Corrosion Engineering Companion

Corrosion engineering consultant

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Cash Flows and Capital Budgeting Techniques

Every corrosion engineering project will have a certain cash flow pattern over time. Usually, there is an initial outflow of cash, when a new asset fitted with a certain corrosion control system is acquired. Subsequently there are inflows of cash, resulting from operations and further cash outflows required for maintenance, corrosion control upgrades, running costs etc. In capital budgeting techniques the different cash flows involved in the project are identified, estimated and analyzed, with a view to maximizing owners wealth.

Such cash flows can be complex, if all the financial implications of project options are investigated in detail. Invariably in corrosion economics calculations a compromise has to be made between two opposing needs, i.e. the need for precision and the need for simplicity. For example, the present costs or investment in two alternative anti-corrosion methods may be known with a high degree of certainty. However, the service lives or future maintenance costs or operating costs may be estimates with only a limited degree of certainty. The need for stringent risk assessment required of many modern engineering systems may also add to the complexity of estimating useful life and cost estimates.

When considering the above cash inflows and outflows over time, the time value of money has to be considered. This concept implies that money has a value that varies depending on when it is received or disbursed. Readers will have gained first-hand knowledge of this principle from any loans they have taken out with financial institutions. A loan received "now" has to be repaid with interest charges in the future. The following is a generalized formula between the present value and future value of cash flows:

which states that present value (PV) of a future cash flow (Fn) after (n) time periods equals the future amount (Cn) discounted to zero date at some interest rate (i). The value of "n" is usually specified in years and "i" as the annual interest rate. Several capital budgeting techniques exist that are based on the time value of money. (reference)