Page 305 - Improving Machinery Reliability

276 Improving Machinery Reliability
accepted and the business becomes a “bank.” Projects are typically screened against a
minimum rate that also changes with time and conditions. For example, if the cost of
money to a corporation is 9%, then the minimum attractive rate of return may be at
least 12% to merit consideration for a successful project. It’s unwise to champion pro-
jects with rates of return less than the minimum attractive rate, and sometimes the
best project may involve the alternative of doing nothing rather than buying into a
poorly performing project. The objective of successful projects is to find opportuni-
ties that are worth much more than they cost over time. Projects must exceed the min-
imum attractive rates of return so wealth is created for the stockholders.
Economic calculations are well defined but the most difficult financial question is
what discount rate should be used. Accounting and finance organizations set internal
discount rates to make economic decisions easy for engineers (remember, the dis-
count rate is always changing). Discount factors reflect a host of relationships and
considerations that include very low risk investment returns such as U.S. govern-
ment T-bills, factors for projects such as estimated uncertainties, internal rates of
returns, and so forth. Discount factors vary by company and over time. In general,
consider a typical discount value of 12%, which is neither very low nor very high for
the calculations that will follow. Using the discount rate of 12%, consider the results
for two questions using FV = PV* (1 + i)n, where FV is future value, PV is present
value, i is discount rate, and n is number of years into the future:
1) What is the present value (PV) of US$1.00 today over time?
2) What is the future value (FV) of US$I.OO received over time?
Cash flows into and out of a business according to cash outlays and receipts of
business transactions. The discounting method is used to summarize transactions
over the life of the investment in terms of present or future dollars. Discount rates in
Table 5-8 are used as multipliers or dividers to put financial transactions into the pre-
sent value of money to answer the two questions posed above.
Net present value (NPV) is an important economic measure for projects or equip-
ment taking into account discount factors and cash flow. The present value (PV) of
an investment is the maximum amount a firm could pay for the opportunity of mak-
ing the investment without being financially handicapped. The net present value
(NPV) is the present value of proceeds minus present value of outlays. Net present
value calculations start with a discount rate, followed by finding the present value of
the cash proceeds expected from the investment, then followed by finding the pre-
sent value of the outlays. The net of this calculation is the net present value. High
NPV projects and processes provide wealth for the shareholders. Cash availability
and strategies aside, when competing projects are judged for acceptance, the project
with the greatest NPV is usually the winner.
Cash flow is very important to any enterprise. Positive cash flow into the company
assures its continuing existence. The concept is simple: no cash, no company! One
project can’t borrow cash from another project; hence, all cash generating actions are
usually judged by themselves. The term cash flow is generalized and refers to the
flow of money. Cash flow is not the same as the accounting terms “profit” and
“income.” For projects, the general view is that cash flows out in one or more years