Key Financial Concepts For Design Engineers
By Ramez Naguib, P.E., Member ASHRAE Accounting for Time From a purely financial standpoint, to decide what investment should be made involves a comparison between the different alternatives in a time-normalized form.* In other words, they account for the present and future values.- The two main tools that serve this end intypical engineering design projects include: Net Present Value (NPV) is a standard method for the financial appraisal of long-term projects. It is equal to the present value of net cash flows. A simple and straightforward example here is that of an aircooled retrofit imitative for all the existing water-cooled HVAC systems (or vice-versa) throughout all the K-12 schoois in a certain county. Theboard of education (especially the board's financial controller) needs to know the NPV of such retrofit projects as compared to maintaining the current system. Assuming a project life of 20 years, the engineer will compute the project cost paid now (air-cooled chillers, larger power supply, modified piping and pumping system, etc.). the maintenance eost next year (finned coil cleaning, lubrication,mechanical seals, etc.) and utility bill, etc.. until year 20. If there is any salvage value for the system after the 20 years assumed, this should be factored in. The following step would be to discount all ofthe.se payment streams into the present time using NPV Basic Financial Evaluation Techniques calculations. Although these types offinancialquestions may be addressed Having done that, the NPVvalue of this option would then in sophisticated ways, they always boil down to some basic be compared to the NPV ofthe current water-cooled HVAC financial evaluation techniques. These financial evaluation system option where no initial project investments are needed (if techniques are used to determine whether the company or cli- there are. such as replacing the cooling towers fill or installingent should spend money on the proposed ideas. Almost every side stream separators, these have to be factored in as wel I). but company has a formal approval process to justify expenditure. where running costs include condenser tube cleaning (brushIl is helpful for design engineers to understand this process ing), chemical supplies for the condenser water treatment, less if they want to obtainapproval for a project or specific major energy consumption, etc. The system having the lower NPV design idea that requires an investment that may come under (because here we are trying to minimize the outgoing cash tlow scrutiny by the client. rather than increase the revenue in a typical investment applicaThe basic concept is very simple: What is the cost (expendi- tion) should be selected by theboard of education. ture)? What is the return (reward)? Internal Rate of Return (IRR) is a capital budgeting method
• Sometimes the cnnccpl ofrcUirn on iiivestmenl (ROI) is used lo make invcstmeiU decisions or assess perlbrmancc. ROI has an important weakness: it fails to account for the timing of tho cash Hows, one dollar now is not eqtial lo one dollar one year from now. This is because ofthediscount rate (i.e., interest rate) as well as the risk ns^ociated with unknown or uncertain future events. Another concept Ihal is sometimes used is the payback analysis. Again this method, although widely used, has two major weaknesses: First, it ignores all cii.'^h flows alicr the culoll'dale. Second, it gives equal weight to all cash flows before ihe cutofFdalc.
et's say you have aninnovative chilled water system design., using state-of-Ihe-art control schemes. After you explain the design's superiority based on its engineering eoncepts, the owner seems a bit skeptical. He wants to know the financial feasibility of the design. So, you leave tlie meeting feelingfrustratedbecause the owner is only thinking about money. He has no idea about energy efficiency, occupational comfort,...