# W6.1_HPO_Determing 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 FPSO will be used in the northwestern part of Indonesia.
• 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.
• According to Bank Indonesia data of Corporate Interest Basis is 10.46%. And according to the average of mutual funds return data is 24.13%. The financing the FPSO will be 80% loan and 20% equity. Thus, WACC is equal to 13.19%.
• Lita Liana (2013) modelled MARR=WACC+Operating Risk Scoring+Country Risk. According to her data, northwestern area  has 4.18% of operating risk. And the country risk of Indonesia in January 2013, according to Aswath Damodaran, the latest data of country risk premium is 3%. Therefore, the total MARR is 20.37%.
• 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 19. So, the economic life of the FPSO is only 18 years.

We should retire the FPSO at the end of year 18, so we will not have an economic loss if we operate the FPSO beyond 18 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 16 November 2013].

Damodaran, Aswath (2013). Country Default Spreads and Risk Premiums January 2013. [ONLINE] Available at: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html. [Last Accessed 16 November 2013].

J. Erna (2013). 20 reksa dana saham dengan return tertinggi. [ONLINE] Available at: http://ekbis.sindonews.com/read/2013/04/12/32/737333/20-reksa-dana-saham-dengan-return-tertinggi. [Last Accessed 16 November 2013].

Liana, Lita, (2013). Using AHP to Determine Appropriate MARR for Oil and Gas Projects in Indonesia. CCP Certification Technical Paper. 118130 (6), pp.13-17

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). Evaluating A Single Project . In Engineering Economy (15th ed., pp. 178-222). 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.