W6_HPO_Determining The Asset’s Economic Life

1. Problem Statement

We plan to buy a new medium FPSO which costs estimated around US\$ 50,000,000. Initially, we don’t have any clue for how long this new asset FPSO to give positive economic value. In finding the economic life of this asset, we will know when should we have to retire the asset. So the problem is how long the economic life of this new FPSO?

2. Feasible Alternatives

According to Sullivan in his book “Engineering Economy”, determining the span of economic value of a new asset can be determined by comparing between the actual Total Cost (TC) of the asset and the Equivalent Uniform Annual Cost (EUAC) of the asset. The span of the economic life of the asset will stop at year k when TC at year k+1 is higher than EUAC at year k+1.

TC = Difference Loss between Market Value at year k (MVk-1 – MVk) + Cost of Capital at year k (i% x MVk-1) + Annual Expense at year k (AEk)

EUAC = Annuity of PV of Investment at year k I(A/P,i%,k) – Annuity of FV of expected MV at year k MV(A/F,i%,k) + Annuity of Sum of PV of the Annual Expense (AE) at year k ƩPVof AE(A/P,i%,k)

3. Develop The Outcome of Each Alternatives

Because we don’t know yet the economic life of the asset, here below the assumptions:

• The calculation year will expand to 20 years.
• The FPSO is very unique because the processing unit above the immovable tanker can not be used by other oil type. So if we sell the FPSO, the new user will still use the storage but have to remove or replace the topside processing unit.
• The investment cost proportion of storage tanker  is 60% and processing unit is 40%.
• Because its uniquness, the expected salvage value of the storage tanker will have a decline rate of 10% and the processing unit will have a decline rate at 85%. Thus, the combined declined value rate is 40% each year.
• MARR is assumed conservatively at 15% to  have a buffer for sudden economic bumpy.
• Expecting at the first beginning operation the annual expense is 10% of the investment cost and will grow 5% annually.
• This analysis is before tax calculation.

4. Selection of Acceptable Criteria

The economic life of the new FPSO is at the end of year k when TC > EUAC at year k+1.

5. Analysis of Comparison Between Alternative and Criteria

The calculation table of TC and EUAC is displayed at the figure below.

(The amount is in thousands of US\$)

6. Selection of The Best Alternative

According to the figure above, the TC starts to surpass the EUAC at year 17. So, the economic life of the FPSO is only 16 years.

We should retire the FPSO at the end of year 16, so we will not have an economic loss if we operate the FPSO beyond 16 years.

References:

Anonym (2013). Suku Bunga Dasar Kredit. [ONLINE] Available at: http://www.bi.go.id/web/id/Perbankan/Suku+Bunga+Dasar+Kredit/. [Last Accessed 9 November 2013].

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Time Value of Money. In Engineering Economy (15th ed., pp. 104-162). Upper Saddle River, N.J: Prentice Hall.

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Replacement Analysis. In Engineering Economy (15th ed., pp. 379-418). Upper Saddle River, N.J: Prentice Hall.

Filed under Hadianto P, Week 06

2 responses to “W6_HPO_Determining The Asset’s Economic Life”

1. Pak Hadianto, you would have gotten 5 stars on this posting except for one FATAL error……. (which you SHOULD have learned about by now) Where did you get your “conservative” MARR of “15%”?

If you want to get 5 stars, you need to go back to Ibu Lita’s paper and this time, pick a much more realistic MARR and redo your calculations using her MARR.

Suggest you also cite those chapters and pages in Engineering Economy explaining MARR and WACC.

Repost as W6.1 and I will be happy to give you 5 stars for what otherwise was an excellent case study……

BR,
Dr. PDG, Jakarta, Indonesia

2. Ok Sir, I’ll do that. Thank You.