Engineering Economy and

System Analysis
Week 4
Future Worth and Annual Worth
Analysis
 Future Worth and
Annual Worth Analysis
Learning Outcome
LO2: Apply investment decision criteria by using
economic decisions (present worth, future worth,
IRR, NPV, and Payback Analysis).
- Future Worth Analysis
- Capitalized Cost Analysis
- Advantages and Uses of Annual Worth Analysis
- Calculation of Capital Recovery and AW Values
- Evaluating Alternatives by Annual Worth Analysis
- AW of a Permanent Investment
FUTURE WORTH ANALYSIS
 Future Worth Analysis
 FW exactly like PW analysis, except calculate FW
 Must compare alternatives for equal service (i.e.
alternatives must end at the same time)
 Future Worth Analysis
Two ways to compare equal service:
Least common multiple (LCM) of lives
Specified study period
(The LCM procedure is used unless otherwise specified)
 FW of Different-Life
Alternatives
Compare the machines below using future worth analysis at i = 10% per
year
Machine A Machine B
First cost, $ -20,000 -30,000
Annual cost, $/year -9000 -7000
Salvage value, $ 4000 6000
Life, years 3 6
 FW of Different-Life
Alternatives
Machine A Machine B
First cost, $ -20,000 -30,000
Annual cost, $/year -9000 -7000
Salvage value, $ 4000 6000
Life, years 3 6
Solution: LCM = 6 years; repurchase A after 3 years
FWA = -20,000(F/P,10%,6) – 9000(F/A,10%,6) – 16,000(F/P,10%,3) + 4000
= $-122,168
FWB = -30,000(F/P,10%.6) – 7000(F/A,10%,6) + 6000
= $-101,157
Select B (Note: PW and FW methods will always result in same selection)
CAPITALIZED COST
 Capitalized Cost (CC)
Analysis
CC refers to the present worth of a project with a
very long life, that is, PW as n becomes infinite
A
Basic equation is: CC = P =
i
“A” essentially represents the interest on a perpetual
investment
 Capitalized Cost (CC)
Analysis
For example, in order to be able to withdraw $50,000 per year forever at i =
10% per year, the amount of capital required is 50,000/0.10 = $500,000

For finite life alternatives, convert all cash flows into an A

value over one life cycle and then divide by i
 Example: Capitalized
Cost
Compare the machines shown below on the basis of their
capitalized cost. Use i = 10% per year
Machine 1 Machine 2
First cost,$ -20,000 -100,000
Annual cost,$/year -9000 -7000
Salvage value, $ 4000 -----
Life, years 3 ∞
Solution: Convert machine 1 cash flows into A and then divide by i

A1 = -20,000(A/P,10%,3) – 9000 + 4000(A/F,10%,3) = $-15,834

CC1 = -15,834 / 0.10 = $-158,340

CC2 = -100,000 – 7000/ 0.10 = $-170,000 Select machine 1

 References
Blank, L.T., and Tarquin, A.J. (2011), Engineering
Economy, 7th edition, McGraw-Hill, New York.
ISBN-13: 9780073376301
 Annual Worth Analysis

Advantages And Uses Of Annual Worth Analysis

Calculation Of Capital Recovery And AW Values
Evaluating Alternatives By Annual Worth Analysis
AW Of A Permanent Investment
Advantages And Uses Of Annual Worth
Analysis
 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)
 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)
CALCULATION OF ANNUAL WORTH
 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
 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
Evaluating Alternatives By
Annual Worth Analysis
Selection Guidelines for AW
Analysis
 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?
 ME Alternative
Evaluation by AW
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
AW OF PERMANENT INVESTMENT
 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 ∞
 AW of Permanent
Investment
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
Typical Life-Cycle Cost
Distribution by Phase
 Life-Cycle Cost Analysis
LCC analysis includes all costs for entire life span,
from concept to disposal
Best when large percentage of costs are M&O
Includes phases of acquisition, operation, & phaseout

 Apply the AW method for LCC analysis of 1 or more cost

alternatives
 Use PW analysis if there are revenues and other
benefits considered
CONCLUSION
 Conclusion
• PW method converts all cash flows to present value at MARR
• Alternatives can be mutually exclusive or independent
• Cash flow estimates can be for revenue or cost alternatives
• PW comparison must always be made for equal service
• Equal service is achieved by using LCM or study period
• Capitalized cost is PW of project with infinite life; CC = P = A/i
 Conclusion
 The annual worth method of comparing alternatives is often
preferred to the present worth method, because the AW
comparison is performed for only one life cycle.

 This is a distinct advantage when comparing different-life

alternatives. AW for the first life cycle is the AW for the second,
third, and all succeeding life cycles, under certain assumptions.

 When a study period is specified, the AW calculation is

determined for that time period, regardless of the lives of the
alternatives.
 Conclusion
 For infinite-life (perpetual) alternatives, the initial cost
is annualized simply by multiplying P by i. For finite-
life alternatives, the AW through one life cycle is equal
to the perpetual equivalent annual worth.
 Life-cycle cost analysis is appropriate for systems that
have a large percentage of costs in operating and
maintenance. LCC analysis helps in the analysis of all
costs from design to operation to disposal phases
 References
Blank, L.T., and Tarquin, A.J. (2011), Engineering
Economy, 7th edition, McGraw-Hill, New York.
ISBN-13: 9780073376301
Thank You