Finance for engineers : evaluation and funding of capital projects / F.K. Crundwell.

Format:

Book

Author/Creator:

Crundwell, F. K. (Frank Kenneth)

Contributor:

Hazel M. Hussong Fund.

Language:

English

Subjects (All):

Capital investments.

Project management--Finance.

Project management.

Engineering--Finance.

Engineering.

Physical Description:

xxiii, 622 pages : illustrations ; 24 cm

Place of Publication:

London : Springer, [2008]

Summary:

Engineering solutions and financial decisions are intimately tied together. The best engineers combine the technical and financial cases in determining new solutions to opportunities, challenges and problems. In order to get a project approved, no matter its size, the financials must be clear and compelling. To have an impact on the company's performance, a practising engineer must learn to argue the business case as part of the technical solution.

Finance for Engineers: Evaluation and Funding of Capital Projects provides a framework for engineers and scientists to undertake financial evaluations and assessments of engineering or production projects. The material covered enables the reader to understand how the economics of a technical project affects the finances of the company. The integration of the technical and financial decision-making is demonstrated through case studies and examples relevant to the practising engineer. The book equips engineers and scientists with the tools to contribute positively to the financial and strategic decisions within the organization.

Contents:

1 An Overview of the Evaluation and Financing of Capital Projects 3

1.1 Evaluation and Funding of Projects 3

1.2 Project Financials 4

1.3 Evaluating the Project Based on Free Cash Flow 8

1.4 Profit (or Earnings) is Not Required for the Assessment of the Project 11

1.5 Investment Decision Precedes the Financing Decision 11

1.6 Past Expenses are Excluded from the Project Financials 12

1.7 Assessment of the Risk of the Project 12

1.8 Financing of a Capital Project 13

1.10 Looking Ahead 16

2 The Theory and Practice of Decision-making Concerning Capital Projects 19

2.2 Cost-benefit Analysis, Engineering Economics and Capital Budgeting 19

2.3 Perspectives for the Assessment of Projects 22

2.4 Enhancing Value for Investors 23

2.5 Business Context 24

2.5.1 Financial Stewardship Within a Business 24

2.5.2 Sources and Use of Funds 25

2.5.3 Investment and Financing Decisions Within the Business 27

2.5.4 Evaluation of Investment Opportunities 28

2.6 Business Decision-making 29

2.7 A Framework for Decision-making 31

2.7.1 Steps in the Decision-making Process 31

2.7.2 Frame: the Decision Context and Possible Alternatives 32

2.7.3 Evaluate: the Assessment of Alternatives Based on Criteria 34

2.7.4 Decide: the Act of Decision-making 35

2.8 The Practice of Decision-making for Capital Projects 36

2.8.1 Classification of Capital Projects 36

2.8.2 Relationship Between Projects 36

2.8.3 Decision Authority for Capital Projects 37

2.8.4 Case Study: Small Project 38

2.8.5 Case Study: Large Project 40

2.10 Looking Ahead 43

3 Financial Statements 45

3.2 Business Process and the Dual Nature of Transactions 45

3.2.1 The Dual Nature of Transactions 46

3.2.2 Business Process 48

3.3 Financial Records 49

3.4 Accounting Principles and Conventions 49

3.4.1 Business Entity 50

3.4.2 Accrual Accounting 50

3.4.3 Historical Cost 51

3.5 Financial Statements 52

3.5.1 Basic Transactions in a Business 52

3.5.2 Income Statement 55

3.5.3 Balance Sheet 60

3.5.4 Cash Flow Statement 62

3.6 Depreciation 65

3.7 The Interaction Between the Financial Statements 69

3.8 Relationship Between the Financial Statements and the Project Cash Flows 71

3.9 Case Study: Santa Anna Hydroelectric Power Scheme 72

3.9.1 Project Financials 72

3.9.2 Income Statement 74

3.9.3 Cash Flow Statement 75

3.9.4 Balance Sheet 76

3.10 Examining the Business Risks 77

3.11 Case Study: Apex Foods 78

3.12 Ratio Analysis and Financial Trees 83

4 Cash Flows for a Project 91

4.2 Determining the Cash Flows for a Project 91

4.3 Overview of the Stages of Engineering Design and Construction 92

4.4 Approval Procedure 93

4.5 Estimation of the Capital Costs 94

4.5.1 Components of Capital Cost Estimates 94

4.5.2 Classification of Capital Cost Estimates Based on their End Use 96

4.5.3 Classification of Capital Cost Estimates Based on their Level of Accuracy 97

4.6 Estimation Techniques for Capital Costs 101

4.6.1 Factored Estimate Techniques 101

4.6.2 Unit Costs Techniques 105

4.7 Estimation of the Total Operating Costs 106

4.7.1 Direct Production or Manufacturing Costs 107

4.7.2 Fixed Manufacturing Costs 108

4.7.3 Plant Overheads 108

4.7.4 General and Administrative 108

4.7.5 Royalties and Production Payment 109

4.8 Forecasts of the Sales or Revenue 109

4.9 Calculation of the Direct Taxes and Royalties 111

4.9.1 Corporate Tax 111

4.9.2 Capital Gains Tax 112

4.9.3 Royalties 113

4.10 Working Capital 113

4.11 Case Study: Order of Magnitude Estimate of the Capital Cost of a Plant 115

4.12 Case Study: Factored Estimate of the Capital Cost of a Plant 115

4.14 Looking Ahead 119

Part II Evaluation of Capital Projects

5 Time Value of Money 125

5.2 Interest and Interest Rates 126

5.3 Effect of Timing on the Value of Money 126

5.4 Future Value 128

5.5 Multiple Periods 128

5.6 Types of Interest Rates 130

5.6.1 Nominal and Period Interest Rate 130

5.6.2 Effective Rate 131

5.7 Compounding 132

5.7.1 Single Payments: Growth 132

5.7.2 Multiple Equal Payments: Annuities 140

5.7.3 Multiple Periods: Growth Annuities 143

5.7.4 Multiple Payments of Unequal Amounts 146

5.8 Discounting 146

5.8.1 Single Amounts of Future Cash Flow 147

5.8.2 Multiple Equal Amounts 148

5.8.3 Uneven Cash Flows 150

5.9 Compound Interest Formula 151

5.9.1 Single Payment Interest Formula 151

5.9.2 Multiple Equal Payments 151

5.9.3 A Notation for Interest Rate Factors 152

5.10 Case Study: Zero Coupon and Coupon Bonds 155

5.12 Looking Ahead 159

6 Evaluation Criteria for Investment Decisions 163

6.1 Creating Value for the Investor 163

6.2 Non-discounted Cash Flow Techniques 164

6.2.1 Payback Period 164

6.2.2 Return on Investment 167

6.3 Discounted Cash Flow Techniques 168

6.3.1 Net Present Value 168

6.3.2 Profitability Index or Benefit-cost Ratio 172

6.3.3 Internal Rate of Return 173

6.3.4 Modified Internal Rate of Return 180

6.3.5 Discounted Payback Period 181

6.3.6 Benefit-Cost Ratio 183

6.3.7 Equivalent Annual Charge 183

6.4 Comparison Between Discounted Cash Flow Techniques 188

6.4.1 Relative and Absolute Measures 188

6.4.2 Agreement and Conflict Between Measures 189

6.4.3 The Reinvestment Assumption in the NPV and IRR 193

6.5 Case Study: Decision Criteria 195

6.6 Survey of the Most Used Criteria 198

6.8 Looking Ahead 200

7 Mutually Exclusive, Replacement and Independent Projects 205

7.1 Classification of Asset Allocation Decisions 205

7.2 Mutually Exclusive Alternatives 206

7.2.1 Ranking Mutually Exclusive Options with Equal Lives 207

7.2.2 Ranking Mutually Exclusive Projects with Unequal Lives 210

7.2.3 Selection of Mutually Exclusive Alternatives 217

7.3 Replacement Studies: Mutually Exclusive Decisions with an Incumbent 217

7.3.1 Economic Service Life 218

7.3.2 Selection of Defender or Challenger Based on Equivalent Annual Charge 221

7.3.3 Replacement for Service Required for Defined Period 223

7.4 Non-mutually Exclusive or Independent Projects 226

7.4.1 Effect of Starting Times Delays and Project Life 226

7.4.2 Ranking 229

7.4.3 Selection of Projects Under Capital Rationing 232

8 Practical Issues in the Evaluation of Projects 247

8.2 Inflation and Price Escalation 247

8.3 Taxation 253

8.3.1 Tax Position of the Company 253

8.3.2 Methods of Calculation of Depreciation 253

8.3.3 Comparison Between Depreciation Methods 260

8.3.4 Effect of the Depreciation Method on NPV and IRR 260

8.3.5 Disposal of a Depreciable Asset 263

8.4 Choice of the Discount Rate 264

9 Sensitivity, Scenario and Other Decision Analysis Techniques 273

9.2 Influence Diagrams 273

9.3 Sensitivity Analysis 277

9.4 Scenario Analysis 281

9.5 Strategy Space 282

9.6 Decision Analysis 283

9.8 Looking Ahead 288

10 Case Studies on the Application of the Decision-making Criteria 291

10.2 Santa Clara HEPS 291

10.2.2 Decision Frame 293

10.2.3 Evaluation 293

10.2.4 Decide 299

10.3 Mobile Crusher 299

10.3.2 Evaluation 300

10.3.3 Recommendation 302

10.4 Mobile Crusher Contractor 302

10.4.2 Evaluation 302

10.5 Filtration Joint Venture 305

10.5.2 Project Financials 306

10.5.3 Assessment 310

10.5.4 Sensitivity Analysis 311

10.5.5 Commercial Arrangement Between Alex and WasteTek 313

10.5.6 Financing of the Project 314

10.5.7 Recommendation 317

10.6 Bakersfield Water Pumps 318

10.6.2 Project Financials 318

10.6.3 Sensitivity Analysis 321

10.6.4 Recommendation 323

10.7 Combine Harvester 323

10.7.2 Project Financials 323

10.7.3 Evaluation 325

10.7.4 Sensitivity Analysis 325

10.7.5 Pricing 327

10.7.6 Recommendation 327

10.8 PetroGen Oil

Field and Petroleum Refinery 327

10.8.1 Project Financials 328

10.8.2 Assessment 329

10.8.3 Financing of the Project 329

10.9 Looking Ahead 331

10.10.1 Santa Clara HEPS 331

10.10.2 Mobile Crusher 332

10.10.3 Mobile Crusher Contractor 332

10.10.4 Filtration Operation 332

10.10.5 Water Pumps 333

10.10.6 Combine Harvester 333

10.10.7 Petroleum Field and Refinery 334

Part III Risk Assessment

11 Risk and Return 337

11.2 Returns 338

11.3 Certainty and Uncertainty 343

11.3.1 Business Risks 344

11.3.2 Financing Risks 345

11.3.3 Investment Risk 345

11.4 Portfolio Risk 346

11.5 Diversification 350

11.6 The Attainable Region and the Efficient Frontier 351

11.7 Capital Asset Pricing Model 355

11.8 Portfolio Selection 357

11.9 Critique of Finance Theory 360

11.11 Looking Ahead 361

12 Cost of Capital 367

12.2 Cost of Equity 368

12.2.1 Calculating the Cost of Equity from the CAPM 368

12.2.2 Calculating the Cost of Equity from the Growth Model 370

12.2.3 Calculating the Cost of Equity from the Historical Returns 370

12.3 Interest Rates and the Cost of Debt 371

12.4 Pooling of Funds 373

12.5 Weighted Average Cost of Capital 375

12.6 Entity Versus Equity Basis 376

12.7 Practices in the Calculation of WACC 379

12.7.1 Cost of Equity Capital 379

12.7.2 Risk-free Rate 379

12.7.3 Market-risk Premium 380

12.7.4 Beta 380

12.7.5 Weighting Factors in WACC 382

12.7.6 Tax Rate 382

12.7.7 Review Period 383

12.8 WACC, Leverage and Debt Financing 383

12.9 Opportunity Cost of Capital, MARR and the Hurdle Rate 386

13 Risk in Engineering Projects 391

13.2 Sources of Uncertainty 391

13.2.1 Company-level Risks 392

13.2.2 Project-level Risks 392

13.3 Probability Method 393

13.4 Risk-adjusted Discount Rate 398

13.4.1 Company-risk Premium 399

13.4.2 Project-risk Premium 399

13.5 Certainty Equivalent Method 403

13.5.1 Certainty Equivalent Coefficients 404

13.5.2 Certainty Equivalent Risk Premiums 406

13.6 Relationship Between the RADR and the CE Methods 407

13.7 Risk Adjustment Practices 408

13.8 Monte Carlo Simulation 408

13.8.1 Discrete and Continuous Distributions 409

13.8.2 Drawing a Random Sample 412

13.8.3 Monte Carlo Simulation of a Project with One Source of Uncertainty 413

13.8.4 Value at Risk (VaR) 415

13.8.5 Monte Carlo Simulation with Multiple Sources of Uncertainty 416

13.8.6 Review of Assumptions 421

13.10 Looking Ahead 422

14 Decision Tree Analysis and Utility Theory 427

14.2 Decision Tree Analysis 428

14.2.1 Decision, Event and Terminal Nodes 428

14.2.2 Basic Decision Trees 429

14.2.3 Events and Probabilities 430

14.2.4 Value of Terminal Nodes 432

14.2.5 Expected Value and Decision Trees 433

14.2.6 Net Present Value 435

14.2.7 Joint Probability 436

14.2.8 Short-cut Notation 437

14.3 Decision Analysis 437

14.4 Utility Theory and Risk 444

14.4.1 Utility 444

14.4.2 Utility Function 444

14.4.3 Lotteries and Certainty Equivalents 445

14.4.4 Expected Utility 445

14.4.5 Utility and Risk Premium 448

14.4.6 Exponential Utility Function 450

14.4.7 Using Utility to Account for Risk in NPV Calculations 451

15 Real Options Analysis 457

15.2 Financial Options 457

15.2.1 Options Contracts 457

15.2.2 Payoff from an Option 460

15.2.3 Price of an Option 461

15.2.4 Use of Options 462

15.3 Options on Non-financial Assets: Real Options 463

15.4 Examples of Real Options 465

15.4.1 Option to Invest (or Deferral Option) 465

15.4.2 Time-to-built Options 466

15.4.3 Growth Options 466

15.4.4 Abandonment Options 467

15.4.5 Switching Options 467

15.5 The Valuation of Financial Options 467

15.5.1 Risk-free Portfolio 467

15.5.2 Risk-neutral Probability 469

15.5.3 Binomial Lattice 470

15.5.4 Black-Scholes Option Pricing Formula 474

15.6 Valuation of Real Options 476

15.6.1 Option to Invest 476

15.6.2 Option to Abandon 478

15.6.3 Option to Temporarily Close Operations 480

15.6.4 Option to Expand or Contract 480

15.6.5 Option to Switch Between Alternatives 482

15.7 Decision-making Process 482

15.8 Real Options Analysis is Not Decision Tree Analysis 483

15.9 Strategic Thinking and Real Options 484

15.10 Case Study: Phased Expansion of Gas-to-Liquids Operation 485

15.10.2 Staging the Investment Decision 486

15.10.3 Real Options Analysis 486

15.11 Case Study: Value of the Joint Venture Contract for Cuprum 489

15.11.2 Market for Copper Concentrates 490

15.11.3 Revenues 491

15.11.4 Capital and Operating Costs for Cuprum and Smelters 492

15.11.5 NPV of Copper Smelting and Cuprum's Process 493

15.11.6 The Value of the Technology 495

15.13 Looking Ahead 501

Part IV Financing of Capital Projects

16 Sources of Finance 507

16.2 Lenders, Borrowers and Financial Institutions 507

16.3 Financial Securities 509

16.3.1 Equity Instruments 509

16.3.2 Debt Instruments 511

16.3.3 Types of Loans 512

16.3.4 Long-term Debt 517

16.3.5 Short-term Debt 518

16.3.6 Public Issue and Private Placement of Financial Securities 519

16.4 Financial Markets 519

16.4.1 Equity Markets 521

16.4.2 Bond Markets 521

16.4.3 Futures and Derivatives Markets 522

16.5 Financing Decisions Within a Company 525

16.5.1 Capital Structure 525

16.5.2 Dividend Policy 525

16.6 Comparison of Equity and Debt Financing 527

17 Financing Engineering Projects 531

17.2 Financing Engineering Construction of Capital Projects 531

17.2.1 Project Delivery Systems 531

17.2.2 Risk in Engineering Contracting 533

17.2.3 Construction Loans 534

17.2.4 Financial Guarantees 534

17.2.5 Indiantown Cogeneration Facility 535

17.2.6 Eurotunnel 536

17.3 Project Finance 537

17.3.1 Overview of Project Finance 537

17.3.2 Project Structure 537

17.3.3 Risks and Risk Mitigation 538

17.3.4 Assessing Debt Capacity 539

17.3.5 Application of Project Finance 540

17.3.6 Project Finance for the Pembroke Cracking Company 541

17.3.7 Project Finance for the Ras Gas Project 541

17.4 Public-private Partnerships and the Funding of Public Infrastructure 542

17.4.1 Risk Sharing in Public-private Partnerships 543

17.4.2 Structuring of a Public-private Partnership 545

17.4.3 The A1-M1 Link Road 545

17.5 Case Study: Project Finance of a Cogeneration Facility 546

17.5.2 Legal Structure 546

17.5.3 Contractual Arrangements for the Project 547

17.5.4 Project Financials 549

17.5.5 Assessment 552

17.5.6 Financing 552

A Equivalent US and UK Terms Used in the Financial Statements 559.

Notes:

Includes bibliographical references (pages [601]-605) and index.

Local Notes:

Acquired for the Penn Libraries with assistance from the Hazel M. Hussong Fund.

ISBN:

9781848000322

1848000324

OCLC:

173499590

Publisher Number:

99936586939