Page 307 - Improving Machinery Reliability

278 Improving Machinery Reliability

Table 5-9
Straight Line and Double Declining Depreciation

When profit before tax is positive, the company pays taxes. For a project or process,
tax numbers are used to calculate cash flows. After the tax is included, the cash flow
is discounted to get present value, and the sum of all present values gives the NPV.
When the net present values are known for the project life, then the discounted
cash flow (DCF) rate can be calculated to arrive at a profitability index. The dis-
counted cash flow rate is the return that forces the NPV to zero. It’s the maximum
cost of capital that can be paid just to break even on the project. The DCF index
defines an economical quality value for the project and is useful for comparing pro-
jects of different sizes. Large DCFs are desirable but small investments and big sav-
ings result in numbers that are often questioned. The DCF index sometimes has
problems in ranking project desirability so base final decisions on the NPV. Of
course, this assumes a common time period for the life of the items.
If equipment life among alternatives is not the same, then a more complicated
analysis is required to divide the NPV by an annuity factor. The annuity factor
depends on equipment lifetime, discount rates, and equivalent annual cash flow to
correct for unequal equipment life. This calculation puts NPV alternatives on an
equivalent annual basis using an annuity factor (AF) where AF = [((l + i)N - l)h*
(1 + i)N] and i = discount rate, N = equipment life. The annual equivalent NPV,
(AENPV) is found by AENPV = NPV/AF. For example, if two competing projects
each project a NPV = $150,000 using a DCF = 12%, and case 1 has equipment life
of five years while case 2 has a life of ten years, by common sense, case 1 is prefer-
= 3.605 and AFN= = 5.650 so that
able. But here is how it works out: AFN=~
AENPVN = = $41,611 and AENPVN = 10 = $26,547. This shows the five-year life
case is 1.6 fold more attractive.
Engineers must be concerned with life cycle costs for making important economic
decisions through engineering actions. Management deplores engineers who are
engineering smart but economics stupid. Engineers must get the equation balanced to
create wealth for shareholders. Often this means: stop doing some things the old
way, and start doing new things in smarter ways.
Example 1 shown below illustrates the above ideas and concepts for a financial
analysis. This example is not a LCC model but it is typical of how equipment is jus-
tified:
Example: Two alternatives are being considered for installing an on-line spare
pump in parallel with an existing ANSI grade pump to avoid outages that have
plagued a chemical plant. The parallel pump (which will be operated every other
week on a rotation schedule and whenever pump failure occurs-this is an incremen-