A civil engineer involved in construction management must decide between two way
ID: 1180559 • Letter: A
Question
A civil engineer involved in construction management must decide between two ways to pump concrete up to the top floors of seven story office building under construction. Plan 1 requires the purchase of equipment for $6000 which costs between $0.40 and $0.75 per metric ton to operate, with a most likely cost of $0.50 per metric ton. The asset is able to pump 100 metric tons per day. If purchased, the asset will last for 5 years, have no salvage value, and be used 50 days per year. Plan 2 is an equipment leasing option and is expected to cost the company $2500 per year for equipment with lost cost estimate of $1800 and a high estimate of $3200 per year. In addition, an extra $5 per hour labor cost will be incurred for operating the leased equipment each 8-hour day. Use i = 12% per year.
A) Which plan should the engineer recommend on the basis of the most likely estimates of cost?
B) Will the decision above change if the pessimistic estimates are used?
Could you please show your excel work? Thank you.
Explanation / Answer
(a)
When equipment is purchased it's first cost is $6000
Most likely operation cost = $0.50 per metric ton
Quantity pumped per day = 100 metric ton
Cost = 100*.5 = $50 per day
No. of days pump is used in a year = 50 days
Operating cost per year = $2500
For calculating the present Value (PV) of the expected costs, we assume that the costs are incurred at the end of the year
When equipment is leased,
Cost of rent per year = $2500
Labour cost = $5 per hour
Cost in a 8-hour day = $40
No. of days pump is used in a year = 50 days
Operating cost per year = $2000
For calculating the present Value (PV) of the expected costs, we assume that the costs are incurred at the end of the year
Thus purchasing the equipment is preferred as the PV of cost in that case is less.
(b) When we use pessimistic values
(1) purchase
Pessimistic operation cost = $0.75 per metric ton
Quantity pumped per day = 100 metric ton
Cost = 100*.75 = $75 per day
No. of days pump is used in a year = 50 days
Operating cost per year = $3750
Making suitable changes in the excel file,
(2)Lease
Pessimistic equipment cost = $3200 per year
Making suitable changes in the excel file,
We now see that the PV of cost is less for Lease option, so if pessimistic estimates are used, Lease of equipment is preferred.
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