W4_A_Selection Oil Pump Using Present Worth Method

  1. Problem Definition

The decline in world oil prices resulted in the need for an efficiency program, one of which is efficiency in investing. In 2014 the price of oil is at USD 89 / barrel, but it has been more than 2 years the position of oil price has not moved from USD 47 / barrel, in 2015 the company conducts efficiency program in terms of investment by pressing Capital Expenditure, in Marketing Directorate one of routine investment on Oil Transfering Facility. High level management want to reduce cost by selection on Pump Investment.

  1. Develop the Feasible Alternative

Management purpose 2 alternative, among others:

1.Using API Pump

2.Using Non-API Pump.

Compare Value from Present Worth Method approaching will be use  will be use to select. 

  1. Development of The Outcome for Alternative

Calculate all variable including Capital Expenditure/Capex, net income, operating cost, maintenance cost, and salvage value from internal company data.

  1. Selection Criteria

The acceptance criteria when the present worth value or PV ≥ 0 or the large value.

5. Analysis & Comparison of Alternative

Regarding to company data, that we summarize on Tabel-1 which represent for using API Pump.

Tabel-1 API Pump Cash Flow (in IDR)

Refer to Bank Indonesia Rate at 2017 is 7%, now we can drag Future Value/FV from 10th year to zero (initial) to calculate Present Value/PV, a summarize calculation represent on Tabel-2.

Table-2 PV for all cash flow API Pump (in IDR)

Regarding to Tabel-1 and Tabel-2 now we can total Cash Flow in and out IDR. 2.133.894.555 + IDR. (900.000.000) = IDR. 1.233.894.555 (API Pump is economically justified because PW ≥ 0 ) but we not finished yet, we have to calculate for NON-API Pump.

next step we calculate for NON-API Pump, the cash flow show on tabel-3.

Tabel-3 NON API Pump Cash Flow (in IDR)

Regarding to tabel-3, now we can calculate PV for all year cash flow, it shown on tabel-4

Tabel-4. PV for all cash flow NON-API Pump (in IDR)

Regarding to Tabel-3 and Tabel-4 now we can total Cash Flow in and out IDR. 1.897.707.948 + IDR. (600.000.000) = IDR. 1.297.707.948 (NON-API Pump is economically justified because PW ≥ 0 )

Now we can compare each PW from API and NON-API Pump, it shown on tabel-5

Tabel-5 Comparasion API and NON-API Present Worth Value (in IDR)

6. Selection of the Preferred Alternative

Regarding to tabel-5 it shown that Non-API Pump has PW Value higher than API Pump, gap value between them is IDR.63.813.394, it can conclude that NON-API Pump in economically point of view can justified to selected. But we prefer select API Pump as our Pump Selection, the reason is API Pump a best practice use in Oil and Gas Industry and has high reliability record. If economy GAP only IDR.63.813.394 management can accept it as cost, cause PW ≥ 0 and investment decision can select API Pump.

7.Performance Monitoring and The Post Evaluation of Result

Management must monitor maintenance cost, because maintenance cost has give effect to select better decision.

Reference :

  1. Sullivan, G. W., Wicks, M. E., & Koelling, C. P.(2014). Engineering economy 16th Edition. Chapter 5 – Evaluating a Single Project., pp.213-215.
  2. BI Rate and Primary Reserve Requirement Lowered Again (February, 2016) Retrieved from http://www.bi.go.id/en/ruang-media/siaran-pers/Pages/sp_181416.aspx
  3. Module 06-5 – Acquiring Equipment for The Project (2016)
    Retrieved from http://www.planningplanet.com/guild/gpccar/acquiring-equipment-for-the-project
  4. Berrado, Abdelaziz Dr. Present Worth Analysis (2016) Retrieved from : www.aui.ma/personal/~A.Berrado/EGR2302/EGR2302_Ch05.pdf

 

 

 

 

 

 

 

 

 

 

 

 

1 thought on “W4_A_Selection Oil Pump Using Present Worth Method”

  1. Hi Pak Ardi,
    I am curious why you would run a PW analysis (which you did a great job on) but then when you find out that the Non-API pump has the better PW, that your management picks the other pump?

    Not to sure why you don’t use the Life Cycle Costing model and then show exactly what your management is using to make a decision?

    Also what about using IRR or ERR as the basis for making the decision?

    Bottom line- I don’t understand why your management would conduct a financial analysis and then IGNORE the results in making their decision? Exactly WHAT are they using then as the basis to make their decision?

    BR,
    Dr. PDG, Perth, Australia

     

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