Escolar Documentos
Profissional Documentos
Cultura Documentos
Engineering
COTM 5104: CONSTRUCTION MANAGEMENT
Chapter 3
Project Financial Appraisal
Contents
Project Financial Appraisal
1. General
2. Time Value of Money
3. Financial Appraisal Methods
4. Depreciation
1. General
1.1 Basic Definitions
1.1.1 Asset
Assets represents how much a company owns at a given
time of reporting usually, it is within the budget year.
Assets are divided into:
1. General
1.1 Basic Definitions
1.1.2 Liabilities
Liabilities represents what the company owes like loans,
debts etc.
Liabilities are divided into:
1. General
1.2 Basic Finance Notes
1.2.1 Balance Sheet
The balance sheet is a statement which shows the
financial position of a company at the end of a certain
reporting period, which is the fiscal year.
It mainly shows the assets, liabilities and stockholders
equity, based on the accounting equations:
Assets = Liabilities + Owners equity
1.2.2 Profit
Profit is an earning of a given period concerned whether
or not they have been received minus the expenses of the
same period whether or not they have been paid.
1. General
1.2 Basic Finance Notes
1.2.3 Income Statement
This is a form of financial statement that shows whether
the company has made or lost money during that
reporting period.
Income statements can be prepared monthly, quarterly,
etc. However, usual accounting periods extend to one
year, which is the fiscal year.
In the income statement one shows or itemizes:
1. General
1.2 Basic Finance Notes
1.2.4 Cash Flow Statement
The income statement shows how much the company has
lost or gained, but does not indicate financing and
investment activities during the period.
Cash flow statement show how the company generated
the cash and how it has spent or utilized it.
1.2.5 Retained Earnings
This is money which is retained from the net profit to be
used for expansion purposes or saved as security for
risks. The remaining balance, which is net profit minus
retained earnings, will be given as dividend to owners.
Receipt
Time
Disbursements
The two computational schemes for calculating this earned interest yield
either simple interest or compound interest.
11
Beginning
Balance (P)
Interest
(I = 9%)
Ending
Balance (F)
1, 500
1, 500
135
1, 635
1, 635
135
1, 770
1, 770
135
1, 905
12
Beginning
Balance (P)
Interest
(I = 9%)
Ending
Balance (F)
1, 500
1, 500
135
1, 635
1, 635
147.15
1, 782.15
1, 782.15
160.40
1, 942.55
13
$1,500
14
n 0: P
n 1: F1 P (1 i )
n 2 : F2 F1 (1 i ) P (1 i ) 2
M
n N : F P (1 i )
15
There are certain rules that one should follow to make these
calculations.
They need to have a common time basis;
Equivalence is dependent on interest rate; and.
16
8
17
F= P(F/P, 10%, 8)
18
Contd
#1. Suppose you buy a share of stock for $10 and sell it for $20; If your
investment takes five years, what would be the rate of return on your
investment?
19
Contd
#2.
20
0
1
$5,000
P
22
$3,000
0
$25,000
$5,000
$3,000
0
1
0
1
P2
$22, 727
P4
P1
P1 $25, 000( P / F ,10%,1)
P P1 P2 P3 $28, 622
P
0
N
24
A
A(1+i)N-1
F A(1 i ) N 1 A(1 i ) N 2 L A
25
(1 i ) N 1
F A
i
A( F / A, i , N )
26
AF
3
N
1 i
1
F ( A / F , i, N )
28
3
N
A=?
i (1 i ) N
A P
(1 i ) N 1
P( A / P, i , N )
29
3
N
1 i 1
PA
N
i 1 i
A( P / A, i, N )
30
A
P
i
A
31
Contd
2.4.2.3
Gradient Series
Sometimes cash flows will vary linearly, that is, they increase or decrease
by a set amount, G, the gradient amount. This type of series is known as a
strict gradient series.
the series begins with a zero cash flow at the end of period zero.
(1 i) N iN 1
P G
2
N
i (1 i)
G ( P / G , i, N )
P
33
5
34
35
Contd
Geometric Gradient Series
Another
1 (1 g ) N (1 i ) N
A1
N
A1
1 i
if i g
if i g
38
Contd
Suppose
40
41
42
43
45
Cash Flow
-3,500,000
1,872,000
1,872,000Pay Back Period = 2yrs
1,872,000
1.872,000
1,872,000
46
=53.5%
47
48
Ci
CSn
52
Report format;
Contd
Contd
54
55
4. Depreciation
2.8 Internal Rate of Return (IRR) Method
IRR is the interest which makes the summation of present
worth value to be zero.
A
A
0 1 .... An
n
0 1
1 i
1 i
1 i
n An
n
PW
0;i IRR
n
i
0 1 i
0
PW i
56
B. Non-simple Investment
57
-8,000
-16,000
10,400
12,000
12,000
58
60
61
B-A
-3,000
-12,000
-9,000
1,350
4,200
2,800
1,800
6,225
4,425
1,500
6,330
4,830
25%
17.43%
15%
IRR
Alternative B is selected
Selection Criterion:IRR (B-A) > MARR - select B
IRR (B-A) < MARR - select A
IRR (B-A) = MARR - select either
62
B-A C-B
-1,000
-1,000
-2,000
900
600
900
-300
300
500
500
900
400
100
500
900
400
400
50
900
50
IRR
100
21% 26.3%
0 -1,000
800
Equity Financing;
64
65
66
Bank overdraft;
Factoring.
i. Bank Overdraft
It has high interest rate.
If not paid, the company will be liquidated and declare
bankruptcy where the client will be sued.
67
68
Risk shared;
Reduces competition.
AAU, AAiT, Construction Management, Lecture Notes,March 2014, Getaneh G.
69
4. Depreciation
4.1 Definition and Requirements
4.1.1 Depreciation: Definition
The number of years over which a machine is depreciated
is called its depreciable life.
Depreciation is a business expense the government
allows to offset the loss in value of business assets.
Depreciation deductions reduce the taxable income of
businesses and thus reduce the amount of tax paid.
Accountants define depreciation as follows:
the systematic allocation of the cost of an asset over
its useful, or depreciable life.
The latter definition is used for determining taxable
income hence, income taxes.
AAU, AAiT, Construction Management, Lecture Notes,March 2014, Getaneh G.
70
4. Depreciation
4.1 Definition and Requirements
4.1.2 Depreciation Requirements
In general business assets can only be depreciated if they
meet the following basic requirements:
71
4. Depreciation
4.2 Depreciation Causes
Due to use and obsolescence every equipment loses its
value. This loss is accounted for by depreciating the
equipment every year. Depreciation is a decrease in
value of an asset each year.
Depreciation: whenever any machine or equipment
performs useful work its wear and tear is bound to occur.
This can be minimized up to some extent by proper care
and maintenance but cant be totally prevented.
Obsolescence: is the depreciation of existing machinery
or asset due to new and better invention, design of
equipment of processes etc.
72
4. Depreciation
4.3 Classification of Depreciation
73
4. Depreciation
4.4 Depreciation Calculation Fundamentals and Methods
4.4.1 Depreciation Calculation Fundamentals
The following are the methods for calculating
depreciation.
BVt = cost basis (d1 + d2 + + dt)
This equation is used to compute the book value of an
asset at the end of any time t.
Book value can be viewed as the remaining unallocated
cost of an asset:
Book value = Cost Depreciation charges made to date
Note:
If the item has a salvage value then the final book value
will be the salvage value.
74
4. Depreciation
4.4 Depreciation Calculation Fundamentals and Methods
4.4.2 Depreciation Calculation Methods
The following are the methods for calculating
depreciation.
75
4. Depreciation
4.5 Calculation of Depreciation
4.5.1 Straight Line Method
This method assumes that the loss of value of machine is
directly proportional to its age. It means one should
deduct the scrap value from the original value and divide
the remaining value by the number of years of useful life.
D = (C-S)/N
Where: D = Depreciation amount per year.
C = Initial cost of a machine.
S = Scrap/Salvage value.
N = Number of years of life of machine.
76
4. Depreciation
4.5 Calculation of Depreciation
4.5.2 [Double] Declining Balance Method
For straight line depreciation with N years, the rate of
decrease each year is 1/N.
Declining balance depreciation uses a rate of either 150%
or 200% of the straight-line rate.
Since 200% is twice the straight-line rate, it is called
double declining balance (DDB).
The DDB equation for any year is
DDB depreciation dt = (2/N) ( Book value)
Book value = Initial cost total charges to date,
So,
DDB deprec. dt = (2/N) (Initial cost total charges to date)
AAU, AAiT, Construction Management, Lecture Notes,March 2014, Getaneh G.
77
4. Depreciation
4.5 Calculation of Depreciation
4.5.2 [Double] Declining Balance Method
It can be shown for DDB, that the depreciation schedule
in year t is given by:
DDB depreciation in year t = (2B/N)(1 2/N)t-1
For
150% declining balance depreciation, the
depreciation in year t is given by:
DB depreciation in year t =(1.5 B/N)(1 1.5/N)t-1.
Where:
B = Book Value
N = Number of years of life of machine.
It is common usually to use DDB in many depreciation
computations.
78
4. Depreciation
4.5 Calculation of Depreciation
4.5.3 Sum of Years Digits (SOYD) Method
SOYD depreciation causes larger decreases in book value
in earlier years than in later years.
dt= [(N+1-t)/SOYD](B-S) = [2(N+1-t)/(N(N+1))](B-S)
79
4. Depreciation
4.5 Calculation of Depreciation
Example: Depreciation
An excavator costs Birr 5, 000,000.00 with a scrap value
of Birr 200,000 after its useful life of 5 years in the
taxpayers hand. Calculate the depreciation value in the
useful life of this machine using:
DDB method.
Show your result in the entire useful life of the excavator.
Compare and comment on both results by the help of a
graph.
80
THANK YOU!
81