CENG – 24: ENGINEERING ECONOMY

PRESENT WORTH ANALYSIS

The evaluation and selection of economic proposals require cash flow estimates over a stated period of time,
mathematical techniques (Engg Economy Factors) to calculate the measure of worth, and a guideline for selecting
the best proposal. Companies constantly evaluate whether or not to pursue projects. From all the proposals that
may accomplish a stated purpose, the alternatives are formulated. Up front, some proposals are viable from
technological, economic, and or legal perspectives; others are not viable. Once the obviously nonviable ideas are
eliminated, the remaining viable proposals are fleshed out to form the alternatives to be evaluated. Economic
evaluation is one of the primary means used to select the best alternative(s) for implementation.

Progression from proposals to economic evaluation to selection:

The nature of the economic proposals is always one of two types:

Mutually Exclusive Alternatives/Projects

 Several projects proposed to address the same need. Only one of the projects can be selected.
 Only one of the proposals can be selected. For terminology purposes, each viable proposal is called an
alternative.
Independent Projects
 Projects that do not compete, and are selected merely on their economic value.
 More than one proposal can be selected. Each viable proposal is called a project.

Do Nothing (DN) Option

 Projects are often compared to the option of taking no action.
 The DN alternative or project means that the current approach is maintained; nothing new is initiated.
No new costs, revenues, or savings are generated.

Mutually exclusive alternatives and independent projects are selected in completely different ways. A mutually
exclusive selection takes place, for example, when an engineer must select the best diesel-powered engine from
several available models. Only one is chosen, and the rest are rejected. If none of the alternatives are economically
justified, then all can be rejected and, by default, the DN alternative is selected. For independent projects one,
two or more, in fact, all of the projects that are economically justified can be accepted, provided capital funds are
available. This leads to the two following fundamentally different evaluation bases:

Project Types:

Revenue
 Each alternative project being evaluated generate costs and revenues. These alternatives usually
involve the purchase of new systems and equipment in order to increase revenue. Both the cost streams
and revenue streams vary by alternative.
 Each alternative generates cost (cash outflow) and revenue (cash inflow) estimates, and possibly
savings, also considered cash inflows. Revenues can vary for each alternative.
Service
 Each alternative has only cost cash flow estimates. These projects are typically for safety, or are
government mandated projects.
 Each alternative has only cost cash flow estimates. Revenues or savings are assumed equal for all
alternatives; thus they are not dependent upon the alternative selected. These are also referred to as
service alternatives.

For mutually exclusive (ME) alternatives, whether they are revenue or cost alternatives, the following
guidelines are applied to justify a single project or to select one from several alternatives.

One alternative – Calculate the present worth (PW) at the MARR. If PW > 0, the requested MARR is met or
exceeded and the alternative is financially viable.

Two or more alternatives – Calculate the PW of each alternative at the MARR. Select the alternative with the
PW value that is numerically largest. (If all PW are negative, and do nothing is an alternative, then do nothing.)