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Present Worth
Analysis
Background
In this chapter (and next few chapters.Stage 2) we are going to use the basic tools
(we learnt already) with some more techniques to evaluate one or more
alternatives using the factors and formulas learned in Stage 1
After completing these chapters, you will be able to evaluate most engineering
project proposals using a well-accepted economic analysis technique, such as
present worth, future worth, capitalized cost, life-cycle costing, annual worth, rate
of return, or benefit /cost analysis
Engineering Economy
1.
Formulate Alternatives
2.
3.
4.
Up to this point, present worth computations have been made for one
project or alternative
5.
From Chapter 1:
Steps in an Engineering Economy Study
Step 1 in
Study
Step 2
Available data
Alternatives for solution
Step 3
Step 4
Step 5
Engineering Economic
Analysis
Step 6
Expected life
Revenues
Costs
Taxes
Project Financing
Step 1 in
Study
Implementation and
Monitoring
New Problem description
Time Passes
Step 7
Problem description
Objective statement
Independent Events
One event is independent of
the other event
In this case the occurrence of
one event is totally
independent of another
event
E.g., it rained today. And a
chair broke down in office
today. These are two
independent events
Formulating Alternatives
2.
Independent Projects: More than one can be selected , these proposals are
called projects; it competes only against DN
Not viable
viable
Formulating
Alternatives
Mutually
Exclusive
Alternatives
Select
only
one
Either of
these
1
2
3
.
.
.
m
Not viable
Project ID
Independent
projects
Select
all
justifi
ed
1
2
3
.
.
.
DN
Solution:
Present Worth
A
B
$ 30,000
$ 12,500
$ 4,000
2,000
Independent Projects
PW Analysis Procedure
The present worth method is quite popular in industry
because all future costs and revenues are transformed
to equivalent monetary units NOW
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 $7,000 after 5 years.
At an MARR of 12% per year, which should be selected?
Solution:
Electric powered
First Cost($)
Annual Operating Costs ($/year)
Salvage value S ($)
Life years
10%
Gas powered
4500
900
200
8
Single Payments
Solar powered
3500
700
350
8
600
50
100
8
Compound
Amount
Present
Worth
Sinking Fund
(A/F)
Compound
Amount
2.1436
0.4665
0.08744
(F/P)
(P/F)
(F/A)
Capital
Recovery
(A/P)
Present
Worth
(P/A)
PW of Different-Life Alternatives
For alternatives with unequal lives the rule is:
PW must be compared over the same number of years
This is called equal service alternatives requirement (i.e.,
alternatives must end at the same time) Why its
important ?
Because if this condition is not meet, For COST
ALTERNATIVES (which involves only cost) will always favor
the shorter-lived mutually exclusive alternative, even if it is
not the more economical choice, because fewer periods of
costs are involved
Precede costs by
minus sign; receipts by
plus sign
Select alternative Y
Class Practice
Electric powered
First Cost($)
Annual Operating Costs ($/year)
Salvage value S ($)
Life years
10%
Gas powered
Solar powered
4500
3500
600
900
700
50
200
350
100
Single Payments
Compound
Amount (F/P)
Present
Sinking Fund
Worth (P/F) (A/F)
Compound
Amount
(F/A)
2.1436
0.4665
0.08744
Capital
Recovery
(A/P)
Present
Worth
(P/A)
PW of Different-Life Alternatives
The following are two equal ways of meeting the equal
service requirements:
1. Least Common Multiple (LCM) of alternative lives
Compare the PW of alternatives over a period of time
equal to the least common multiple (LCM) of their
estimated lives
2. Study Period Approach
Compare the PW of alternatives using a specified study
period of n years. This approach does not necessarily
consider the useful life of an alternative. The study period
is also called the planning horizon.
Vendor A
15,000
3,500
1,000
6
Vendor B
18,000
3,100
2,000
9
(a)
Solution:
Solution:
PWA = -15,000 15,000(P/F,15%,6) +1000(P/F,15%,6) 15,000(P/F,15%,12)
+1000(P/F,15%,12) + 1000(P/F,15%,18) 3,500(P/A,15%,18)
= $ 45,036
= $ 26, 236
= $ 41,384
Select vender B
Salvage value is
the estimated
market value at the
end of study period
Select vender A
F=?
F=?
0
$80,000
A = $27,000
A = $30,000
$97,000
Robot X CF
Robot Y CF
$50,000
$40,000
i = 15%
Select robot X
CW or CC =
or
$100,000
Solution:
Example:
Recurring
Non-recurring
One time present or future cash
flows (e.g., first cost, cost once
in 25th year etc)
Non-recurring
Convert it to PW (will be PW of
all non-recurring costs for
whole life)
(Step 2)
(Step 5)
Uniform Equal
Recurring Amounts:
e.g., Annuity Series
(say A2)
Add A1 and A2 to
get one Uniform
Series (Annuity
Series) starting
from time 0 and
continue till infinity
(Step 3)
The system has an installed cost of $150,000 and an additional cost of $50,000 after 10
years. The annual software maintenance contract cost is $5000 for the first 4 years and
$8000 thereafter. In addition, there is expected to be a recurring major upgrade cost of
$15,000 every 13 years. Assume that i is 5% per year for county funds.
CC1 = $-180,695
$5000, $8000
CC3 = 5000 (P/A, 5%, )
= 5000/i or 5000/0.05
CC3 = = $ 100,000
Alternative:
A1 = $ 847
A2= $ 5000
A = A1+A2 = $ 5847
CCA = $5847(P/A, 5%, )
= 5487/0.05 = $116940
(same as CC2 + CC3 above)
Example
First Cost, $
Life, years
Single Payments
150000
50,000
8000
5
Alternative N
800000
12000
1000000
Compoun
d Amount
(F/P)
Present
Worth
(P/F)
Sinking
Fund
(A/F)
Compound Capital
Amount
Recovery
(F/A)
(A/P)
Present
Worth
(P/A)
1.6105
0.6209
0.16380
6.1051
3.7908
0.26380
Solution!!!!
Salvage value, $
B
$40000
1000
10000
25
Solution
Solution
First Cost, $
A
$12000
2200
0
10
Thank You
10