Page 191 - DMGT521_PROJECT_MANAGEMENT

Project Management

Notes law. While it is almost certain that a new development would occur when it would occur is
anybody’s guess. Yet an estimate of the technological life has to be made.
Product Market Life of the Plant: A Plant may be physically usable, its technology may not be
obsolete, but the market for its products may disappear or shrink and hence its continuance may
not be justified. The product Market Life of a plant refers to the period for which the product of
the plant enjoys a reasonably satisfactory market.
Investment Planning Horizon of the Firm: The time period for which a firm wishes to look
ahead for purposes of investment analysis may be referred to as its investment planning horizon.
It naturally tends to vary with the complexity and size of investment. For small investment it
may be 5 years, for medium investment it may be 10 years and for large size investments it may
be 15 years.

Notes To evaluate a project, you must determine the relevant Cash Flows, which are the
incremental after-tax cash flows associated with the project.

Self Assessment

Fill in the blanks:
1. ………………… is the movement of money into or out of a business, project, or financial
product.

2. New Technological Developments tend to render existing plants …………………
3. A ………………… may be physically usable, its technology may not be obsolete.
4. The ………………… for which a firm wishes to look ahead for purposes of investment
analysis may be referred to as its investment planning horizon.

11.3 Cash Flow for a Replacement Project

These are projects where the firm must either: replace worn out equipment or invest in new
equipment that is expected to lower current production costs and/or increase current sales.

1. Example Q: The old machine has the following history of high maintenance cost and
significant downtime. Downtime on the machine is a major inconvenience, but it doesn’t
usually stop production unless it lasts for an extended period. This is because the company
maintains an emergency inventory of stamped pieces and has been able to temporarily
reroute production without much notice. Manufacturing managers estimate that every
hour of downtime costs the company $500, but have no hard data backing up that figure.
Example $45 $42 $35 $10 In warranty Maintenance expense ($000) 128 130 100 60 40 Hours
down 5 4 3 2‘ 1 Year.
2. Example Q: The makers of the replacement machines have said that Harrington will spend
about $15,000 a year maintaining their product and that an average of only 30 hours of
downtime a year should be expected. However, they are not willing to guarantee those
estimates after the one-year warranty runs out. The new machine is expected to produce
higher quality output than the old one. The result is expected to be better customer
satisfaction and possibly more sales in the future. Management would like to include
some benefit for this effect in the analysis, but is unsure of how to quantify it. Estimate the
incremental cash flows over the next five years associated with buying the new machine.
Assume Harrington’s marginal tax rate is 34%, and that the company is currently profitable

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