ENGR 3360U Winter 2014

Unit 5
Present Worth Analysis
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 5 Present Worth Analysis

Change Record
2014-I-01 Initial Creation
Text Chapter 5

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Course Outline
1.
2.

3.
4.
5.
6.
7.
8.
9.
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Engineering Economics
General Economics
1.
Microeconomics
2.
Macroeconomics
3.
Money and the Bank of
Canada
Engineering Estimation
Interest and Equivalence
Present Worth Analysis
Annual Cash Flow
Rate of Return Analysis
Picking the Best Choice
Other Choosing Techniques
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10. Uncertainty and Risk

11. Income and Depreciation
12. After-tax Cash Flows
13. Replacement Analysis
14. Inflation
15. MARR Selection
16. Public Sector Issues
17. What Engineering should know
about Accounting
18. Personal Economics for the
Engineer

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Economics in the World

Alphabet soup
Where is the economy headed?
V
W
L
X

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Unit 5 Road Map

5.1 Introduction to Present Worth
5.2 Equal Lives
5.3 Unequal Lives
5.4 Capitalized Cost Analysis
5.5 Payback Period Analysis
5.6 Life Cycle Costing
5.7 Bonds
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

5.1 Introduction to Present Worth

Assumptions

End of Period Convention

All cash flow amounts are calculated as amounts at the end of each period:

Now = end of period 0 (beginning of period 1)

Future amounts happen at the end of the period specified

No Sunk Costs

Only the current situation and the potential future is considered

Two viewpoints

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Investor and Borrower (at some interest rate)

Conventional assumptionrequired money is obtained at interest rate i

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Economic Rules
Alternatives are judged based on economic
efficiency.
Typically follows these rules:
Situation
Rule
1. Fixed Input
Maximize Output
2. Fixed Output
Minimize Input
3. Neither input or output fixed
Max (outputinput)

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Formulating Mutually Exclusive Alternatives

One of the important functions of financial
management and engineering is the creation of
alternatives
If there are no alternatives to consider then there
really is no problem to solve!
Given a set of feasible alternatives, engineering
economy attempts to identify the best economic
approach to a given problem

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Types of Economic Projects

Mutually exclusive alternatives
From a set of feasible alternatives, pick one and only one to
execute
Mutually exclusive alternatives compete against each other

Independent projects
From a set of feasible alternatives select as many as can be
funded in the current period

The Do Nothing (DN) alternative should always

be considered

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Cash Flow Types for Projects

Revenue each alternative generates costs and
revenues over the estimated life of the project.
Criterion: Select the alternative that maximizes
the economic measure of merit

Service each alternative has only current and

future costs over the estimated life of the
project.
Criterion: Select the alternative that minimizes the
economic measure of merit, which is a cost-based
measure

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Present Worth Techniques

Three potential analysis periods are
possible when comparing alternatives:

Equal lives
Not equal lives
Infinite analysis period

Present worth requires that the analysis is

made between equal time periods

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Present Worth
A process of obtaining the equivalent
worth of future cash flows BACK to some
point in time.
called the Present Worth Method
Find PW at a stated interest rate, which is usually
equal to or greater than the organizations
established MARR

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco