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Lecture 4 ( Engineering Economics )

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Shakir Ahmad
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15 views

Lecture 4 ( Engineering Economics )

Uploaded by

Shakir Ahmad
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 17

PRSENT WORTH

ANALYSIS

By
Azhan Umer
Lecturer
Civil Engineering Department
University of Management and
Technology ,Lahore

5-1
LEARNING
OUTCOMES

1.Formulate Alternatives
2.PW of equal-life
alternatives
3.PW of different-life
alternatives
4.Future Worth analysis
5.Capitalized Cost analysis
5-2
Formulating
Alternatives
Two types of economic
proposals
Mutually Exclusive (ME) Alternatives: Only one can be
selected;
Compete against each other

Independent Projects: More than one can be selected;


Compete only against DN

Do Nothing (DN) – An ME alternative or independent


project to maintain the current approach; no new
costs, revenues or savings 5-3
Two types of cash flow estimates

Revenue: Alternatives include estimates of costs


(cash inflows) and revenues (cash
outflows)

Cost: Alternatives include only costs; revenues and


savings assumed equal for all alternatives;
also called service alternatives

5-4
Convert all cash flows to PW using MARR
Precede costs by minus sign; receipts
by plus sign

EVALUATION
For one project, if PW > 0, it is justified
For mutually exclusive alternatives,
select one with numerically largest
PW

For independent projects, select all 5-5


For the alternatives shown below, which should be
selected
selected
selected
if they are (a) mutually exclusive; (b) independent?
Project Present
ID Worth
A $30,000
B $12,500
C $-4,000
D $ 2,000

Solution (a) Select numerically largest PW;


: alternative A with PW > 0; projects A, B
(b) Select all
&D
Alternative X has a first cost of $20,000, an operating cost of $9,000 per
year,
and a $5,000 salvage value after 5 years. Alternative Y will cost
$35,000 with an operating cost of $4,000 per year and a salvage value
of $7,000 after 5 years. At an MARR of 12% per year, which
shouldSolution:
be selected?
Find PW at MARR and select numerically larger PW
value
PWX = -20,000 - 9000(P/A,12%,5) + 5000(P/F,12%,5)
= -$49,606

PWY = -35,000 - 4000(P/A,12%,5) + 7000(P/F,12%,5)


= -$45,447

Select alternative Y
5-7
PW of Different-Life
Alternatives
Must compare alternatives for equal
service
(i.e., alternatives must end at the
same time)

Two ways to compare


equal service:
Least common multiple (LCM) of
5- © 2012 by McGraw-Hill

lives Specified study period


8
All Rights Reserved
Assumptions of LCM
approach

 Service provided is needed over the LCM or


more years

 Selected alternative can be repeated


over each life cycle of LCM in exactly the
same manner

 Cash flow estimates are the same for


each life cycle
(i.e., change in exact accord
with the inflation or
Compare the machines below using present worth analysis at i =
10% per year

Machin Machin
First cost, $ e 20,00
A e30,000
B
Annual cost, 0
$/year 9000 7000
Salvage value, 4000 6000
$ Life, years 3 6
Solution LCM = 6 years; repurchase A after 3
: PW = -20,000years
– 9000(P/A,10%,6) – 16,000(P/F,10%,3) +
A
4000(P/F,10%,6)
20,000 – 4,000
PWB == $-68,961
-30,000 – 7000(P/A,10%,6) + in
= $-57,100
6000(P/F,10%,6) year 3

Select alternative
B 5-
PW Evaluation Using a Study
Period
Once a study period is specified, all cash
flows
after this time are ignored

Salvage value is the estimated market


value at the
end of study period

Short study periods are often defined by


management when business goals are
short-term

Study periods are5-


© 2012 by McGraw-Hill

11
commonly used in
All Rights Reserved
Compare the alternatives below using present worth analysis at i
= 10% per year and a 3-year study period
Machine Machine B
First cost, $ A -30,000
Annual cost, -20,000 -7,000
$/year -9,000 6,000 (after 6
Salvage/
4,000 years)
market value,
Life,
$ years 10,000 (after 3
3 years)
6 after 3
Solution: Study period = 3 years; disregard all estimates
years

PWA = -20,000 – 9000(P/A,10%,3) + 4000(P/F,10%,3) =


$-39,376 PWB = -30,000 – 7000(P/A,10%,3) +
10,000(P/F,10%,3)= $-39,895 5- © 2012 by McGraw-Hill
All Rights Reserved
12
FW exactly like PW analysis, except
calculate FW
Must compare alternatives for equal
service
(i.e. alternatives must end at the same
time)

Two ways to compare equal


service:
Least common multiple (LCM) of lives
5-
Specified study period
13
Machin Machin
First cost, $ eA - e-30,000
B
Annual cost, 20,00
$/year 0
Salvage value, -9000 -7000
$ Life, years 4000 6000
Solutio LCM = 6 years;3repurchase A after 36
years
n:FW = -20,000(F/P
A ,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
5-
will always result in same
selection) 14
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
Basic equation is: CC
i
=P= A
“A” essentially represents the interest on a perpetual
investment
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 =
$500,000
For finite life alternatives, convert all cash flows
into an A value over one life cycle and then
divide by i
5- © 2012 by McGraw-Hill
All Rights Reserved
15
Compare the machines shown below on the basis of
their
capitalized cost. Use i = 10%Machine
per year Machine
First cost,$ 1 2
Annual cost, - -
$/year 20,000 100,00
Salvage -9000 0
value, $ Life,
4000 -7000
years
Solution: Convert machine 1 cash3 flows into A and
-----then
∞ by i
divide
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
Summary of Important
Points

• PWmethod converts all c ash 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

5-

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