ME 291

Engineering

ME-291 Engineering Economy

Economy
Lecture 13

Chapter 5
Present Worth Analysis

Faculty of Mechanical Engineering

Ghulam Ishaq Khan Institute, Topi, Swabi
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 Formulating Mutually Exclusive
Alternatives

• Some projects are economically and

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technologically viable, and other are not.
• Once the viable projects are defined, it is
possible to formulate the alternatives.
• To help formulate alternatives, categorize
each project as one of the following
– Mutually Exclusive
– Independent

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 Mutually Exclusive

• Only one of the viable projects can be

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selected by the economic analysis. Each
viable project is an alternative. Mutually
exclusive alternatives compete with one
another in the evaluation.

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 Independent

• More than one viable projects may be

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selected by the economic analysis.
Independent projects do not compete with
one another in evaluation. Each is evaluated
separately. The comparison is only between
“one project at a time and the DO-Nothing
(DN) alternative.

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 Independent Projects

• If we have “m” independent projects, then zero, one, two or

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more may be selected.
• There are a total of 2m alternatives. This include the DN
alternative.
For example, if we have three projects A,B,C, then we have
23 = 8 possible selections
DN, A,B,C,AB,AC,BC,ABC
• In real world problems, there is an upper budgetary limit,
that eliminate many of 2m alternatives.

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 Nature or type of Alternatives

• It is important to recognize the nature or type

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of alternatives before starting an evaluation.
• There are two main types of alternatives
– Revenue Based
– Service Based

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 Revenue Based

• Each alternative generates cost and revenue

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cash flow estimates, and possibly savings.
• The alternatives usually involve those that
require capital investment to generate
revenue or savings.
• To purchase new equipment to increase
productivity and sales is revenue alternative.

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 Service Based

• In this case, each alternative has only cost

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cash flow estimates.
• These may be public sector (government)
initiatives. May be safety improvements.

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 Present Worth analysis of Equal-Life
Alternatives

• In present worth analysis, the P value, now called PW, is

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calculated at the MARR for each alternative.
• This method is popular because future cost and revenue
estimates are transformed into equivalent worth now.
• This makes it easy to determine the economic advantage of
one alternative over another.
• The PW comparison of alternatives with equal lives is
straightforward. If both alternatives are used in identical
capacities for the same time period, they are termed equal-
service alternatives.

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 Selecting one alternative

• Whether mutually exclusive alternatives involve

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disbursement only (service) or receipts and disbursement
(revenue), the following guidelines are applied to select one
alternative.
– One alternative: Calculate PW at the MARR. If PW≥0,
the requested MARR is met or exceed 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, that is, less
negative or more positive, indicating a lower PW of cost
cash flows or larger PW of net cash flows of receipts
minus disbursements.

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 ME-291 Engineering Economy
PW1 PW2 Selected
Alternative
$ -1500 $ -500 2

-500 +1000 2

+2500 -500 1

2500 1500 1

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 Independent Alternatives

• For one or more independent projects, select

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all projects with PW ≥ 0 at the MARR
• This compares each project with the do-
nothing alternative. The project must have
positive and negative cash flows to obtain a
PW value that exceeds zero; that is, they
must be revenue projects.
• A PW analysis requires a MARR for use as
the “i” value in all PW relations.

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 Example 5.1

• Perform a present worth analysis of equal-service

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machines with the cost shown below, if the MARR is
10% per year. Revenues for all three alternatives are
expected to be the same.

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