $170,617
6 $52,429 $155,000 $46,858 125166.3 $172,024

Challenger
n Market Value O&M Cost CR(15%) AOC(15%) AEC(15%)
0 $450,000
1 $337,500 $60,000 $180,000 $60,000 $240,000
2 $253,125 $60,000 $159,070 $60,000 $219,070
3 $189,844 $60,000 $142,419 $60,000 $202,419
4 $142,383 $60,000 $129,105 $60,000 $189,105
5 $106,787 $60,000 $118,404 $60,000 $178,404
6 $80,090 $60,000 $109,757 $60,000 $169,757

a) Find the economic service life for the defender and the challenger and their cost.
b) Using marginal analysis, determine when the defender should be replaced by the
challenger.

Note: Show all details of your solution and show all results rounded to the nearest integer. If
a problem can be solved by a series, you are required to solve it as a series, otherwise you
will be penalized.

Solution:

(ii)

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IMPORTANT, to get full credit in any question, you need to show your detailed work
a) Economic service life of defender, Nd*=3, and AECd* = $168,992.
Economic service life of challenger, Nc*=6, and AECc* = $169,757.
(1 mark)

b) Marginal Analysis:

Since AECd*=$168,992< AECc* = 169,757, then we need to keep the defender for its
economic service life i.e., 3 years. (1 mark)

Next, we need to find the cost of using the defender for the fourth year.

I = 102,400, S = 81,920, OMC = 133,000

Cost = 102,400 (F/P,15%,1)+ 133,000-81,920
=102,400*1.15+133,000-81,920=168,840

Since 168,840< AECc* = 169,757, this means that we should keep the defender for the
fourth year. (1.5 marks)

Next, we need to find the cost of using the defender for the fifth year.
I = 81,920, S = 65,536, OMC = 144,000
Cost = 81,920 (F/P,15%,1)+144,000-65,536
= 81,920*1.15+144,000-65,536 = 172,672

Since 172,672 > AECc* = 169,757, this means that we should replace the defender by the
challenger at the end of the fourth year. (1.5 marks)

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IMPORTANT, to get full credit in any question, you need to show your detailed work

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