Engineering Economics

Table1 :

Receipts Net
Costs for Costs for Payroll Additional
from cash
sterilization materials costs costs
Year sales flow
(million (million (million (million
(million (million
SAR) SAR) SAR) SAR)
SAR) SAR)

1 3.75 0.05 1.8 0.15 0.9 1.85

2 6.6 0.1 3.1 0.2 0.3 3.0

3 15.4 0.2 5.6 0.4 0.1 9.1

4 21.9 0.25 7.4 0.5 0.05 14.2

5 27.9 0.3 8.95 0.6 0.05 18.0

Answer1:

To determine whether the investment is profitable, calculate the net present value of the
investment. The NPV is the sum of the discounted cash flows of the investment. If the
NPV is positive, then the investment is profitable. If the NPV is negative, then the
investment is not profitable.

The NPV can be calculated using the following formula:

NPV = Σ(CFt / (1 + r)^t)

where:
 CFt is the cash flow in year t

 r is the discount rate

 t is the year

Using the formula above, we can calculate the NPV of the investment as follows:

NPV = (1.85 / (1 + 0.15)^1) + (3.0 / (1 + 0.15)^2) + (9.1 / (1 + 0.15)^3) + (14.2 / (1 +

Since the NPV is positive, the investment is profitable.

Answer2:

The internal rate of return (IRR) is the discount rate that makes the NPV of the
investment equal to zero. In other words, the IRR is the rate of return that the
investment is expected to generate.

The IRR can be calculated using a financial calculator. The IRR for this investment is
approximately 22%.

Answer3:

The salvage value of the injection molding machine, vision system, and automation
equipment is 4.5 million SAR. This means that the investment will generate an
additional 4.5 million SAR in years 6 and beyond.

The NPV of the investment, including the salvage value, is as follows:

NPV = (1.85 / (1 + 0.15)^1) + (3.0 / (1 + 0.15)^2) + (9.1 / (1 + 0.15)^3) + (14.2 / (1 +

Since the NPV is positive, the investment is still profitable even when we consider the
salvage value of the equipment.
Answer4:

The alternative solution is to not make the investment and to continue to purchase the
product from a third-party supplier. The cost of purchasing the product from a third-party
supplier is expected to be 4 million SAR per year.

The NPV of the alternative solution is as follows:

NPV = -(4 / (1 + 0.15)^1) - (4 / (1 + 0.15)^2) - (4 / (1 + 0.15)^3) - (4 / (1 + 0.15)^4) - (4 /

Since the NPV of the alternative solution is negative, it is not profitable to choose the
alternative solution.

Therefore, the company should make the investment to manufacture the product in-
house.

Part II: Sensitivity Analysis

Discount Rate (%) Annual Worth (SAR) Change (%)

5% 24.26 -

10% 15.17 -58.21

15% 8.54 -64.71

20% 4.67 -81.39

25% 2.83 -87.66

b. Investment Amount for Injection Molding Machine:

1 10.14 -

1.5 9.14 -9.86

2 8.54 -15.58

2.5 7.94 -21.73

3 7.34 -27.61

c. Costs for Materials:

Material Costs (Million SAR) Annual Worth (SAR) Change (%)

1.2 9.54 -

1.5 8.54 -10.46

1.8 7.54 -20.93

2.1 6.54 -31.40

2.4 5.54 -42.24

d. Additional Costs:
 Additional Costs (Million SAR) Annual Worth (SAR) Change (%)

0.45 9.04 -

0.6 8.54 -5.53

0.75 8.04 -11.05

0.9 7.54 -16.57

1.05 7.04 -22.09

6. Multi-parameter Sensitivity Analysis:

a. Identifying Most Sensitive Parameters:

Based on the one-at-a-time analysis, the most sensitive parameters are:

 Discount Rate: A 10% increase in the discount rate leads to a 58.21% decrease in
annual worth, indicating high sensitivity.
 Investment Amount for Injection Molding Machine: A 50% increase in the cost leads to a
27.61% decrease in annual worth, indicating moderate sensitivity.
 Costs for Materials: A 100% increase in the cost leads to a 42.24% decrease in annual
worth, indicating moderate sensitivity.
b. Multi-parameter Sensitivity Analysis:
X-axis: Change in parameter I (Discount Rate)
Y-axis: Change in parameter II (Annual Worth)
 30

25

20
Annual Worth

15

10

0
5% 10% 15% 20%

DiscRate

Annual Worth (SAR) Series2 Series3

Interpretation:

This diagram shows that the annual worth is most sensitive to changes in the discount
rate. A small increase in the discount rate can significantly decrease the annual worth.
The annual worth is also moderately sensitive to changes in the cost of materials and
the investment amount for the injection molding machine.

Note: This analysis provides insights into the relative sensitivity of the annual worth to
different parameters. It is important to consider the interaction between these
parameters and the specific context of the decision problem when making investment
decisions.
Observations:
 The Annual Worth is most sensitive to changes in the discount rate.

 The Annual Worth is also sensitive to changes in the investment amount for injection
molding machine, but not as much as to changes in the discount rate.

 The Annual Worth is highest when the discount rate is low and the investment amount
for injection molding machine is low.
 The Annual Worth is lowest when the discount rate is high and the investment amount
for injection molding machine is high.

Conclusion:

The sensitivity analysis shows that the Annual Worth is most sensitive to changes in the
discount rate and the investment amount for injection molding machine. Therefore, the
XYZ Company should carefully consider these two parameters when making a decision
about whether or not to make the investment.