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Eco

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by

Mahmoud El Zahed

on 8 June 2014

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Transcript of Eco

Economic Strategies
What is the problem?
Elmer owns the “
gulf coast wholesale auto parts
” business.
He needs the business to keep running for the next
5 years
and wants to sell it
after that
.
However his son provided him with
4 other alternatives
that would keep the business running.
Calculations Needed
In order to evaluate the given alternatives, we need to calculate:
Present Worth
Annual Worth
Rate of Return (ROR)
We need to get the expected number of RORs
Incremental Analysis
Alternatives
We have 5 alternatives to choose the
most economic
one between them
Incremental Analysis
How an Engineering Graduate can help his Father?

A CASE STUDY

For each alternative
Mutually Exclusive
events
Alternative 1
Gulf coast operates an additional rebuild shop providing their customers with major automobile components. This alternative suggests
removing
this part of the business and
concentrate
on selling
wholesale
parts. The removal of the rebuild operations and the switch to an all parts house are expected to cost $750,000 in the first year. Overall revenues will drop to $1,000,000 the first year with an expected 4% increase per year thereafter. Expenses are projected at $800,000 the first year, increasing 6% per year thereafter.
Alternative Description
Cash flow
$ 1134.81

$ 1265.3

$ 1351.53

$ 1275.0

$ 1202.290

$ 1070.58

$ 1009.982

$ 952.812

$ 898.88

$ 848

$ 800

$ 1423.312

$ 1000

$1040

$ 1081.6

$ 1124.864

$ 1169.859

$ 1216.653

$ 1315.932

$ 1368.569

$750

years

3

10

9

8

7

6

5

4

1

2

0

Alternative 2
$ 2000

$ 1876.67

$ 1400

$ 2000

$ 2000

$ 2000

$ 2000

$ 1400

$ 1400

$ 1400

$ 1400

$ 2171.86

$ 1400

$1470

$ 1543.5

$ 1620.67

$ 1701.70

$ 1786.79

$ 1969.94

$ 2068.43

$ 400

years

3

10

9

8

7

6

5

4

1

2

0

$ 5000

$ 500

$ 500

$ 1650

$ 1150

$ 1150

$ 1150

$ 1150

$ 1250

$ 1250

$ 1250

$ 1250

$ 1250

years

3

10

9

8

7

6

5

4

1

2

0

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3500

$ 3000

$ 1000

$ 3000

$ 3000

$ 3000

$ 3000

$ 3000

$ 3000

$ 3000

$ 3000

$ 3000

years

3

10

9

8

7

6

5

4

1

2

0

$ 1000

$ 1000

$ 1000

$ 1000

$ 1000

$ 1000

$ 1000

$ 1000

$1000

$ 1000

$ 500

$ 1500

$ 500

$ 500

$ 500

$ 500

$ 500

$ 500

$ 500

$ 500

$ 500

years

3

10

9

8

7

6

5

4

1

2

0

Alternative Description
Cash flow
Alternative 3
Alternative Description
Cash flow
Alternative 4
Alternative Description
Cash flow
Alternative 5
Alternative Description
Cash flow
To get the rebuild shop ready for an
operations contractor
to
take over
will cost $400,000 immediately. If expenses stay the same for 5 years, they will average $1.4m per year, but they can be expected to rise to $2m per year in year 6 and thereafter. Elmer thinks revenues under a contract arrangement can be $1.4m in the first year and expected to rise 5% per year for the duration of a 10 year contract.
Elmer’s Wish is to
sell out completely
after 5 more years at this price, and to make a deal that the new owner pay $500,000 per year at the end of year 5 (sale time) and the same amount for the next 3 years. There is
no cost now
, but the current trend of
negative

net profit
will probably continue. Projections are $1.25 million per year for expenses and $1.15 million per year in revenue. Elmer had an appraisal last year, and the report indicated Gulf Coast Wholesale Auto Paris is
worth a net $2 million
.
Elmer has a close friend in the antique auto parts business who is making a large profit, “so he says, with
e-commerce
”. Although the possibility is risky, it is enticing to Elmer to consider a
completely

new

line
of parts, but still in the basic business, that he already understands. The trade-out would cost an estimated $1 million for Elmer immediately. The10-year horizon of annual expenses and revenues is consider-ably higher than for his current business. Expenses are estimated at $3 million per year and revenues at $4.5 million each year.
Gulf Coast could be
leased
to some turnkey company with Elmer remaining the owner and bearing
part of the expenses
for building delivery trucks, insurance, etc. The first-cut estimates for this option are $1.5 million to get the business ready now, with annual expenses at $500,000 per year and revenues at $1 million per year for a 10-year contact.
PW vs i
PW vs i
PW vs i
PW vs i
PW vs i
The 4 options were arranged in ascending order according to the initial cost.
The rates of return were compared to the MARR which was 25% and alternatives with a rate of return less than the MARR were rejected. Alternatives rejected were 1 and 2.
Alternative 4 was compared to alternative 3
by calculating the incremental cash flow and from it the incremental ROR. The incremental ROR was calculated to be 49.85% which was found to be higher than MARR so
alternative 4 became the defender and 3 was rejected
.
Alternative 4 became the defender.
Alternative 4 was compared to alternative 5
using the same previous method and since alternative 5 was converted all to a single payment such that it has
no ROR
.
Alternative 4 is the best option
Net Cash flow
Expected 1 ROR
Net Cash flow
Expected 3 ROR
Net Cash flow
Expected 1 ROR
Net Cash flow
Expected 1 ROR
Net Cash flow
Expected 1 ROR
ROR = 17.44 %
ROR = 10 %
ROR = 46.41 %
ROR = 49.08 %
ROR = 31.11 %
How to make Alternative 3 the most Economic Alternative?
Since alternative 3 was Elmer’s
favourite
some
adjustments
had to be made to make it the
best
economic alternative

First of all, the
value
needed to be
added
to alternative 3 was
calculated
using
solver
by using the following equation:
Using this equation we would find the
minimum
needed value to be
added
to the cash flow of alternative 3 for it to become the defender against alternative 4. This value was calculated to be
$589,804.5895
.
ROR(Cash flow (4) – (Cash flow (3) – X)) = MARR
PW vs i Graph
THANK YOU !
Full transcript