EQUIPMENT COSTS

Peters Timmerhaus & West

PURCHASED EQUIPMENT p.243 PT&W

Cost a/Cost b=(size a/size b)0.6

Lang Factor (in this example) = 4.3

We will say IF = 5.0*E

SHOW ME THE MONEY!CHE462

“Figures don’t lie, but liars sure can figure!” BECKMAN 2012

CASH FLOW & ROI (standard)

Operating Cost

Gross Sales $/yr

S

Operating cost$/yr bye-bye

C

Net sales, $/yr

S-C depreciation

Profit before tax, $/yr

S-C-d

depreciation$/yr

d=IF/NF

Income tax

Income tax$/yr bye-bye

(S-C-d)

Profit after tax, $/yr

(S-C-d)

Total Profit after tax

(S-C-d)+d IF+IW Total Investment

= ROI = ($/yr)/$

IF =

IW =(C/12)*NW

Total Investment. $

EXAMPLE of ROI (standard)

S (sales) = $100 million/yearC (operating cost) = $60 million/yearE (equipment cost) = $10 millionN (project life) = 20 yearsNW (working capital months) = 3

(income tax rate ) = 0.4

Then IF = 5*$10 = $50d = $50/20 yr = $2.5/yrIW = $60/yr*3mo/12mo/yr = $15

ROI = ((100-60-2.5)*(1-.4) +2.5)/(50+15) = 0.385/yr = 38.5%/yr

EXAMPLE MAX ROI (standard)

S (sales) = $100 million/yearC (operating cost) = $40 million/yearE (equipment cost) = $15 millionN (project life) = 20 yearsNW (working capital months) = 3

(income tax rate ) = 0.4

Then IF = 5*$15 = $75d = $75/20 yr = $3.75/yrIW = $40/yr*3mo/12mo/yr = $10

ROI = ((100-40-3.75)*(1-.4) +3.75)/(75+10) =0.435/yr =43.5%/yr

By observation, if E is increased from $10 million to $15 million,maybe C will decrease from $60 million/yr to $40 million/yr so:

Lets EXPENSE the Investmentwe will BORROW IF

i(1+i)N

(1+i)N -1R/IF =

= .05*(1.05)20 /[1.0520 -1]= 0.0802 /yr

Total loan payback = N*R/IF = 20*.0802 = 1.60 or 60% more than you borrowed!

If interest rate is 5% and project life is 20 years, then

CASH FLOW & ROI (IF Expensed)

Operating Cost

Gross Sales $/yr

S

Operating cost$/yr bye-bye

C+R

Net sales, $/yr

S-C-R depreciation

Profit before tax, $/yr

S-C-R-d

depreciation$/yr

d=IF/NF

Income tax

Income tax$/yr bye-bye

(S-C-R-d)

Profit after tax, $/yr

(S-C-R-d)

Total Profit after tax

(S-C-R-d)+d IW Total Investment

= ROI = ($/yr)/$

IF =isRIF*i(1+i)N /[(1+i)N -1]

IW =[(C+R)/12]*NW

Total Investment. $

EXAMPLE of ROI with IF expensed

S (sales) = $100 million/yearC (operating cost) = $60 million/yearE (equipment cost) = $10 millionN (project life) = 20 yearsNW (working capital months) = 3

(income tax rate ) = 0.4i=5%Then IF = 5*$10 = $50R= 0.0802*$50 = $4.0/yrd = $50/20 yr = $2.5/yrIW = $60/yr*3mo/12mo/yr = $15

ROI = ((100-60-4.0-2.5)*(1-.4) +2.5)/(0+15) = 1.51/yr = 151%/yrIf E=$15 million and C= $40 million/yr, then ROI=295% wow

RULE # 1 IN BUSINESS

• NEVER BUY something when you can either rent or borrow (or steal?) !!!!!

CASH FLOW & ROI (d Payback into IF)

Operating Cost

Gross Sales $/yr

S

Operating cost$/yr bye-bye

C

Net sales, $/yr

S-C depreciation

Profit before tax, $/yr

S-C-d

depreciation$/yr

d=IF/NF

Income tax

Income tax$/yr bye-bye

(S-C-d)

Profit after tax, $/yr

(S-C-d)

Total Profit after tax

(S-C-d) IF+IW Total Investment

= ROI = ($/yr)/$

IF =n*d

IW =(C/12)*NW

Total Investment. $

OK here

(where n is the nth year of the projectIF = 0 after n = NF )

EXAMPLE of ROI ( d payback)

S (sales) = $100 million/yearC (operating cost) = $60 million/yearE (equipment cost) = $10 millionN (project life) = 20 yearsNW (working capital months) = 3

(income tax rate ) = 0.4

Then IF = 5*$10 = $50 initiallyd = $50/20 yr = $2.5/yrIW = $60/yr*3mo/12mo/yr = $15

ROI = ((100-60-2.5)*(1-.4) +2.5)/(50-2.5+15) = 0.40/yr = 40%/yrFor year 1

05

101520253035404550

0 5 10 15 20

year number

IF -

n*d

Series1

IF with d payback as a function on time (“book value”)

ROI as a function of time(with d payback into IF)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

0 5 10 15 20

year number

RO

I