Introduction

Overview

Discounted Cash Flow analysis, NPV, and ratios are the best techniques for evaluation of an investment project from any type of industry, especially for after-tax evaluation. These are methods and equations that require accurate, realistic and reliable data to generate reliable results. If these methods are fed with poor data and assumptions, generated results won’t be reliable. Input parameters such as tax, inflation, escalation, risk, salvage, loan and borrowed money, the minimum rate of return and more should be utilized properly. For example, if you are calculating After-Tax Cash Flow, you should apply the minimum rate of return with after tax considerations.

In this lesson, some other measures (such as payback period) will be explained that are helpful but not as important and useful as techniques that we have learned so far. These measures were more common before the 1960s and 1970s, and the disadvantage is they don’t properly consider the time value of money and tax effects.

We will also discuss after-tax decision methods and analysis including sell versus keep, general replacement, comparing the economics of leasing and purchasing, operating and capital leases. For an oil/gas or mining project, it is a common problem to analyze the economics of sell versus keep and replacing existing assets with new assets that are more capital intensive. Replacement analysis does not require any new engineering economy decision making techniques. We will use rate of return, net present value, and break even analysis to address this problem. It is frequently necessary to replace equipment, vehicles, piping systems, and other assets on a periodic basis. Another investment decision for a natural resource project is leasing or purchasing. We will also talk about operating and capital leases in this section.

Learning Objectives

At the successful completion of this lesson, students should be able to:

• conduct payback period analysis;
• distinguish sunk costs and opportunity costs in evaluation; and
• conduct break-even analysis for after-tax cash flows.
• understand the philosophy of general replacement; and
• be able to compare the economics of leasing versus purchasing, and operating versus capital leases.

What is due for Lesson 9?

This lesson will take us one week to complete. Please refer to the Course Syllabus for specific time frames and due dates. Specific directions for the assignment below can be found within this lesson.

Questions?

If you have any questions, please post them to our discussion forum, located under the Modules tab in Canvas. I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.