Comparing Alternatives

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Module 5: Comparing Alternatives

Alternatives

Case 1: Useful
Lives are Equal
to the Study
Period

Case 2: Useful
Lives are
Different Among
Alternatives

Capitalized
Worth Method

Incremental B/C
Analysis

Project
Combination

Learning Objectives
1. Differentiate the different types of alternatives
2. Compare projects when the useful lives are equal to the study period and when the
useful lives are different among alternatives
3. Compare alternatives using the capitalized worth method and incremental B/C
analysis
4. Compare project combinations

CHE40: ENGINEERING ECONOMY

Alternatives
Mutually Exclusive
at most one project can be chosen
Independent
the choice is not dependent of the choice
of any other project; all or none of the
projects may be selected
Contingent
the choice is conditional on the choice of
one or more other projects

CHE40: ENGINEERING ECONOMY

Investment Alternatives
with initial capital investments that produce
positive cash flows from increased revenue,
savings through reduced costs, or both

Cost Alternatives
with negative cash flows, except for a
positive cash flow element from disposal of
assets at the end of the projects useful life

Alternatives
The alternative that requires the minimum investment of capital and produces satisfactory
functional results will be chosen unless the incremental capital associated with an alternative
having a larger investment can be justified with respect to its incremental benefits.
When revenues and other economic benefits are present and vary among the alternatives,
choose the alternative that maximizes overall profitability (i.e., greatest positive equivalent
worth at i=MARR and satisfies all project requirements.
When revenues and other economic benefits are not present or are constant among
alternatives, consider only the costs and select the alternative that minimizes total cost (least
negative equivalent worth at i=MARR and satisfies all project requirements.

CHE40: ENGINEERING ECONOMY

Case 1: Useful Lives are Equal to the Study Period

Equivalent Worth Methods
for investment alternatives, the one with the greatest positive equivalent worth is selected
for cost alternatives, the one with the least negative equivalent worth is selected

An airport needs a modern material handling system for facilitating access to and from a busy
maintenance hangar. A second-hand system will cost $75,000. A new system with improved
technology can decrease labor hours by 20% compared to the used system. The new system will cost
$150,000 to purchase and install. Both systems have a useful life of 5 years. The market value of the
used system is expected to be $20,000 in 5 years, and the market value of the new system is
anticipated to be $50,000 in 5 years. Current maintenance activity will require the used system to be
operated 8 hours per day for 20 days per month. If labor costs $40 per hour and the MARR is 1% per
month, which system should be recommended?

CHE40: ENGINEERING ECONOMY

Case 1: Useful Lives are Equal to the Study Period

Rate of Return Methods
each increment of capital must
justify itself by producing a
sufficient rate of return ( MARR)
on that increment
compare a higher investment
alternative against a lower
investment alternative only when
the latter is acceptable
select the alternative that requires
the largest investment of capital as
long as the incremental
investment is justified by benefits
that earn at least the MARR
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Arrange the feasible alternatives based on increasing

capital investment.

Establish a base alternative.

Use iteration to evaluate differences (incremental cash

flows) between alternatives until all alternatives have
been considered.

If the incremental cash flow between the next alternative

and the current selected alternative is acceptable, choose
the next alternative.

Otherwise, retain the last acceptable alternative as the

current best.

Case 1: Useful Lives are Equal to the Study Period

Two mutually exclusive diesel generators are considered for purchase by a power generation
company. Information relevant to compare the alternatives are summarized below:
A

Capital Investment, $

100,000

80,000

120,000

Salvage Value, $

35,000

10,000

20,000

Annual Maintenance Expenses, $

3,000

5,000

2,500

10

10

10

Service Life

Use the ERR method to determine the better machine. MARR is 10% per year. The external
reinvestment rate is 8%.

CHE40: ENGINEERING ECONOMY

Case 2: Useful Lives are Different Among Alternatives

Repeatability Assumption

Coterminated Assumption

assumes that the economic estimates for an

alternatives initial useful life will be repeated
in the subsequent replacement cycles

repeat part of the useful life and then use an

estimated market value to truncate it at the
end

Useful Life < Study Period

Use the repeatability assumption

Use the imputed market value

Useful Life > Study Period technique

CHE40: ENGINEERING ECONOMY

Case 2: Useful Lives are Different Among Alternatives

As the supervisor of a facilities engineering department, you consider mobile cranes to be critical
equipment. The purchase of a new medium-sized truck-mounted crane is being evaluated. The
economic estimates for the two best alternatives are shown below. Which of the two alternatives
would you recommend? MARR is 15%.
A

Capital Investment, $

272,000

346,000

Annual Expenses, $

28,800

19,300

Useful Life, years

Salvage Value, $

25,000

40,000

CHE40: ENGINEERING ECONOMY

Case 2: Useful Lives are Different Among Alternatives

Imputed Market Value Technique
based on assumptions about the value of the remaining useful life for an asset

MVT = PW at end of year T of remaining CR amounts + PW at end of year T of original market value at end
of useful life

Use the imputed market value technique to develop an estimated market value at the end of year 5
for crane B in SP3. I = $346,000; S = $40,000; useful life = 9; MARR = 15%

CHE40: ENGINEERING ECONOMY

10

Case 2: Useful Lives are Different Among Alternatives

A 50 hp motor is required to power a large capacity blower. Two motors, A and B, mutually exclusive,
have been proposed. Their cost data are as follows.

Capital Investment, $

9,000

8,000

Annual Expenses, $

5,000

6,000

Useful Life, years

10

15

Salvage Value, $

1,000

The MARR is 5% per year. Determine which alternative should be selected if the analysis period is 10
years.

CHE40: ENGINEERING ECONOMY

11

Capitalized Worth Method

Capitalized Worth

used when the period of needed service is indefinitely long

1
=

A firm is considering the purchase of one of two new machines. The data on each are given below:

Capital Investment, $

3,400

6,500

Annual Expenses, $

2,000

1,800

Useful Life, years

Salvage Value, $

100

500

If perpetual service from the machine is assumed, which machine would you recommend? The
MARR is 10% per year.
CHE40: ENGINEERING ECONOMY

12

Incremental B/C Analysis

The city of Oak Ridge is evaluating three MEAs for refurbishing a public greenway. Benefits to the
community have been estimated and summarized. The citys discount rate is 8% per year and the
planning horizon is 10 years. Which plan is best?
A

Investment, $

75,000

50,000

65,000

Annual maintenance cost, $

4,000

5,000

4,700

Annual benefits, $

20,000

18,000

20,000

CHE40: ENGINEERING ECONOMY

13

Project Combination
Mutually Exclusive

Contingent

Independent

at most one project can be

chosen

the choice is conditional on the

choice of one or more other projects

the choice is not dependent of the

choice of any other project; all or none
of the projects may be selected

Engineering projects A, B1, B2 and C are being considered with cash flows estimated over 10 years as
shown. B1 and B2 are mutually exclusive, C depends upon B1 and A depends upon B2. The capital
investment budget limit is $100,000 and the MARR is 12% per year. What combination of projects
should be selected?
A

B1

B2

Cap Inv, $

30,000

22,000

70,000

82,000

Annual Profit, $

8,000

6,000

14,000

18,000

Salvage Value

3,000

2,000

5,000

7,000

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14

Project Combination
A small company has $20,000 in surplus capital that it wishes to invest in new revenue-producing
projects. Three independent sets of mutually exclusive projects have been developed. The useful
life of each is five years, and all market values are zero. You have been asked to perform ERR analysis
to select the best combination of projects. MARR is equal to the external reinvestment rate (12%).

Mutually exclusive
Mutually exclusive
Mutually exclusive

CHE40: ENGINEERING ECONOMY

Project

Cap Inv, $

Net Annual
Benefits, $

A1

5,000

1,500

A2

7,000

1,800

B1

12,000

2,000

B2

18,000

4,000

C1

14,000

4,000

C2

18,000

4,500
15

Module 5: Comparing Alternatives

Alternatives

Case 1: Useful
Lives are Equal
to the Study
Period

Case 2: Useful
Lives are
Different Among
Alternatives

Capitalized
Worth Method

Incremental B/C
Analysis

Project
Combination

Learning Objectives
1. Differentiate the different types of alternatives
2. Compare projects when the useful lives are equal to the study period and when the
useful lives are different among alternatives
3. Compare alternatives using the capitalized worth method and incremental B/C
analysis
4. Compare project combinations

CHE40: ENGINEERING ECONOMY

16

Comparing Alternatives
Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

17