Module-IV

Value Analysis and value Engineering: Cost Value, Exchange Value, Use Value,
Esteem Value - Aims, Advantages and Application areas of Value Engineering -
Value Engineering Procedure Capital Budgeting: Time value of money - Net
Present Value Method - Benefit Cost Ratio – Internal Rate of Return -– Payback
– Accounting Rate of Return.

Value Analysis (VA) and Value Engineering (VE) are systematic, function-
oriented approaches used in product design, cost reduction, and process
improvement. Both aim to increase the value of a product or service by either
improving its function or reducing its cost without affecting quality or
performance. Though closely related, they differ mainly in their timing and
application.
Value=Function/Cost
To increase value, we can:
Improve the function (better quality, features, durability, etc.)
Reduce the cost (cheaper materials, simpler processes, etc.)
Or ideally, [Link] values are of four types- cost value, use value, esteem
value& exchange value
Cost Value
Definition: The total cost incurred to produce a product or service, including
materials, labor, overheads, etc.
Example: If it costs ₹500 to manufacture a chair, then ₹500 is its cost value.
Exchange Value
Definition: The market price at which a product or service can be sold or
exchanged.
Example: If the fan sells in the market for ₹1,200, that’s its exchange value.
Use Value
Definition: The value derived from the functionality or utility of a product or
service.
Example: A fan provides air circulation — that’s its use value.
Esteem Value (Psychological or Prestige Value)
Definition: The emotional or social value a customer attaches to a product, often
due to brand, design, or status.
Example: A luxury watch may have high esteem value due to its brand name,
even if its use value is the same as a basic watch.
Value Analysis(VA)
Definition:
Value Analysis is a method to improve the value of an existing product, system,
or service.
Key Characteristics:
Applied after a product or service is in production.
Focuses on cost reduction, quality improvement, or process enhancement.
Examines if the product can be made cheaper or better without affecting
function.
Example:
A manufacturer reviews an existing chair design to see if a different material can
be used to lower cost without compromising strength or comfort.

[Link] Devi T R ,Associate Professor,ASIET Kalady

Value Engineering(VE)

Definition:
Value Engineering is a similar methodology but applied before the product or
process is fully developed — usually during the design phase.
Key Characteristics:
A proactive approach during product development or project planning.
Aims to prevent unnecessary costs before they occur.
Seeks innovative alternatives in materials, processes, or design to deliver
maximum value.
Example:
An engineering team designing a new smartphone evaluates different battery
types and screen technologies to optimize performance, cost, and durability
before finalizing the design.
Value Analysis (VA) Value Engineering (V
Feature
E)

Timing After production Before production

Cost reduction of existin Design optimization and

Focus
g product cost prevention
Goal Improve value through r Maximize value from th
edesign e start
Nature Corrective Preventive

Aims of Value Engineering

 Improve Value
 Reduce Costs
 Encourage Innovation
 Promote creative and alternative thinking to solve design and process
challenges.
 Enhance Product Quality
 Improve durability, usability, and reliability by selecting better materials,
processes, or designs.

Advantages Of Value Engineering

 Helps to reduce unnecessary costs by identifying and eliminating

unnecessary cost.
 It improves the overall value of a product or service
 Value Engineering encourages innovation by promoting creative thinking
and the exploration of alternative materials, designs, or methods.
 It increases efficiency in design and production, resulting in faster processes,
less waste, and smoother operations.
 VE enhances product quality and customer satisfaction.

[Link] Devi T R ,Associate Professor,ASIET Kalady

 .VE minimizes material and resource waste, leading to more sustainable and
environmentally friendly outcomes.
 VE gives companies a competitive advantage by enabling them to deliver
high-quality products at lower costs compared to their competitors.

Application Areas of Value Engineering

 Value Engineering can be applied in almost any field where cost, design, and
function matter. Major areas include:
 In manufacturing- By improving product design, reducing waste and
streamlining the production process
 In construction and civil engineering, VE helps optimize building designs,
select cost-effective materials.
 Infrastructure project- By optimising design
 Energy & Utilities: By optimising energy production, transmission &
distribution
 It is also useful in machine tool industries, auto industries etc

Value Engineering Procedure

The basic steps are:

A) Blast: identify the product, Collect relevant information & Define different
functions(primary, secondary etc).
B) Create: different alternatives and critically evaluate the
alternatives(brainstorming session can be used)
C) Refine: Develop the best alternative and implement the alternative

Value Engineering Procedure

Phase Objective
Information Understand the product/process
Function Analysis Identify and classify functions
Creative Generate alternative ideas
Evaluation Screen and select best ideas
Development Turn ideas into practical solutions
Presentation Recommend changes to stakeholders
Implementation/Follow-
Apply and monitor improvements
Up

Capital budgeting

Rational allocation of a firm’s scare resources in to various investment

opportunities to maximise the objective. The various steps are planning,
analysing, selecting, financing, implementing and reviewing. Investment criteria
can be broadly classified in to two categories: (1) Discounting criteria

[Link] Devi T R ,Associate Professor,ASIET Kalady

(2) Non –Discounting criteria. Discounting criteria takes in to account of time
value of money

The Time Value of Money (TVM)

The Time Value of Money (TVM) is a basic financial principle that says:
“A sum of money today is worth more than the same sum in the future.”
This is because money can earn interest, be invested, or lose value due to
inflation over time.
The popular methods under discounting criteria are:
(i) NPV (Net Present Value)
(ii) BCR( Benefit Cost Ratio)
(iii) IRR(Internal Rate of Return)

NPV(Net Present Value)

NPV is the difference between the sum of the present values of all the cash flows
and the initial investment

ie, NPV=C1/1+r)1+ C2/1+r)2+…..+Cn/(1+r)n –Co

Where C1, C2, … Cn are cash flows of the year 1 to n
r= discounting factor which is given as cost of capital
Co= Initial investment
NPV = ∑PV - Co
If NPV› 0 , accept the project
NPV‹ 0, Reject the project

1. Initial investment is 50 million

Year: 1, 2, 3, 4
Cash flows(million): 11, 19, 32, 37
Cost of capital is given as: 10%
NPV= 11/ (1+.10)1 + 19/ (1+.10)2+ 32/ (1+.10)3+ 37/ (1+.10)4 -50 =25.02
If NPV › 0 we accept the project
Initial investment is only 50, PV= 75

2. A firm invest 25000 in a project and it gets returns for a period of 5 years. The
cost of capital is 10%. Cash flows before tax and depreciation are 9000, 8000,
7000, 6000 and 5000 respectively. If tax is 10% estimate NPV

Year Cashflow Cashflow after PV@10%

tax
1 9000 8100 8100/(1+.10)1= 7363.64
2 8000 7200 7200/(1+.10)2 = 5950.41
3 7000 6300 6300/(1+.10)3 = 4733.28
4 6000 5400 5400/(1+.10)4 = 3688.27
5 5000 4500 4500/(1+.10)5 =2794.15
NPV = ∑PV - Co = 24529.75 -25000= -470.25 ∑PV = 24529.75

[Link] Devi T R ,Associate Professor,ASIET Kalady

3. Suppose the initial investment of a project is Rs. 2500 and during the second
year firm makes an additional investment of Rs 1000. The cost of capital or the
opportunity cost of capital is 10%. Estimate NPV of the project based on the
cashflows (before depreciation and after tax) given below. The scrap value at the
end of the 5 th year is Rs. 400
Year: 1 2 3 4 5
Cashflow: 900 800, 700, 600, 500
Co= 2500+(1000/(1+.10)2= 3326
NPV=900/(1+.10)1+800/(1+.10)2+700/(!+.10)3+600/(1+.10)4+500/(1+.10)5+400/(1
+.10)5- 3326
=2793-3326= -353 (Reject the project)

4. Consider the following projects having cash flows after tax and before
depreciation
1. Calculate NPV
2. Rank the project
3. if the projects are independent which one will be selected
4. If the projects are mutually exclusive which one will be the best

Project Co C1 C2 C3

A -10000 7500 7500 -

B -10000 2000 4000 12000
C -10000 10000 3000 3000

Merits of NPV
It recognise time value of money
It is easy to calculate and simple to understand
It considers all cash flows
NPV of two or more projects can be compared to take a decision
Demerits
Computation is difficult
It is difficult to determine an appropriate discount rate.
It is expressed in absolute terms rather than in relative terms without
considering the scale of investment

Profitability Index (PI)or Benefit Cost Ratio(BCR)

It is the ratio of present value of cash flows to initial investment

BCR= C1/1+r)1+ C2/1+r)2+…..+Cn/(1+r)n/Co

BCR= ∑PV Ú Co
If BCR›1 we accept the project

[Link] Devi T R ,Associate Professor,ASIET Kalady

BCR= 1, Indifferent
BCR‹ 1 , Reject
1. A project initial outlay is Rs. 5000 and gives Rs. 4000,3000 and 2000 in year
one, two and three respectively. If the discount rate is 10% calculate BCR
BCR= 4000/(1+.10)1+ 3000/(1+.10)2+ 2000/(1+.10)3
5000

= 1.52

Merits & Demerits of BCR

Merits
Recognises the time value of money
It considers all cashflows
A relative measure of a project’s profitability
Limitations
Due to uncertainty , it is difficult to obtain the estimate of cash flows
It is difficult to measure the discount rate precisely

IRR(Internal Rate of Return)

It is the discount rate which makes its NPV=0

Or it is the discount rate that equates the investment outlay with the present
value of cash inflows
Co= ∑PV
If IRR> Cost of capital = accept the project
IRR< Cost of capital = Reject
Merits
1. Recognise the time value of money
2. Considers all cash flows during the entire life of a project
[Link] is consistent with the shareholders wealth maximisation objective
Demerits
1. It is very difficult to esimate IRR
2. It is time consuming
3. It is not a suitable method to rank project when capital costs are different

[Link] Devi T R ,Associate Professor,ASIET Kalady

Non Discounting Criteria

Pay Back Period(PBP)

It is the length of time required to recover initial investment. If the PBP< TP
(targeted period), we accept the project
P= CÚA where P= PBP, C is the initial cash outlay and A is the annual cash flow.
If cash flows are unequal the PBP is found out by adding up the cash inflows
until the total is equal to the initial cash outlay.
PBP= N+ B Ú A

[Link] Devi T R ,Associate Professor,ASIET Kalady

[Link] Devi T R ,Associate Professor,ASIET Kalady
[Link] Devi T R ,Associate Professor,ASIET Kalady
ARR(Average Rate of Return)

ARR= Average Earnings/Average investment*100

Average Earnings= Total Earnings/ life of the project
Average investment= Total investment/2
If in the question salvage value or scrap value is given ,
Average investment= Total investment+ salvage/ scrap value/2

1. Cost of capital = 80000

Year: 1, 2, 3, 4, 5
Cash flows: 8000, 24000, 32000,48000,32000
Here Average Earnings= 8000+24000+32000+48000+32000/5=28800
Average investment= 80000/2= 40000
So ARR= 28800/40000*100= 72%

2. Cost of capital 70000

Years: 1, 2,3,4,5
Earnings: 24000,32000,40000,24000, 16000
Salvage value is given as 2000
Average Earnings= 24000+32000+40000+24000+16000/5=27200
Average investment+ 70000+2000/2=36000
ARR= 27200/36000*100= 75.5%

[Link] of capital 70000

Years: 1, 2,3,4,5
Earnings: 24000,32000,40000,24000, 16000
Salvage value is given as 2000
Average Earnings= 24000+32000+40000+24000+16000/5=27200
Average investment+ 70000+2000/2=36000
ARR= 27200/36000*100= 75.5%

[Link] Devi T R ,Associate Professor,ASIET Kalady

[Link] Devi T R ,Associate Professor,ASIET Kalady