Page 306 - Improving Machinery Reliability

Life Cycle Cost Studies 277

Table 5-8
Present Value and Future Value
-..- ""....."." .-.. I
ni*m,,n, D.1. = ,,w
~
Vearshencel 01 11 21 31 41 51 61 71 81 91 101 111 121 131 141 151 161 171 181 191 20
0.151
0.13I
Presenlvalve olUSSl.OOI 1.0010.89( 0601 0.71I0.Bl~0.57l0.51~0.45~040~0.36~0.32~0.29~0.26~0.23~020~0.1~~0.16~ 0.121 0 10
F~l~revalueol US11.001 1 001 1.121 1251 1.401 1.571 1.761 1.9112 211 2.481 2 7?13 1113.461 39014.3614 88l547l6.13l 6 871 7.691 8 811 965
and cash begins to flow in for a series of many years. The amount of cash "thrown
off" by a project is an important consideration and a helpful criterion for evaluating
projects. For many projects cash flow results from cost savings, depreciation, and
taxes. Of course, depreciation schedules change as accounting departments select the
schedule that legally results in the greatest profits. Most accounting departments use
the same general form for calculating relative changes in cash flow, although specif-
ic details are highly variable. For example, the straight line depreciation schedule
may be used for accounting profit purposes and accelerated depreciation for tax pur-
poses. Depreciation is a non-cash cost and must be excluded or added back to deter-
mine actual cash flow. Cash flows (after taxes to get the real flow of cash) in each
period are adjusted by a discount factor to calculate present value for each year. The
net present value is the sum of all present values for the allowed time periods.
Most fixed assets and other projects have a limited useful life. Accounting prac-
tices gradually change fixed assets into expense with a process called depreciation
over the accepted long life of an asset. All equipment has a finite life based on both
deterioration and obsolescence. Judgment is required in estimating and setting actual
service life of assets. Tw0 common methods are used for calculating depreciation
based on acquisition cost less salvage:

1. The straight line method is based on consumption of a fixed percentage of the
equipment cost. Often straight-line depreciation is used for internal accounting
reports of profit/loss.
2. The accelerated method is based on the amount of service provided when a
larger amount of depreciation is consumed in the early years and the deprecia-
tion for each year is found by applying a rate to the book value of the asset at
the beginning of that year rather than to the original cost of the asset. Book
value is cost less total depreciation accumulated up to that time. Accelerated
depreciation is often used for tax and cash reporting purposes. Depreciation
methods are different for accounting and tax considerations. Remember that
depreciation is non-cash and is only a process of allocation to future periods.
For the calculations below, the straight-line depreciation schedule will be used,
and Table 5-9 shows the contrast between straight-line and double-declining-
balance depreciation.

Income tax rates vary and may require inclusion of state as well as federal taxes.
For calculation purposes, consider the tax rate is 38% based on the profit before tax
numbers. Profit before taxes may be positive or negative. When profit before tax is
negative, the company receives a tax credit either a carry-back or carry-forward.