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Tutorial 3

The document is a tutorial on engineering economics that provides examples and solutions for evaluating projects using various methods like present worth, annual worth, internal rate of return, and external rate of return. It summarizes key concepts in chapter 5 such as present worth, future worth, annual worth, and internal and external rates of return. It then works through examples applying these methods to evaluate projects like a retrofitted heating system, corporate jet, and welding equipment.

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210 views

Tutorial 3

The document is a tutorial on engineering economics that provides examples and solutions for evaluating projects using various methods like present worth, annual worth, internal rate of return, and external rate of return. It summarizes key concepts in chapter 5 such as present worth, future worth, annual worth, and internal and external rates of return. It then works through examples applying these methods to evaluate projects like a retrofitted heating system, corporate jet, and welding equipment.

Uploaded by

touhid
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Tutorial 5

Gongqiu Zhang

SEEM, The Chinese University of Hong Kong


[email protected]

October 15, 2014

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 1 / 15


Outline

1 Summary of Chapter 5

2 Example 5-2

3 Example 5-9

4 Example 5-12

5 Example 5-17

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 2 / 15


Summary of Chapter 5

Evaluating a Project

Present worth (PW)

C1 CN
P W = C0 + + + . (1)
1 + M ARR (1 + M ARR)N

If P W 0, acceptable.
Future worth (FW)

F W = C0 (1 + M ARR)N + C1 (1 + M ARR)N 1 + + CN . (2)

If F W 0, acceptable.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 3 / 15


Summary of Chapter 5

Evaluating a Project

Annual Worth (AW)

AW = P W (A/P, M ARR, N ) = F W (A/F, M ARR, N )


= R E CR, (3)

CR = I(A/P, M ARR, N ) S(A/F, M ARR, N ) (4)


where,
R: annual equivalent revenues;
E: annual equivalent expenses;
CR: annual equivalent capital recovery cost;
I: initial investment;
S: salvage value.
If AW 0, acceptable.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 4 / 15


Summary of Chapter 5

Internal rate of return (IRR)

C0 + C1 (1 + IRR)1 + + CN (1 + IRR)N = 0. (5)

If IRR M ARR, acceptable.


External rate of return (ERR) Suppose the cash flows can be
invested with external investment rate  (usually  =MARR).
 
E1 EN
E0 + + + (1 + ERR)N
1+ (1 + )N
= R0 (1 + )N + R1 (1 + )N 1 + + RN . (6)

PN !1/N
N k
k=0 Rk (1 + )
ERR = PN 1. (7)
k
k=0 Ek (1 + )

If ERR M ARR, acceptable.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 5 / 15


Example 5-2

Example 5-2

A retrofitted spaceheating system is being considered for a small office


building. The system can be purchased and installed for $110,000 and
it will save an estimated 300,000 kilowatt-hours (kWh) of electric
power each year over a six year period. A kilowatt-hour of electricity
costs $0.10, and the company uses a MARR of 15% per year in its
economic evaluations of refurbished systems. The market value of the
system will be $8,000 at the end of six years, and additional annual
operating and maintenance expenses are negligible. Use the PW
method to determine whether this system should be installed.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 6 / 15


Example 5-2

Example 5-2: Solution

A retrofitted spaceheating system is being considered for a small office


building. The system can be purchased and installed for $110,000 and
it will save an estimated 300,000 kilowatt-hours (kWh) of electric
power each year over a six year period. A kilowatt-hour of electricity
costs $0.10, and the company uses a MARR of 15% per year in its
economic evaluations of refurbished systems. The market value of the
system will be $8,000 at the end of six years, and additional annual
operating and maintenance expenses are negligible. Use the PW
method to determine whether this system should be installed.
The saved power is worth 300, 000kWh$0.10/kWh=$30,000 per year.

PW(15%) = $110, 000 + $30, 000(P/A, 15%, 6) + $8, 000(P/F, 15%, 6)


= $6, 993.40 0. (8)

So the retrofitted space heating system should be installed.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 7 / 15


Example 5-9

Example 5-9

A corporate jet costs $1,350,000 and will incur $200,000 per year in
fixed costs (maintenance, licenses, insurance and hangar rental) and
$277 per hour in variable costs (fuel, pilot expense, etc.). The jet will
be operated for 1,200 hours per year for five years and then sold for
$650,000. The MARR is 15% per year.
(a) Determine the capital recovery cost of the jet.
(b) What is the EUAC (Equivalent Uniform Annual Cost) of the jet?

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 8 / 15


Example 5-9

Example 5-9: Solution


A corporate jet costs $1,350,000 and will incur $200,000 per year in
fixed costs (maintenance, licenses, insurance and hangar rental) and
$277 per hour in variable costs (fuel, pilot expense, etc.). The jet will
be operated for 1,200 hours per year for five years and then sold for
$650,000. The MARR is 15% per year.
(a) Determine the capital recovery cost of the jet.

CR = $1, 350, 000(A/P, 15%, 5)$650, 000(A/F, 15%, 5) = $306, 310.


(9)
(b) What is the EUAC of the jet? The total annual expense for the jet
is the sum of the fixed costs and the variable costs.

E = $200, 000 + (1, 200hours)($277/hours) = $532, 400, (10)

EUAC(15%) = E + CR = $838, 710. (11)

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 9 / 15


Example 5-12

Example 5-12

AMT, Inc, is considering the purchase of a digital camera for the


maintenance of design specifications by feeding digital pictures directly
into an engineering workstation where computer-aided design files can
be superimposed over corrections, as appropriate, can then be made by
design engineers. The capital investment requirement is $345,000 and
the estimated market value of the system after a six-year study period
is $115,000. Annual revenues attributable to the new camera system
will be $120,000, whereas additional annual expenses will be $22,000.
You have been asked by management to determine the IRR of this
project and to make a recommendation. THe corporations MARR is
20% per year. Solve first by using linear interpolation and then by
using a spreadsheet.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 10 / 15


Example 5-12

Example 5-12: Solution


AMT, Inc, is considering the purchase of a digital camera for the
maintenance of design specifications by feeding digital pictures directly
into an engineering workstation where computer-aided design files can
be superimposed over corrections, as appropriate, can then be made by
design engineers. The capital investment requirement is $345,000 and
the estimated market value of the system after a six-year study period
is $115,000. Annual revenues attributable to the new camera system
will be $120,000, whereas additional annual expenses will be $22,000.
You have been asked by management to determine the IRR of this
project and to make a recommendation. THe corporations MARR is
20% per year. Solve first by using linear interpolation and then by
using a spreadsheet.

PW = $345, 000 + ($120, 000 $22, 000)(P/A, i%, 6)


+ $115, 000(P/F, i%, 6) = 0. (12)

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 11 / 15


Example 5-12

Example 5-12: Linear Interpolation

PW = $345, 000 + ($120, 000 $22, 000)(P/A, i%, 6)


+ $115, 000(P/F, i%, 6) = 0. (13)

At i% = 20%: PW=+$19,413;
At i% = 25%: PW=-$25,621;
Then,

25% 20% i% 20%


= = i% = 22.16%. (14)
$19, 413 ($25, 621) $19, 413 $0

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 12 / 15


Example 5-12

Example 5-12: Using Excel

PW = $345, 000 + ($120, 000 $22, 000)(P/A, i%, 6)


+ $115, 000(P/F, i%, 6) = 0. (15)

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 13 / 15


Example 5-17

Example 5-17

A piece of new equipment has been proposed by engineers to increase


the productivity of a certain manual welding operation. The investment
cost is $25,000 and the equipment will have a market (salvage) value of
$5,000 at the end of its expected life of five years. Increased
productivity attributable to the equipment will amount to $8,000 per
year after extra operating costs have been substracted from the value
of the additional production. Calculate ERR with  = MARR = 20%
per year and decide whether this project is acceptable.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 14 / 15


Example 5-17

Example 5-17: Solution

A piece of new equipment has been proposed by engineers to increase


the productivity of a certain manual welding operation. The investment
cost is $25,000 and the equipment will have a market (salvage) value of
$5,000 at the end of its expected life of five years. Increased
productivity attributable to the equipment will amount to $8,000 per
year after extra operating costs have been substracted from the value
of the additional production. Calculate ERR with  = MARR = 20%
per year and decide whether this project is acceptable.

$25, 000(F/P, i%, 5) = $8, 000(F/A, 20%, 5)+$5, 000 = i% = 20.88%.


(16)
For i% > MARR, the project is acceptable.

Gongqiu Zhang (CUHK-SEEM) Engineering Economics October 15, 2014 15 / 15

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