NigeriaAACE

April 22, 2011

Week 8_ Agbato Oluwabusayo_Using Equivalence Calculations Method to resolve Financial Capital Problem_Week 19 _SeeGod Meregini

I have been thinking of establishing a family business that my wife will manage fulltime and I supporting on part-time weekend basis. An opportunity came our way for the wholesale distribution of FMCG covering the area we have our property. In the past we have done our feasibility and confirmed the viability of this business in the locality. The initial Capital of $32,000.00 required was more than our combined savings of $23,000.00. We resolved that this opportunity must not be allowed to slip by, so we resolved to raise the required starting capital. In doing this we have to look at various alternatives of raising the required capital, hence the need to evaluate these alternatives to determine the best. In this analysis the time value of money is a consideration.

Development of Feasible Alternatives/Solutions

After brainstorming on the different ways of raising the required capital, the following alternatives were considered.

Alternative 1

To obtaining a bank facility of $32,000.00 from a bank using the $23,000.00 savings, as collateral at 20% local interest rate, payable in 3 years.

Alternative 2

To obtain a bank facility of $9,000.00 to make up the capital required at 20% local interest rate payable in 3 years.

Alternative 3

Taking a loan of $32,000.00 from a cooperative society that I’m a member, at membership rate of 9.0% simple interest, payable in 3 years and fixing our $23,000.00 at the current deposit interest rate of 11%

Probable Outcomes of Alternatives / Solutions.

Having read books and discussed with friend, colleagues, mentors and others, the common solution was that we have to look outside ourselves to raise the amount required. Friends and families would have love to help, but wants their money back in months, which was not convenient for us, Hence our looking up to institutions for assistance.

Selection Criteria in determining the solution

1. The least interest payment per time

2. Convenience of payment of loan.

3. Assurance of debt payment, in order not to ending up with debts (I dread this)

4. Need to maintain at least my current standard of living

5. Use my savings only to cater for this project

Analysis and Comparison of the alternatives

In finding the future equivalent of invested savings

The formulas below were used in determining the Future Equivalent of savings relative to bank interest on loans.

I = (P)(N)(i) ......................................................................................Equation 1

F = P(1 + i)^N ......................................................................................Equation 2

P = A (P/A, i%, N) ......................................................................................Equation 3

and Discrete Compounding Tables,

Where:

F = Future Value

P = Present Equivalent value

N= Number of compounding (interest) periods

A= Annual Equivalent value (occurs at end of periods 1 through N, inclusive.

Quantitative analysis of the alternatives

Alternative 1

I = 20%

P = $32,000.00

N = 3 years

Using equation 2, Compound interest calculations

F_$32000 = $32000(1 + 0.2)³

= $32000(1.2)³

= $32000 x 1.44

= $46,080

Fixing our $23,000.00 at the current deposit interest rate of 11%

F_$23000 = $23000(1 + 0.11)³

= $23000(1.11)³

= $23000 x 1.3676

= $31,455

Loss over 3 year period = $31,455 - $46,080 = -$14,625

Alternative 2

Using also equation 2,

I = 20%

P = $9,000.00

N = 3 years

Using equation 2, Compound interest calculations

F_$9000 = $9000(1 + 0.2)³

= $9000(1.2)³

= $9000 x 1.728

= $15,552

Loss over 3 year period = P – F = $9,000 - $15,552 = -$6,552

Alternative 3

Using similar cash flow diagram,

Using also equation 1,

I = 9%

P = $9,000.00

N = 3 years

Using equation 1, Simple interest calculations

I = (P)(N)(i)

I = $32000(3)(0.09)

= $9,600.00

Loss over 3 year period = $31455 - $23000 - $8,640 = -$185.00

Selection of Preferred Alternative

Based on the above quantitative analysis and criteria, I recommend ALTERNATIVE 3, because, it satisfies all the selection criteria.

The time value of money effect has resulted in Alternative 3 being chosen.

Performance Monitoring/Post Evaluation

The performance monitoring and post evaluation required is to ensure that:

· Savings investment performs

· The FCMG distributorship business is profitable.

References

Sullivan, W. G., Wicks, E.M., & Koelling, C.P. (2009). Cost Concepts and Design Economics. In M.J. Horton (Ed.), Engineering economy (15^th ed.) (chapter 4) New Jersey, NJ: Pearson Education, Inc.

United States Government Accountability Office (2009, March). Cost Risk and Uncertainty. GAO Cost Estimating and Assessment Guide. Best Practices for Developing and Managing Capital Program Costs. (chapter 14) (pp.160).Washington, DC: GAO.

AACE International Education Board. (2006). Risk Management. In J.K.Hollmann (Ed), Total cost management framework – A process for applying the Skills & knowledge of cost engineering (1st ed) (chapter 7.6.1) (pp.159-160). Morgantown, West Virginia: AACE International.

Week 7_ Agbato Oluwabusayo__Determining the right deal in material purchase_Week 18 _SeeGod Meregini

Problem Recognition/Evaluation

A new material was to be bought by my purchasing company and I was told to work with the team in evaluating a good deal from a list of alternatives.

The root cause needed for this extra support was because of the following reasons:

· Previous purchases had been made based on incorrect analysis of cost cut deals in the offers.

· Previous purchases had higher prices gotten from hidden charges in the proposed offers

· Improper evaluation of previous vendor deals associated with the purchases materials resulted in more costly investments.

I needed to correctly evaluate the best economic alternative.

In this analysis the life of the materials would exceed one year hence the time value of money is a consideration.

Development of Feasible Alternatives/Solutions

After evaluations of different vendors and cut deals on their materials, three feasible alternatives is used based on cost that would be saved due to cut deals in the offers. The life of each of these materials was 7 years.

In carrying out this analysis, an assumption is that depreciation would not be calculated for each alternative.

Alternative 1-

Material 1

Alternative 2 –

Material 2

Alternative 3-

Material 3

Probable Outcomes of Alternatives / Solutions.

Stakeholders meetings within and between various departments including the vendors were held to determine the various savings included in the offers.

In this analysis evaluation is made on the potential cost savings in each bid offers.

Costs used are factored but have same equivalence with original for the purpose of showing the final result.

A breakdown is given below

Attributes	Material 1	Material 2	Material 3
Saved cost due to free services	$50	$70	$30
Free services	2/year	1/year	3/year
Interest on savings	5%	3%	2%

Selection Criteria in determining the solution

1. The highest cost deal would be selected

2. The most economical material based on cost savings from the deals offered would be selected.

Analysis and Comparison of the alternatives

In finding the present equivalent of the cost of future savings, a cash flow diagram would be used.

The formula below is used in determining the Present Equivalent of this future costs assuming the company is saving these costs (A) annually in a bank at different interest rates based on the provision of the banks.

P = A (P/A, i%, N) ......................................................................................Equation 1

Where:

P = Present Equivalent value

N= Number of compounding (interest) periods

A= Annual Equivalent value (occurs at end of periods 1 through N, inclusive.

Using N = 7 years for all alternatives

Quantitative analysis of the alternatives

A = $50

Alternative 1- Material 1

Time of purchase

133

End of Quarter

P = ?

I = 5%

A = $50

N (Cash flows periods) = 14 free services (2 free services /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $50(P/A, 5%, 14)

= $50 *9.8986

= $494.93

Alternative 2 – Material 2

Using similar cash flow diagram,

I = 3%

A = $70

N (Cash flows periods) = 7 free services (1 free service /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $70(P/A, 3%, 7)

= $70 *6.2303

= $436.1

Alternative 3- Material 3

Using similar cash flow diagram,

I = 2%

A = $30

N (Cash flows periods) = 21 free services (3 free services /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $30(P/A, 2%, 21)

= $30 *17.0112

= $510.336

Selection of Preferred Alternative

Based on the above quantitative analysis and criteria, I recommend ALTERNATIVE 3.

In addition, the fact that material 1 seems to have more cost savings that material 3, this does not mean it is a better deal.

The time value of money effect has resulted in Alternative 3 being chosen.

Performance Monitoring/Post Evaluation

This would be monitored by constantly evaluating

· The other risk factors not being analysed in the calculations like increased cost of maintenance to mention a few.

· The effect of depreciation on the market value of these materials after 7 years.

References

Sullivan, W. G., Wicks, E.M., & Koelling, C.P. (2009). Cost Concepts and Design Economics. In M.J. Horton (Ed.), Engineering economy (15^th ed.) (chapter 4) New Jersey, NJ: Pearson Education, Inc.