Page 45 - An Introduction To Predictive Maintenance

Financial Implications and Cost Justification 35

ing streams of cost and/or return over life. Unfortunately, the calculation requires a
computer spreadsheet macro or a financial calculator. Ask your controller to run the
numbers.

Net Present Value (NPV)
Net present value has the advantages of IRR and is easier to apply. We decide what
the benefit stream should be by a future period in financial terms. Then we decide
what the cost of capital is likely to be over the same time and discount the benefit
stream by the cost of capital. The term net is used because the original investment
cost is subtracted from the resulting present value for the benefit. If the NPV is pos-
itive, you should do the project. If the NPV is negative, then the costs outweigh the
benefits.

Cost–Benefit Ratio (CBR)
The cost–benefit ratio takes the present value (initial project cost + NPV) divided by
the initial project cost. For example, if the project will cost $250,000 and the NPV is
$350,000, then:

$250 000 + $350 000
,
,
= 24
.
$250 000
,
It may appear that the CBR is merely a mirror of the NPV. The valuable addition is
that CBR considers the size of the financial investment required. For example, two
competing projects could have the same NPV, but if one required $1 million and the
other required only $250,000, that absolute amount might influence the choice.
Compare the previous example with the $1 million example:

$1, 0 ,000 + $350 000
0
,
0
= 135
.
$1, 0 ,000
0
0
There should be little question that you would take the $250,000 project instead of
the $1 million choice. Tables 2–1 through 2–5 provide the factors necessary for eval-
uating how much an investment today must earn over the next three years in order to
achieve a target ROI. This calculation requires that we make a management judgment
on what the inflation/interest rate will be for the payback time and what the pattern
of those paybacks will be.
For example, if we spend $5,000 today to modify a machine in order to reduce break-
downs, the payback will come from improved production revenues, reduced mainte-
nance labor, having the right parts, tools, and information to do the complete job, and
certainly less confusion.

The intention of this brief discussion of financial evaluation is to identify factors that
should be considered and to recognize when to ask for help from accounting, control,