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6 Annual Worth Analysis

The document discusses annual worth (AW) analysis for evaluating engineering project alternatives over multiple time periods. It provides examples of calculating the AW of projects with different cash flow profiles, lives, and salvage values. The AW method allows for analysis of alternatives with differing lives by converting all cash flows to equivalent uniform annual values at a specified interest rate.
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0% found this document useful (0 votes)
41 views14 pages

6 Annual Worth Analysis

The document discusses annual worth (AW) analysis for evaluating engineering project alternatives over multiple time periods. It provides examples of calculating the AW of projects with different cash flow profiles, lives, and salvage values. The AW method allows for analysis of alternatives with differing lives by converting all cash flows to equivalent uniform annual values at a specified interest rate.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 6

Annual Worth
Analysis
Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

6-1 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved


LEARNING OUTCOMES
1. Advantages of AW
2. Capital Recovery and AW values
3. AW analysis-equal life and
different life

6-2 © 2012 by McGraw-Hill All Rights Reserved


Advantages of AW Analysis
AW calculated for only one life cycle
Assumptions:
Services needed for at least the LCM of lives of alternatives
Selected alternative will be repeated in succeeding life cycles
in same manner as for the first life cycle
All cash flows will be same in every life cycle (i.e., will change
by only inflation or deflation rate)

6-3 © 2012 by McGraw-Hill All Rights Reserved


Alternatives usually have the following
cash flow estimates
Initial investment, P – First cost of an asset
Salvage value, S – Estimated value of asset at end of
useful life
Annual amount, A – Cash flows associated with asset, such
as annual operating cost (AOC), etc.

Relationship between AW, PW and FW


AW = PW(A/P,i%,n) = FW(A/F,i%,n)
n is years for equal-service comparison (value of LCM or
specified study period)
6-4 © 2012 by McGraw-Hill All Rights Reserved
Calculation of Annual Worth
AW for one life cycle is the same for all life cycles!!

An asset has a first cost of $20,000, an annual operating


cost of $8000 and a salvage value of $5000 after 3 years.
Calculate the AW for one and two life cycles at i = 10%

AWone = - 20,000(A/P,10%,3) – 8000 + 5000(A/F,10%,3)


= $-14,532
AWtwo = - 20,000(A/P,10%,6) – 8000 – 15,000(P/F,10%,3)(A/P,10%,6)
+ 5000(A/F,10%,6)
= $-14,532

6-5 © 2012 by McGraw-Hill All Rights Reserved


Capital Recovery and AW
Capital recovery (CR) is the equivalent annual amount that
an asset, process, or system must earn each year to just
recover the first cost and a stated rate of return over its
expected life. Salvage value is considered when calculating
CR.
CR = -P(A/P,i%,n) + S(A/F,i%,n)

Use previous example: (note: AOC not included in CR )


CR = -20,000(A/P,10%,3) + 5000(A/F,10%,3) = $ – 6532 per year

Now AW = CR + A
AW = – 6532 – 8000 = $ – 14,532
6-6 © 2012 by McGraw-Hill All Rights Reserved
Selection Guidelines for AW Analysis

6-7 © 2012 by McGraw-Hill All Rights Reserved


ME Alternative Evaluation by AW
Not necessary to use LCM for different life alternatives

A company is considering two machines. Machine X has a first cost of


$30,000, AOC of $18,000, and S of $7000 after 4 years.
Machine Y will cost $50,000 with an AOC of $16,000 and S of $9000 after
6 years.
Which machine should the company select at an interest rate of 12% per
year?
Solution: AWX = -30,000(A/P,12%,4) –18,000 +7,000(A/F,12%,4)
= $-26,412
AWY = -50,000(A/P,12%,6) –16,000 + 9,000(A/F,12%,6)
= $-27,052
Select Machine X; it has the numerically larger AW value
6-8 © 2012 by McGraw-Hill All Rights Reserved
AW of Permanent Investment
Use A = Pi for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives

Compare the alternatives below using AW and i = 10% per year


C D
First Cost, $ -50,000 -250,000
Annual operating cost, $/year -20,000 -9,000
Salvage value, $ 5,000 75,000
Life, years 5 ∞

Solution: Find AW of C over 5 years and AW of D using relation A = Pi


AWC = -50,000(A/P,10%,5) – 20,000 + 5,000(A/F,10%,5)
= $-32,371
AWD = Pi + AOC = -250,000(0.10) – 9,000
= $-34,000 Select alternative C
6-9 © 2012 by McGraw-Hill All Rights Reserved
Summary of Important Points
AW method converts all cash flows to annual value at MARR

Alternatives can be mutually exclusive, independent,


revenue, or cost

AW comparison is only one life cycle of each alternative

For infinite life alternatives, annualize initial cost as A = P(i)

6-10 © 2012 by McGraw-Hill All Rights Reserved


Examples 1
Given two alternatives. Assuming that alternatives
are replaced at the end of their useful life,
determine the better alternative using annual cash
flow analysis at an interest rate of 9%.
Alternative A (RM) Alternative B (RM)

First Cost 4,000 6,000


Annual Cost 1,000 500
Annual Benefit 2,000 2,200
Life 4 10
Salvage Value 3,000 1,000

1-11 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Example 2
Two types of power converters are under consideration
for a specific application. An economic comparison is
to be made using a MARR of 20% and the following
cost estimates:
(a). Determine the Equivalent Annual Costs of the two
alternatives and recommend the economically superior
system.
(b). Determine a Salvage Value for the Beta system such
that the Beta system will have an Equivalent Uniform
Annual Cost equal to the Alpha system.

1-12 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved
Data of example 2
Alfa System (RM) Beta system (RM)

First cost 10,000 20,000

Annual operating cost 2,500 1,200

Salvage value 0 5,000

Service life 5 years 9 years

1-13 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Example 3

Use data in example 2. Which alternative is to be


selected if 5 year analysis period is being
used. Market value for Beta system at the end
of year 5 is RM 8,000.

1-14 © 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

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