Engineering Economics

Engineering Economic Analysis
9th Edition
Chapter 1
MAKING ECONOMIC DECISIONS
Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle 1

People are Surrounded
by Problems
• Which career to pursue?
• What level of preparation is required for the
career chosen?
• Where may the preparation be obtained?
• How to get up and get to class?
The problems are often not

isolated from each other.
Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle. 2

Organizations Have Opportunities
• Do we make part A or B • Would a mechanized or

today? computerized drilling
• Should we use a drilling machine be the
or boring machine? preferred alternative?
• Should we purchase a • Where do we locate
boring machine? machinery in the plant?
• When must we replace
the drilling machine?
Decisions concerning these opportunities may be

arrived at with the help of economic analysis.
Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Inc. 3
Problems
Simple Problems:
• Simple
• Intermediate
• Complex
• Can generally be worked in one’s head

without extensive analysis.
Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 4
Intermediate Problems
• Must be organized and analyzed
• Are sufficiently important to justify serious thought
and action
• Have significant economic aspects
• Are primarily economic
• Are the principal subject of this course
• Assume an economic situation in equilibrium
• Are generally adequately solved with single-criteria
decision making
Complex Problems
• Such problems represent a mixture of 3 elements:

economic, political and humanistic.
• Complex problems are beyond the scope of this
course from a decision-making criteria point of view,
but the economic aspects of complex problems will
be discussed.
Role of Engineering Economic
Analysis
• Assists in making decisions where:
• The decision is sufficiently important that serious
thought and effort is required.
• Careful analysis requires that the decision
variables be carefully organized and the
consequences be understood.
• ECONOMIC ISSUES are a significant component
of the analysis leading to a decision.
The Decision Making Process
1. Recognize problem;
2. Define the goal or objective;
3. Assemble relevant data;
4. Identify feasible alternatives;
5. Select criterion to determine the best alternative;
6. Construct a model;
7. Predict each alternative’s outcomes or
consequences;
8. Choose the best alternative; and
9. Audit the result.
1. Recognize the Problem
• A problem exists when:

• A standard or expectation is not being met.
• A new standard or expectation is established and
needs to be achieved. (An opportunity.)
In the beginning the problems are a given.

Later you might have to analyze the information
provided to determine the real problem.
2. Define the Goal or Objective
• A goal or objective is the standard or

expectation we wish to meet.
• A goal is a general statement about what we
expect.
• Pay all our bills on time.
• An objective is narrow and specific.
• Pay the auto loan on Tuesday morning at the bank.
0
3. Assemble Relevant Data
• Information may be Example 1-1

published or individual Economic analysis - Inside vs outside supplier
knowledge.
For: Large company
• Deciding which data is Comparison: Inside vs. outside printing of copies for shipping.
Requestor: Shipping department
relevant may be a complex Unit affected: Printing department
process. Supplier: Outside printer
Requirements 30,000 copies
• In engineering decision
making two important Printing department
Apparent cost
sources of data are the Cost per Cost per
organization’s accounting Copies 1000 30,000
Direct labor $ 7.60 $ 228.00
and purchasing Materials and supplies $ 9.80 $ 294.00
departments. Overhead costs $ 9.05 $ 271.50
Total $ 26.45 $ 793.50
Shipping department savings $ 111.00
1
4. Identify Feasible Alternatives
• The best alternative should be implemented.

Occasionally this is to maintain the existing
situation.
• Alternatives considered should include both
conventional and innovative approaches.
• Only feasible alternatives should be retained for
further analysis.
2
5. Select the Criterion to Determine the
Best Alternative
• A criterion, or a set of criteria, is used to evaluate
the alternatives to determine which is best.
• The “best” alternative is relative.
• Selecting criteria to use is not easy because
different groups often support different criteria.
• The criterion most often used in economic
decision-making is to “use money in the most
efficient manner.”
3
Economic Decision-Making Problems
Fall Into Three Categories
1. For fixed input situations, maximize the
benefits or other outputs.
2. For fixed output situations, minimize the costs
or other inputs.
3. Where inputs and outputs vary, maximize
(benefits – costs).
4
6. Construct the Model
• Requires merging the various elements:

objective, relevant data, feasible alternatives
and selection criteria.
• In economic decision making the models are
usually mathematical.
• A model is a representation of reality.
• A model must represent the important parts of the
system at hand.
• Be adequate to solve the problem.
5
7. Predicting the Outcomes for Each
Alternative
• To avoid complications, we assume that a
decision is based on a single criterion. If
necessary, multiple criteria are combined into
a single criterion.
• Usually the consequences or alternatives are
stated in the form of money, i.e.,
costs/benefits.
• Costs and benefits may occur over a short or
long time period.
6
8. Choosing the Best Alternative
• When choosing the best alternative both economic

and non-economic criteria must be considered.
• During the prior steps in the decision making
process, only dominant alternatives may be
included based on either economic or non-
economic criteria.
• The elimination of feasible alternatives may
predetermine the outcome of the decision making
process.
7
9. Audit the Results
• Compare the results of changes to the

predictions to assure that the chosen
alternative was implement as planned and
the results are as expected.
• Fix deviations from planned changes.
• Make sure prediction errors are not repeated.
• Identify added opportunities.
• Audits promote realistic economic analysis
and implementation.
8
Engineering Decision Making
• Some short time period Example 1- 2, 3 & 4

Source A B C
economic decisions are % sand 25% 40%
illustrated in these three %% aggregate
course aggregate 75% 60%
examples.
Cost $ 3.00 $ 4.40
% of source in mix 80% 20% 0%
9
9th Edition
Chapter 2
ENGINEERING COSTS AND
COST ESTIMATING
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 2
0
Engineering Costs
Classifications of costs
• Fixed - constant, unchanging
• Rent is constant (single, married, children)
• Variable - depend on activity level
• Food depends on the number of occupants
• Marginal - variable cost for the next unit
• Depends on the next unit (adult, child, baby)
• Average - total cost/number of units
• Rent+ food+…+n/number of units
1
Fixed, Variable, and Total Costs
Example 2-1
Fixed Costs Variable Costs
Bus Rental $ 80.00 Event Tickets $ 12.50
Gas Expense $ 75.00 Refreshments $ 7.50
Other Fuels $ 20.00 Total costs
Bus Driver $ 50.00
Total FC $ 225.00 Total VC $ 20.00 $800.00
$600.00
Cost ($)
Total cost
$400.00
Fixed cost
People Fixed cost Variable cost Total cost $200.00
0 $ 225.00 $ - $ 225.00 $-
5 $ 225.00 $ 100.00 $ 325.00
0 5 10 15 20
10 $ 225.00 $ 200.00 $ 425.00
15 $ 225.00 $ 300.00 $ 525.00 Volume
20 $ 225.00 $ 400.00 $ 625.00
2
Profit and Loss Terms
• Breakeven: total revenue = total costs

• Just getting by
• Profit region: total revenue > total costs
• Putting money in the bank
• Loss region: total revenue < total costs
• Going into debt
3
Breakeven Charts
Example 2-2
Fixed Costs Variable Costs Ticket price
Bus Rental $ 80.00 Event Tickets $ 12.50 $ 35.00
Gas Expense $ 75.00 Refreshments $ 7.50
Other Fuels $ 20.00
Bus Driver $ 50.00
Total FC $ 225.00 Total VC $ 20.00
People Fixed cost Variable cost Total cost Revenue Profit Region
0 $ 225.00 $ - $ 225.00 $ - $ (225.00) Loss
5 $ 225.00 $ 100.00 $ 325.00 $ 175.00 $ (150.00) Loss
10 $ 225.00 $ 200.00 $ 425.00 $ 350.00 $ (75.00) Loss
15 $ 225.00 $ 300.00 $ 525.00 $ 525.00 $ - Breakeven
20 $ 225.00 $ 400.00 $ 625.00 $ 700.00 $ 75.00 Profit
25 $ 225.00 $ 500.00 $ 725.00 $ 875.00 $ 150.00 Profit
30 $ 225.00 $ 600.00 $ 825.00 $ 1,050.00 $ 225.00 Profit
35 $ 225.00 $ 700.00 $ 925.00 $ 1,225.00 $ 300.00 Profit
40 $ 225.00 $ 800.00 $ 1,025.00 $ 1,400.00 $ 375.00 Profit
Profit-loss breakeven chart
$1,500.00
Total cost
Cost ($)
$1,000.00
Fixed cost
$500.00
Revenue
$-
0 5 10 15 20 25 30 35 40
Volume
4
Past (Sunk) Costs and
Future (Opportunity) Costs
• Sunk cost: money spent due to a past decision. We

cannot do anything about these costs.
• Purchase price paid for a car two years ago
• Opportunity cost: a benefit that is foregone by
engaging a resource in a chosen activity instead of
engaging that same resource in some foregone
activity. We make a choice or decision.
• Buying lunch instead of gas
5
Which amount is the value at present?
Example 2-3
Price when purchased $ 7,000.00 Sunk cost Past decisions
Storage costs $ 1,000.00 Sunk cost Past decisions
List price when purchased $ 9,500.00 Old list Past decisions
Current list price of new pumps $ 12,000.00 New list different features Past decisions
Amount offered for pumps 2 years ago $ 5,000.00 Foregone opportunity Past decisions
Current price that the pumps could be sold for $ 3,000.00 Market value Present opportunity
6
Expense Types
• Recurring expense: anticipated and occur at regular

intervals.
• Purchasing food, paying rent
• Non-recurring expense: one-of-a-kind event that
occurs at an irregular interval.
• Illness, accident, death
•Sometimes we attempt to plan for

large non-recurring costs by
buying insurance. Paying the
periodic insurance premium turns
7
Incremental Costs
• An incremental cost is the difference between the

costs of two alternatives.
•Example 2-4 Costs

Model
Incremental
Cost Items A B
Purchase price $ 10,000.00 $ 17,500.00 $ 7,500.00
Installation costs $ 3,500.00 $ 5,000.00 $ 1,500.00
Annual maintenance costs $ 2,500.00 $ 750.00 $(1,750.00)
Annual utility expenses $ 1,200.00 $ 2,000.00 $ 800.00
Disposal costs after useful life $ 700.00 $ 500.00 $ (200.00)
8
Cash vs. Book Costs
• Cash costs: movement of money from one

owner to another - also known as a cash flow.
• Payment this month on an auto loan
• Book cost: cost of a past transaction that is
recorded in a book.
• Down payment recorded in your checkbook from
last year’s automobile purchase
9
Life-cycle Costs
• Life-cycle: all the time from conception to

death of a product (process).
• Life-cycle costs: sum total of all the costs
incurred during the life cycle.
• Life-cycle costing: designing with an
understanding of all the costs associated with
a product during its life-cycle.
0
Cost Estimating
• Economic analysis is future based.

• Costs and benefits in the future require
estimating.
• Estimated costs are not known with certainty.
• The more accurate the estimate, the more
reliable the decision.
1
Types of Estimates
• Rough: gut level, inaccurate

• -30% to +60%.
• Semi-detailed: based on historical records,
reasonably sophisticated and accurate
• -15% to +20%.
• Detailed: based on detailed specifications
and cost models, very accurate
• -3% to +5%.
2
Estimating Models
Model Explanation Examples
Per Unit Uses a “per unit” factor
$/sq ft, Benefits/employee
Segmenting Divide problem into items,
estimate each & sum
Cost Indexes Index number based on history
•US CPI
Power Sizing Scaling previous known costs up
or down
Triangulation Looking at costs from several
perspectives
Learning Curve Tracking cost improvements
3
Cash Flow Diagrams
• Summarizes the flow of money over time
• Can be represented using a spreadsheet
Year Capital costs O&M Overhaul Total
0 $ (80,000.00) $ (80,000.00)
1 $ (12,000.00) $ (12,000.00)
2 $ (12,000.00) $ (12,000.00)
3 $ (12,000.00) $ (25,000.00) $ (37,000.00)
4 $ (12,000.00) $ (12,000.00)
5 $ (12,000.00) $ (12,000.00)
6 $ 10,000.00 $ (12,000.00) $ (2,000.00)
Cash flow
$20,000.00
$-
Cash flow
$(20,000.00) 0 1 2 3 4 5 6 Overhaul
$(40,000.00) O&M
$(60,000.00) Capital costs
$(80,000.00)
$(100,000.00)
Ye ar
4
9th Edition
Chapter 3
INTEREST AND EQUIVALENCE
Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford Unversity Press, Inc. 3
5
Economic Decision Components
• Where economic decisions are immediate we need to

consider:
• amount of expenditure
• taxes
• Where economic decisions occur over a considerable
period of time we also need to consider:
• interest
• inflation
6
Computing Cash Flows
• Cash flows have:

• Costs (disbursements) > a negative number
• Benefits (receipts) > a positive number
•Example 3-1
End of
Year Cash flow
0 $ (1,000.00)
1 $ 580.00
2 $ 580.00
7
Time Value of Money
• Money has value

• Money can be leased or rented
• The payment is called interest
• If you put $100 in a bank at 9% interest for one time period
you will receive back your original $100 plus $9
•Original amount to be returned

= $100
•Interest to be returned = $100
8
Simple Interest
• Interest that is computed only on the original

sum or principal
• Total interest earned = I = P x i x n
• Where
• P – present sum of money
• i – interest rate
• n – number of periods (years)
•I = $100 x .09/period x 2
periods = $18
9
Future Value of a Loan with
Simple Interest
• Amount of money due at the end of a loan

• F = P + P i n or F = P (1 + i n )
• Where
• F = future value
•F = $100 (1 + .09 x 2)
= $118
• Would you accept payment with simple
interest terms?
• Would a bank?
0
Compound Interest
• Interest that is computed on the original
unpaid debt and the unpaid interest
• Total interest earned = In = P (1+i)n - P
• Where
• P – present sum of money
• i – interest rate
• n – number of periods (years)
•I2 = $100 x (1+.09)2 - $100 = $18.81
1
Future Value of a Loan with
Compound Interest
• Amount of money due at the end of a loan

• F = P(1+i)1(1+i)2…..(1+i)n or F = P (1 + i)n
• Where
• F = future value
•F = $100 (1 + .09)2 =
$118.81
• Would you be more likely to accept
payment with compound interest terms?
• Would a bank?
2
Comparison of Simple and Compound
Interest Over Time Simple and compound interest
Single payment
Principal = 100.00
•If you loaned a friend money Interest = 9.00%
for short period of time the •Check Simple Compound

Period amount factor amount factor
difference between simple
and compound interest is
the n
Find Fs
Given P
Fs/P
Find F Given P
F/P
0 100.000 100.000
negligible. table to 1
2
3
109.000
118.000
127.000
109.000
118.810
129.503
•If you loaned a friend money
for a long period of time the
see the 4
5
6
136.000
145.000
154.000
141.158
153.862
167.710
7 163.000 182.804
difference between simple differen 8

9
10
172.000
181.000
190.000
199.256
217.189
236.736
and compound interest may
amount to a considerable ce over 11
12
13
199.000
208.000
217.000
258.043
281.266
306.580
14 226.000 334.173
difference. time. 15
16
17
235.000
244.000
253.000
364.248
397.031
432.763
•Short or long? When is the $ difference significant? 18
19
262.000
271.000
471.712
514.166
20 280.000 560.441
•You pick the time period.
3
Four Ways to Repay a Debt
Plan Repay Repay Interest Interest Earned
Principal
1 Equal annual Interest on Declines
installments unpaid balance
2 End of loan Interest on Constant
unpaid balance
3 Equal annual installments Declines at
increasing rate
4 End of loan Compound and Compounds at
pay at end of increasing rate
loan until end of loan
4
Loan Repayment – Four Options
Loan Repayment Option Calculator
•This calculator is
$5,000 Principal
10.00% Interest rate (enter as .1 for 10%)
10 Years
Plan 1 Enter 1 through 4
Principal payment Equal annual installments
partially complete.
Interest payment EOY on unpaid principal
Amount
owed at the Interest Total owed Total end
beginning owed for at the end Principal of year
Years of the year that year of year payment payment
1 5,000 500 5,500 500 1,000
If you complete the 2

3
4
5
4,500
4,000
3,500
3,000
450
400
350
300
4,950
4,400
3,850
3,300
500
500
500
500
950
900
850
800
6 2,500 250 2,750 500 750
calculator you can 7

8
9
10
2,000
1,500
1,000
500
200
150
100
50
2,200
1,650
1,100
550
500
500
500
500
700
650
600
550
2,750 5,000 7,750
earn 10 bonus 1
2
3
5,000
5,000
5,000
500
500
500
5,500
5,500
5,500
0
0
0
500
500
500
4 5,000 500 5,500 0 500
points for your 5
1
5,000
5,000
500
2,500
500
5,500
5,500
5,000
5,000
314
5,500
7,500
814
2 4,500 450 4,950 345 814
team. 3
4
5
4,000
3,500
3,000
400
350
300
2,000
4,400
3,850
3,300
380
418
459
1,915
814
814
814
4,069
1 5,000 500 5,500 -500 0

2 5,500 550 6,050 -550 0
3 6,050 605 6,655 -605 0
4 6,655 666 7,321 -666 0
5 7,321 732 8,053 7,321 8,053
3,053 5,000 8,053
5
Equivalence
• When an organization is indifferent as to whether it

has a present sum of money now or the assurance of
some other sum of money (or series of sums of
money) in the future, we say that the present sum of
money is equivalent to the future sum or series of
sums.
•Each of the plans on the

previous slide is equivalent
because each repays $5000 at
the same 10% interest rate. 6

Given the choice of these two plans which
would you choose?
Year Plan 1 Plan 2
1 $1400 $400
2 1320 400
3 1240 400
4 1160 400
5 1080 5400
Total $6200 $7000
•To make a choice the cash

flows must be altered so a
comparison may be made. 7

Technique of Equivalence
• Determine a single equivalent value at a point

in time for plan 1.
• Determine a single equivalent value at a point
in time for plan 2.
•Both at the same

interest rate.
•Judge the relative attractiveness of the
two alternatives from the comparable
equivalent values.
8
Repayment Plans
Establish the Interest Rate
Equivalence Calculator
$5,000
1. Principal Plan
8.00%
5
1
outstanding
Interest
Year owed for Total owed at
s Amount owed at the beginning of the year that year the end of year
1 5,000 400 5,400
over time
2 4,000 320 4,320
3 3,000 240 3,240
4 2,000 160 2,160
5 1,000 80 1,080
Totals 1,200
2. Amount repaid Interest paid over time 1,200

= 8.00%
•As
Total owed over time 15,000
an time
over example: $4,876.63
9.00%
5
•If F = P (1 + i)n
Plan 1
Interest
Year owed for Total owed at
•Then i=(F/P)1/n-1
s Amount owed at the beginning of the year that year the end of year
1 4,877 439 5,316
2 3,901 351 4,252
3 2,926 263 3,189
4 1,951 176 2,126
5 975 88 1,063
Totals 1,317
9
Application of Equivalence Calculations
•Pick an Comparing alternatives

Interest rate 10.00%
alternative Year
0
A
$600
B
Alternative
-$600
C
-$850
D
$850
. Which 1
2
$115
$115
-$115
-$115
-$80
-$80
$80
$80
3 $115 -$115 -$80 $80
would you 4
5
$115
$115
-$115
-$115
-$80
-$80
$80
$80
•Change
choose? 6 $115 -$115 -$80 $80
7 $115 -$115 -$80 $80
8 $115 -$115 -$80 $80
the 9
10
$115
$115
-$115
-$115
-$80
-$80
$80
$80
interest P $1,306.63 ($1,306.63) ($1,341.57) $1,341.57

Present
worth
Annual
rate. What A $212.65 ($212.65) ($218.33) $218.33
worth
Future
F $3,389.05 ($3,389.05) ($3,479.68) $3,479.68
happens worth
at
0
Interest Formulas
• To understand equivalence, the underlying

interest formulas must be analyzed.
• Notation:
I = Interest rate per interest period
n = Number of interest periods
P = Present sum of money (Present worth)
F = Future sum of money (Future worth)
1
Single Payment Compound Interest
Beginning Interest for Ending

Year
balance period balance
1 P iP P(1+i)
2 P(1+i) iP(1+i) P(1+i)2
3 P(1+i)2 iP(1+i)2 P(1+i)3
n P(1+i)n-1 iP(1+i)n-1 P(1+i)n
•P at time 0 increases to P(1+i)n at the end

of time n.
•Or a Future sum = present sum (1+i)n

2
Notation for
Calculating a Future Value
• Formula:
F=P(1+i)n is the
single payment compound amount factor.
• Functional notation:
F=P(F/P,i,n) F=5000(F/P,6%,10)
• F =P(F/P) which is dimensionally correct.
3
Notation for
Calculating a Present Value
• P=F(1/1+i)n=F(1+i)-n is the
single payment present worth factor.
• Functional notation:
P=F(P/F,i,n) P=5000(P/F,6%,10)
4
Compound Interest Factors
Examples 10.00% Single Amount Factor

Compound Amount Factor Present Worth Factor
F=P(F,i,n) n
0 $1.00
F/P
$5,000.00 $1.00
P/F
$8,052.55
1 1.100 $5,500.00 0.90909 $7,320.50
P=F(F,i,n) 2
3
1.210
1.331
$6,050.00
$6,655.00
0.82645
0.75131
$6,655.00
$6,050.00
4 1.464 $7,320.50 0.68301 $5,500.00
5 1.611 $8,052.55 0.62092 $5,000.00
6 1.772 $8,857.81 0.56447 $4,545.45
7 1.949 $9,743.59 0.51316 $4,132.23
F=$5000 i=0.10 n=5 P=? 8 2.144 $10,717.94 0.46651 $3,756.57
9 2.358 $11,789.74 0.42410 $3,415.07
F=P(1+i)–n=$5000(1+0.10)–5 10 2.594 $12,968.71 0.38554 $3,104.61
11 2.853 $14,265.58 0.35049 $2,822.37
=$5000(1.611)=$8055 12 3.138 $15,692.14 0.31863 $2,565.79
13 3.452 $17,261.36 0.28966 $2,332.54
F=P(F/P,10,5)=$5000(1.611) 14 3.797 $18,987.49 0.26333 $2,120.49
15 4.177 $20,886.24 0.23939 $1,927.72
=$8055 16 4.595 $22,974.86 0.21763 $1,752.47
17 5.054 $25,272.35 0.19784 $1,593.15
18 5.560 $27,799.59 0.17986 $1,448.32
19 6.116 $30,579.55 0.16351 $1,316.66
P=F(P/F,10,5)=$8055(.62092) 20 6.727 $33,637.50 0.14864 $1,196.96
25 10.835 $54,173.53 0.09230 $743.22
=$5000 30 17.449 $87,247.01 0.05731 $461.48
40 45.259 $226,296.28 0.02209 $177.92
50 117.391 $586,954.26 0.00852 $68.60
60 304.482 $1,522,408.20 0.00328 $26.45
72 955.594 $4,777,969.09 0.00105 $8.43
100 13,780.612 $68,903,061.70 0.00007 $0.58
5
18% Compounded Monthly
• 18% interest: Assume a yearly rate if not stated

• Compounded monthly: Indicates 12 periods/year
• [18%/year] / [12months/year] = 1.5% / month
Effective vs Nominal Interest Comparator
Nominal Interest rate 9.00% @ 365 Periods/year

Effective Interest rate 9.42% per year
Number of years 1.00
Single Amount Factor

Compound Amount Factor Present Worth Factor
F/P P/F
i n $1.00 $500.00 $1.00 $547.08
9.00% 1.00 1.090 $545.00 0.99975 $501.91
0.02% 365 1.094 $547.08 0.91394 $500.00
6
9th Edition
Chapter 4
MORE INTEREST FORMULAS
Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 5
7
Components of Engineering Economic
Analysis
• Calculation of P,A,and F are fundamental.

• Some problems are more complex and
require an understanding of added
components:
• Uniform series
• Arithmetic or geometric gradients
• Nominal and effective interest rates
• Continuous compounding
8
Uniform Payment Series
Compound Amount Factor F
• The future value of an

Interest rate 10.00% The interest rate may be changed.
P
F
A $1.00 A' may be changed.
investment based on Compound

Amount
Factor
periodic, constant Year

1
2
F/A
$1.00 These values will be modified.

$2.10
3 $3.31
payments and a constant 4

5
6
7
$4.64
$6.11
$7.72
$9.49
interest rate. 8
9
10
11
$11.44
$13.58
$15.94
$18.53
12 $21.38
13 $24.52
14 $27.97
15 $31.77
16 $35.95
17 $40.54
18 $45.60
•F= A(F/A,i,n)
19 $51.16
20 $57.27
21 $64.00
22 $71.40
23 $79.54
24 $88.50
25 $98.35
26 $109.18
27 $121.10
28 $134.21
29 $148.63
30 $164.49
9
•Example 4-1
•At 5%/year
Year Cash Cash
in out
0 0
1 $500 Cash flow calculator
Initial deposit $0.00
2 $500 Annual deposit
Years
$500.00
5
Cash flow diagram
$1,000.00
Interest rate 5.00%
3 $500 Year Deposit Future worth $500.00

0 0.00
1 500.00
4 $500 2 500.00 $0.00
3 500.00 0 2 4 6 8 10 12 14 16 18 20
4 500.00
5 $500 $2763 5 500.00 ($2,762.82)
($500.00)
6 0.00
7 0.00 ($1,000.00)
$
8 0.00
•F =
9 0.00
10 0.00 ($1,500.00)
11 0.00
12 0.00 ($2,000.00)
13 0.00
•$500(F/A, 5%,5)
14 0.00
15 0.00 ($2,500.00)
16 0.00
17 0.00
($3,000.00)
18 0.00
19 0.00 Years
•= $500(5.526)
20 0.00
• = $2763
0
Sinking Fund Factor
Interest rate 8.00%
P
F $1.00
• The constant periodic A $1.00
Sinking Compound
amount, at a constant Fund

Factor
A/F
Amount
Factor
F/A
interest rate, that must Year

1
2
$1.00000
$0.48077
$1.000
$2.080
3 $0.30803 $3.246
be deposited to 4
5
6
$0.22192
$0.17046
$0.13632
$4.506
$5.867
$7.336
accumulate a future 7
8
9
$0.11207
$0.09401
$0.08008
$8.923
$10.637
$12.488
10 $0.06903 $14.487
value. 11
12
13
$0.06008
$0.05270
$0.04652
$16.645
$18.977
$21.495
14 $0.04130 $24.215
15 $0.03683 $27.152
16 $0.03298 $30.324
17 $0.02963 $33.750
18 $0.02670 $37.450
19 $0.02413 $41.446
20 $0.02185 $45.762
21 $0.01983 $50.423
•A = F(A/F,i,n)
22 $0.01803 $55.457
23 $0.01642 $60.893
24 $0.01498 $66.765
25 $0.01368 $73.106
26 $0.01251 $79.954
27 $0.01145 $87.351
28 $0.01049 $95.339
29 $0.00962 $103.966
30 $0.00883 $113.283
1
Capital Recovery Factor
• The series of P
F
$1.00
Interest rate =
$345.62
10.00%
uniform payments
A $1.00
Sinking Fund Capital Recovery Compound Amount

Factor Factor Factor
that will recover an Year

1
2
A/F
$1.00000
$0.47619
A/P
$380.1820
$199.1430
F/A
$1.000
$2.100
3 $0.30211 $138.9789 $3.310
initial investment. 4
5
6
7
$0.21547
$0.16380
$0.12961
$0.10541
$109.0330
$91.1737
$79.3569
$70.9922
$4.641
$6.105
$7.716
$9.487
8 $0.08744 $64.7844 $11.436
9 $0.07364 $60.0136 $13.579
10 $0.06275 $56.2481 $15.937
11 $0.05396 $53.2127 $18.531
12 $0.04676 $50.7243 $21.384
13 $0.04078 $48.6559 $24.523
•A = P(A/P,i,n)
14 $0.03575 $46.9166 $27.975
15 $0.03147 $45.4400 $31.772
16 $0.02782 $44.1760 $35.950
17 $0.02466 $43.0864 $40.545
18 $0.02193 $42.1415 $45.599
19 $0.01955 $41.3178 $51.159
20 $0.01746 $40.5964 $57.275
21 $0.01562 $39.9621 $64.002
22 $0.01401 $39.4024 $71.403
23 $0.01257 $38.9071 $79.543
24 $0.01130 $38.4674 $88.497
25 $0.01017 $38.0763 $98.347
26 $0.00916 $37.7275 $109.182
27 $0.00826 $37.4160 $121.100
28 $0.00745 $37.1372 $134.210
29 $0.00673 $36.8874 $148.631
30 $0.00608 $36.6631 $164.494
2
Present Worth Factor
•The present value

Interest rate = 10.00%
P $1.00
F $1.00
A $1.00 $1.00
of a series of Sinking
Fund
Factor
A/F
capital
Recovery
Factor
A/P
Compound
Amount
Factor
F/A
Present
Worth
Factor
P/A
Year
uniform future 1
2
3
4
5
$1.00000
$0.47619
$0.30211
$0.21547
$0.16380
$1.1000
$0.5762
$0.4021
$0.3155
$0.2638
$1.000
$2.100
$3.310
$4.641
$6.105
$0.909
$1.736
$2.487
$3.170
$3.791
payments.
6 $0.12961 $0.2296 $7.716 $4.355
7 $0.10541 $0.2054 $9.487 $4.868
8 $0.08744 $0.1874 $11.436 $5.335
9 $0.07364 $0.1736 $13.579 $5.759
10 $0.06275 $0.1627 $15.937 $6.145
11 $0.05396 $0.1540 $18.531 $6.495
12 $0.04676 $0.1468 $21.384 $6.814
13 $0.04078 $0.1408 $24.523 $7.103
•P = A(P/A,i,n)
14 $0.03575 $0.1357 $27.975 $7.367
15 $0.03147 $0.1315 $31.772 $7.606
16 $0.02782 $0.1278 $35.950 $7.824
17 $0.02466 $0.1247 $40.545 $8.022
18 $0.02193 $0.1219 $45.599 $8.201
19 $0.01955 $0.1195 $51.159 $8.365
20 $0.01746 $0.1175 $57.275 $8.514
21 $0.01562 $0.1156 $64.002 $8.649
22 $0.01401 $0.1140 $71.403 $8.772
23 $0.01257 $0.1126 $79.543 $8.883
24 $0.01130 $0.1113 $88.497 $8.985
25 $0.01017 $0.1102 $98.347 $9.077
26 $0.00916 $0.1092 $109.182 $9.161
27 $0.00826 $0.1083 $121.100 $9.237
28 $0.00745 $0.1075 $134.210 $9.307
29 $0.00673 $0.1067 $148.631 $9.370
30 $0.00608 $0.1061 $164.494 $9.427
3
Example 4-5
Interest rate = 1.00%
A = $140/month P
F
A
$1.00
$1.00
$1.00 $140.00
i= 1%/month
Sinking Fund Capital Recovery Compound Amount Present Worth
Factor Factor Factor Factor
A/F A/P F/A P/A
Year
1 $1.00000 $1.0100 $1.000 $138.614
2 $0.49751 $0.5075 $2.010 $275.855
n= 30 months 3
4
5
6
$0.33002
$0.24628
$0.19604
$0.16255
$0.3400
$0.2563
$0.2060
$0.1725
$3.030
$4.060
$5.101
$6.152
$411.738
$546.275
$679.480
$811.367
• Is the above
7 $0.13863 $0.1486 $7.214 $941.947
8 $0.12069 $0.1307 $8.286 $1,071.235
9 $0.10674 $0.1167 $9.369 $1,199.242
10 $0.09558 $0.1056 $10.462 $1,325.983
11 $0.08645 $0.0965 $11.567 $1,451.468
12 $0.07885 $0.0888 $12.683 $1,575.711
equivalent to 13
14
15
$0.07241
$0.06690
$0.06212
$0.0824
$0.0769
$0.0721
$13.809
$14.947
$16.097
$1,698.724
$1,820.518
$1,941.107
16 $0.05794 $0.0679 $17.258 $2,060.502
$6800 now? 17
18
19
20
$0.05426
$0.05098
$0.04805
$0.04542
$0.0643
$0.0610
$0.0581
$0.0554
$18.430
$19.615
$20.811
$22.019
$2,178.715
$2,295.758
$2,411.641
$2,526.377
21 $0.04303 $0.0530 $23.239 $2,639.978
22 $0.04086 $0.0509 $24.472 $2,752.453
23 $0.03889 $0.0489 $25.716 $2,863.815
24 $0.03707 $0.0471 $26.973 $2,974.074
25 $0.03541 $0.0454 $28.243 $3,083.242
26 $0.03387 $0.0439 $29.526 $3,191.329
27 $0.03245 $0.0424 $30.821 $3,298.345
28 $0.03112 $0.0411 $32.129 $3,404.302
29 $0.02990 $0.0399 $33.450 $3,509.210
30 $0.02875 $0.0387 $34.785 $3,613.079
60 $0.01224 $0.0222 $81.670 $6,293.705
4
Year Cash flow
Example 4-6 1 $100
2 $100
3 $100
4 $0
•F1 = $100(F/A,15%,3) 5 F
•= $347.25 Cash flow calculator
•F2 =
Initial deposit $0.00
Annual deposit $100.00 Cash flow diagram
Start deposits in year 1
End deposits in year 3 $200.00
$347.25(F/P,15%,2) Years to withdrawal

5
$100.00
•= $459.24 Year
0
1
Deposit
0.00
100.00
Future worth
$0.00
2 100.00 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
3 100.00
($100.00)
4 0.00
5 0.00 ($459.24)
$
6 0.00
($200.00)
7 0.00
8 0.00
9 0.00
($300.00)
10 0.00
11 0.00
12 0.00
($400.00)
13 0.00
14 0.00
15 0.00
($500.00)
16 0.00
17 0.00 Years
18 0.00
5
Year Cash flow
Example 4-7 0 P
1 0
2 $ 20
•P = $20(P/F,15%,2) + 3 $ 30
4 $ 20
$30(P/F,15%,2) +
$20(P/F,15%,2) Cash flow calculator
Cash flow diagram
•= $46.28
$40.00
Deposit
Year required Withdrawals $30.00
0 $ (46.28)
1 $ - $20.00
2 $ 20.00
3 $ 30.00 $10.00
4 $ 20.00
5
$0.00
6
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
7
($10.00)
$
8
9
10 ($20.00)
11
12 ($30.00)
13
14 ($40.00)
15
16 ($50.00)
17
18
($60.00)
19
20 Years
6
Arithmetic Gradient
• A uniform increasing
amount.
• The first cash flow is
always equal to zero.
• G = the difference
between each cash
amount.
•G = $10
7
Arithmetic Gradient
•Example 4-8 Interest

rate = 5.00%
•The equivalent Year

0
Cash
series
present value of a 1
2
3
$120.00
$150.00
$180.00
uniformly increasing 4
5
6
$210.00
$240.00
amount. 7
8
9
10
11
PG = G(P/G,i,n) 12
PW = $766.64
8
Arithmetic Gradient
Uniform Series Factor
•Example 4-9 Interest

rate = 6.00%
Year Cash series
•The equivalent 0
1
2
$100.00
$200.00
4
$300.00
$400.00
5 $500.00
uniformly increasing 6
7
8
amount. 9
10
11
12
•AG = G(A/G,i,n) AW ($288.36)
9
Geometric Series
Example 4-12 Geometric Gradient

Year Cash series
The equivalent Interest rate 8.00%
0
1 $100.00
3
$110.00
$121.00
Initial cash
geometrically flow
$100.00 4
5
$133.10
$146.41
increasing amount. Uniform

6
7
rate of cash 10.00% 8
flow change 9
10
•P = A(P/A,g,i,n) Years 5.0

11
12
PW $480.43
0
Nominal and Effective Interest
• Nominal interest rate/year: the annual interest rate
w/o considering the effect of any compounding.
• 12%/year
• Interest rate/period: the nominal interest rate/year
divided by the number of interest compounding
periods.
• 12%/year/12 months/year = 1%/period
• Effective interest rate/year: the annual interest rate
taking into account the effect of the compounding
periods in the year.
• 12%/year compounded monthly is equivalent to 12.68%/year
compounded yearly
1
Nominal vs. Effective Rates
A Comparison - A Deposit
Nominal and Effective Interest Rate Comparison - A deposit
Amount deposited $10,000.00
Nominal Interest Rate/Year 30.00 %
Yearly Bi-annually Quarterly Monthly Bi-monthly
1 2 4 12 24
Period rate 30.00% 15.00% 7.50% 2.50% 1.25%
Effective annual rate 30.0000% 32.2500% 33.5469% 34.4889% 34.7351%
Year Account value Interest paid Account value Interest paid
0 $10,000.00 $3,000.00 $10,000.00 $3,448.89
1 $13,000.00 $3,900.00 $13,448.89 $4,638.37
2 $16,900.00 $5,070.00 $18,087.26 $6,238.09
3 $21,970.00 $6,591.00 $24,325.35 $8,389.54
4 $28,561.00 $8,568.30 $32,714.90 $11,283.00
5 $37,129.30 $11,138.79 $43,997.90 $15,174.38
6 $48,268.09 $14,480.43 $59,172.28 $20,407.86
7 $62,748.52 $18,824.56 $79,580.14 $27,446.30
8 $81,573.07 $24,471.92 $107,026.44 $36,912.22
9 $106,044.99 $31,813.50 $143,938.66 $49,642.84
10 $137,858.49 $41,357.55 $193,581.50 $66,764.10
11 $179,216.04 $53,764.81 $260,345.59 $89,790.29
12 $232,980.85 $69,894.26 $350,135.88 $120,757.95
13 $302,875.11 $90,862.53 $470,893.83 $162,406.02
14 $393,737.64 $118,121.29 $633,299.85 $218,418.04
15 $511,858.93 $153,557.68 $851,717.89 $293,747.98
16 $665,416.61 $199,624.98 $1,145,465.87 $395,058.38
17 $865,041.59 $259,512.48 $1,540,524.25 $531,309.60
18
Engineering Economic $1,124,554.07
Analysis - Ninth Edition$337,366.22 $2,071,833.85
Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford $714,552.34 7
University Press, Inc.
19 $1,461,920.29 $438,576.09 $2,786,386.19 $960,993.46 2
20 $1,900,496.38 $570,148.91 $3,747,379.65 $1,292,429.36
Nominal vs. Effective Rates
A Comparison - A Loan Repaid Monthly
Nominal and Effective Interest Rates A Comparison

A loan paid monthly
Amount Borrowed $10,000.00
Nominal Interest Rate/Year 12.00 %
Yearly Monthly
1 12
Period rate 12.00% 1.00%
Effective annual rate 12.00% 12.68%
Year Payments Total repaid Payments Total repaid
1 ($11,200.00) ($11,200.00) ($888.49) ($10,661.85)
2 ($5,916.98) ($11,833.96) ($470.73) ($11,297.63)
3 ($4,163.49) ($12,490.47) ($332.14) ($11,957.15)
4 ($3,292.34) ($13,169.38) ($263.34) ($12,640.24)
5 ($2,774.10) ($13,870.49) ($222.44) ($13,346.67)
6 ($2,432.26) ($14,593.54) ($195.50) ($14,076.14)
7 ($2,191.18) ($15,338.24) ($176.53) ($14,828.30)
8 ($2,013.03) ($16,104.23) ($162.53) ($15,602.73)
9 ($1,876.79) ($16,891.10) ($151.84) ($16,398.97)
10 ($1,769.84) ($17,698.42) ($143.47) ($17,216.51)
11 ($1,684.15) ($18,525.69) ($136.78) ($18,054.80)
12 ($1,614.37) ($19,372.42) ($131.34) ($18,913.24)
13 ($1,556.77) ($20,238.04) ($126.87) ($19,791.19)
14 ($1,508.71) ($21,121.97) ($123.14) ($20,688.02)
15 ($1,468.24) ($22,023.64) ($120.02) ($21,603.03)
16 ($1,433.90) ($22,942.40) ($117.37) ($22,535.52)
17 ($1,404.57) ($23,877.64) ($115.12) ($23,484.80)
18 ($1,379.37) ($24,828.72) ($113.20) ($24,450.13)
19 ($1,357.63) ($25,794.97) ($111.54) ($25,430.79)
20 ($1,338.79) ($26,775.76) ($110.11) ($26,426.07)
21 ($1,322.40) ($27,770.42) ($108.87) ($27,435.23)
22 ($1,308.11) ($28,778.31) ($107.79) ($28,457.57)
Engineering Economic Analysis - Ninth23Edition Newnan/Eschenbach/Lavelle
($1,295.60) ($29,798.79) Copyright($106.86)
2004 by Oxford University
($29,492.39) Press, Inc. 7
24 ($1,284.63) ($30,831.23) ($106.04) ($30,539.00) 3
25 ($1,275.00) ($31,874.99) ($105.32) ($31,596.72)
26 ($1,266.52) ($32,929.48) ($104.70) ($32,664.92)
9th Edition
Chapter 5
PRESENT WORTH ANALYSIS
4
•Jerome P. Lavelle:
•In general I like this type of slide, it provides a map of the material in terms
of past coverage and future materials. My only comment is that if we chose
•Where we have been:
to use this approach as a first slide, we need to do it for all chapters. Also, I
believe that we need “chapter learning objectives” incorporated into all of
the chapter slides (however, we don’t yet have these for any chapters).
• Equivalence concept
Given all of this, and for consistency sake, I would say for now we need to
eliminate this slide.
• Cash flows
• Compound interest factors
Where we are going in this chapter:
• Understanding economic criteria
• Applying present worth techniques
• Assumptions in solving economic analysis
problems
5
Economic Criteria
•Projects are judged against an economic cr
Situation Criterion
Fixed input Maximize output
Fixed output Minimize input
Neither fixed Maximize difference

(output-input)
6
Economic Criteria Restated
Present Worth Techniques
Situation Criterion
Fixed input Amount of Maximize
capital available present worth of
fixed benefits
Fixed output $ amount of Maximize
benefit is fixed present worth of
costs
Neither fixed Neither capital Maximize net
nor $ benefits present worth
are fixed (NPV)
7
Economic Criteria - Example
Purchasing Building Space
Alt Situation Example Criterion

A Fixed $150,000 Maximum square feet of
input max building for the price
B Fixed 20,000 ft2 Negotiate for minimum

output building cost/ft2
available
C Neither $150,000 max Simultaneously negotiate
fixed 15-20,000 ft2 for maximum building
required size & minimum cost/ft2
8
•Would it be useful to have a slide that
demonstrates the mechanics of calculating
Applying by hand using the tabled factors and equati
too?
Present Worth Techniques
• Analysis period must be considered

• Useful life of the alternative equals the analysis
period
• Alternatives have useful lives different from the
analysis period
• The analysis period is infinite, n = 
9
Useful Lives
Equal the Analysis Period
•Examples 5-1, 2, 3, & 4
1. Require a project to Examples Applying present worth techniques
last five years. 5-1 Interest rate
Year
0
A
7.00 %
Alternative
-1000
B
-1000
1 300 400
2 300 350
2. The equipment and

3 300 300
4 300 250
5 300 200
PW of benefits $1,230.06 $1,257.75

NPW $230.06 $257.75
tooling will last five 5-2 Interest rate
Year A
6.00 %
Alternative
B
0 -300 -400 <<<< Some cells are hidden.
years. 25
PW of costs
NPW
-350
($381.55)
($381.55)
($400.00)
($400.00)
0 You need to unhide them to enter
5-3 Interest rate 7.00 %
3. Calculate the PW or
Alternative
Year Speedy Allied Alternative Speedy Allied
NPW ($1,357.40) ($1,368.28)
0 -1500 -1600
1 0 0
2 0 0
NPW over a five

3 0 0
4 0 0
5 200 325
PW of costs ($1,500.00) ($1,600.00)

NPW ($1,357.40) ($1,368.28)
year span and junk 5-4 Interest rate
Year
8.00 %
Alternative
Atlas Tom Thumb
Alternative
NPW
Atlas
$143.31
Tom Thumb
$214.85
the equipment and

0
•We need a slide that mentions the
Repeatability Assumption for handling
these problems – definition andUseful Lives Different
parameters
From the Analysis Period
1. Require a project to last 10 •Based on example 5-3
Based on 5-3 The lives of the equipment differ, one is a multiple of the other and we
years. can use the equipment as long as it will last.
Interest rate 7.00 %
2. The equipment and tooling Year Speedy

Alternative
Allied Alternative Speedy
NPW
Allied
($2,325.21) ($1,434.79)
will last five years. Purchase new Speedy 0

1
2
-1500
0
0
-1600 Purchase new Allied
0
0
3. Calculate the PW or NPW Salvage old Speedy

3
4
5 -1300
0
0
0
0
0
over a 10 year span. Purchase new Speedy 6

7
8
0
0
0
0
0
0
1. Purchase new equipment Salvage old Speedy
9
10 200
0 0
325 Salvage old Allied
and tooling twice, at the PW of costs ($2,325.21) ($1,434.79)

NPW ($2,325.21) ($1,434.79)
beginning of year one and

six. Based on 5-3 The lives of the equipment differ and the least common multiple of the
lives is longer than we can use the equipment.
2. Junk the equipment and Interest rate 7.00 %

Alternative
Year Speedy Allied Alternative Speedy Allied
tooling at the end of each five Purchase new Speedy
Life
0
7
-1500
13
-1600 Purchase new Allied
NPW ($1,793.91) ($1,294.45)
year period. 1
2
3
0
0
0
0
0
0
4 0 0
Salvage old Speedy 5 0 0
Purchase new Speedy 6 0 0
7 -1500 0
Salvage old Speedy 8 1100 525 Salvage old Allied
PW of costs ($1,793.91) ($1,294.45)

NPW ($1,793.91) ($1,294.45)
1
Infinite Analysis Period
Capitalized Cost
•Examples 5 - 5 & 6
•For: 5-5
Infinite analysis period
Annual disbursement $50.00 Note: this is
• n=
Interest rate 4% maintenance and
0.04 occurs at the end of
Capitalized cost $1,250.00 each period.
• A = Pi 5-6 Disbursement
Periods between disbursements
$8,000,000
70
Note: this is
construction and
•Then:
Interest rate 7% occurs at the
0.07 beginning of each
A/F $4,956.22 period.
PW of perpetual reconstruction $70,803.11 A/F/Interest rate
•Capitalized
Capitalized cost $8,070,803.11 Disbursement + Pw of perpetual
reconstruction
Alternate solution A
cost A/P
Capitalized cost
$564,956.22
$8,070,803.11 A/P/Interest rate
•
Alternate solution B
P = A/i 70 year interest rate

PW of perpetual reconstruction
Capitalized cost
112.99
$70,803.11 Disbursement/70 year interest rate
$8,070,803.11 Disbursement + Pw of perpetual
reconstruction
•This
2
•The text of this table is quite difficult to
read, it seems some of the row widths
need to be readjusted
Multiple Alternatives
•Examples 5 - 7, 8, 9 & 10
•Where more than
5-7 Operating years 5
Operating hours/year 2000
MARR 7.00 %
0.07
Alternative A B C D
Description 2" Pipe 3" Pipe 4" Pipe 6" Pipe
Installed cost of pipeline and pump $22,000.00 $23,000.00 $25,000.00 $30,000.00
Cost per hour for pumping $1.20 $0.65 $0.50 $0.40
Annual cost of pumping $2,400.00 $1,300.00 $1,000.00 $800.00
one alternative
PW of pumping costs ($9,840.47) ($5,330.26) ($4,100.20) ($3,280.16)
PW of pipeline costs ($31,840.47) ($28,330.26) ($29,100.20) ($33,280.16)

MARR 10.00 %
0.1
Alternative A B C D
exists, we
Vegetable
Description Do nothing market Gas station Small motel
Total capital investment $0.00 ($50,000.00) ($95,000.00) ($350,000.00)
Uniform net annual benefit $0.00 $5,100.00 $10,500.00 $36,000.00
Terminal value at end of project $0.00 $30,000.00 $30,000.00 $150,000.00
PW investment $0.00 ($50,000.00) ($95,000.00) ($350,000.00)

PW of benefits $0.00 $43,419.17 $89,392.42 $306,488.29
generally want to
PW of terminal value $0.00 $4,459.31 $4,459.31 $22,296.54
NPW of project $0.00 ($2,121.52) ($1,148.27) ($21,215.16)

MARR 10.00 %
0.1
Alternative A B C D
compare the
Strip mining
Description Do nothing project
Total capital investment $0.00 ($610,000.00)
Net annual benefit 1 $0.00 $200,000.00
2 $0.00 $200,000.00
3 $0.00 $200,000.00
4 $0.00 $200,000.00
5 $0.00 $200,000.00
alternatives in a
6 $0.00 $200,000.00
7 $0.00 $200,000.00
8 $0.00 $200,000.00
9 $0.00 $200,000.00
10 $0.00 $200,000.00
Terminal value at end of project $0.00 ($1,500,000.00)
PW investment $0.00 ($610,000.00) $0.00 $0.00
single table. 5-10

PW of benefits
PW of terminal value
NPW of project
Operating years
MARR
$0.00
$0.00
$0.00
8
8.00 %
$1,228,913.42
($578,314.93)
$40,598.49
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
0.08
Alternative Null A B C
Description CE-1 CE-2
Total capital investment $0.00 ($2,000.00) ($1,500.00)
Net annual benefit 1 $0.00 $1,000.00 $700.00
2 $0.00 $850.00 $300.00
3 $0.00 $700.00 $300.00
4 $0.00 $550.00 $300.00
5 $0.00 $400.00 $300.00
6 $0.00 $400.00 $400.00
•The goal is to
7 $0.00 $400.00 $500.00
8 $0.00 $400.00 $600.00
9 $0.00 $0.00 $0.00
10 $0.00 $0.00 $0.00
Terminal value at end of project $0.00 $0.00 $0.00
develop a single 3
•Should Assumptions slide come at the beginning of the
chapter versus the end?
Assumptions in Solving Economic
•In looking back over the chapter I think we need a few
Analysis Problems
slides inserted on the theory or pedagogy involved in each
case of the use of Present Worth.
• End-of-year convention (simplifies calculations)

• Viewpoint (generally the firm)
• Sunk costs (past has no bearing)
• Borrowed money (consider investing only)
• Effect of inflation (prices are not stable)
• Income taxes (must be considered for realism)
4
9th Edition
Chapter 6
ANNUAL CASH FLOW ANALYSIS
5
Annual Cash Flow Calculations
Resolving a Present Cost
to an Annual Cost
• Simplest case is to convert the PV to a series
of EUAW (equivalent uniform annual worth)
cash flows – [previously A].
• A=p(a/p,i,n)
• A is -PMT in Excel®
• Where there is salvage value
• A will be reduced
• A = F(A/F,i,n)
6
Annual Cash Flow
Four Essential Points
1. EUAW = PW(A/P,i,n)
2. EUAW is
1. Decreased by a cost
2. Increased by a benefit
3. In Excel® use “-PMT” to calculate EUAW
1. (remember the minus sign)
4. For an irregular cash flow over the analysis
period, first determine the PW then convert to
EUAW
7
Annual Cash Flow Analysis
Situation Criterion
Fixed input Amount of Maximize
capital available EUAW
fixed
Fixed output $ amount of Maximize
benefit is fixed EUAW
Neither fixed Neither capital Maximize

nor $ benefits EUAW
are fixed
8
Analysis Period Considerations
1. Analysis period equal to alternative lives

2. Analysis period a common multiple of
alternative lives
3. Analysis period for a continuing requirement
4. Some other period such as project life
9
Analysis Period
Equal to Alternative Lives
• Base the comparison on the life of the
alternatives
• This is the case we have most often considered in
our examples
• This is rarely the case in “real-life” organizations
0
Analysis Period a Common Multiple
of Alternative Lives
• When the lives of the equipment in the two
alternatives varies, use a common multiple of
the two lives.
1
Analysis Period for a
Continuing Requirement
• Where the project will last forever (nothing
does) use an infinite time period.
• In most analyses, organizations often use a
representatively long time period to get a
reasonable estimate.
2
Some Other Period Such As
Project Life
• Physical equipment usually has a useful life
that is different from the project life.
• In this case, use the project life as the
analysis period.
• This is the most common case in “real-life”
organizations.
3
9th Edition
Chapter 7
RATE OF RETURN ANALYSIS
4
Three Major Methods of
Economic Analysis
• PW - Present Worth
• AW - Annual Worth
• IRR - Internal Rate of Return
•If PW = A(P/A,i,n)
•Then (P/A,i,n) = PW/A
•Solve for (P/A,i,n) and look
up interest in Compound
Interest Tables 5
Internal Rate of Return
Lender’s Viewpoint
• The interest rate on the balance of a loan
such that the unpaid loan balance equals
zero when the final payment is made.
Plan
Year A B C D
0 $ (5,000.00) $ (5,000.00) $ (5,000.00) $ (5,000.00)
1 $ 1,400.00 $ 400.00 $ 1,252.28 $ -
2 $ 1,320.00 $ 400.00 $ 1,252.28 $ -
3 $ 1,240.00 $ 400.00 $ 1,252.28 $ -
4 $ 1,160.00 $ 400.00 $ 1,252.28 $ -
5 $ 1,080.00 $ 5,400.00 $ 1,252.28 $ 7,346.64
IRR 8.00% 8.00% 8.00% 8.00%
6
Internal Rate of Return
Investor’s Viewpoint
• The interest rate earned on the unrecovered
investment such that the unrecovered
investment equals zero at the end of the life
of the investment.
Unrecovered
Return on Investment Unrecovered
investment at
Year Cash flow unrecovered repayment at investment at
beginning of
investment end of year end of year
year
0 ($5,000.00)
1 $1,252.28 $5,000.00 $400.00 $852.28 $4,147.72
2 $1,252.28 $4,147.72 $331.81 $920.47 $3,227.25
3 $1,252.28 $3,227.25 $258.18 $994.10 $2,233.15
4 $1,252.28 $2,233.15 $178.65 $1,073.63 $1,159.52
5 $1,252.28 $1,159.52 $92.76 $1,159.52 ($0.00)
IRR 8.00% Total $1,261.40 $5,000.00
•Reset the cash flow to

determine the IRR. 7

Calculating Rate of Return
• The IRR is the interest rate at which the

benefits equal the costs. IRR = i*
• PW Benefit - PW Cost = 0
• PW Benefit/PW Cost = 1
• NPW = 0
• EUAB - EUAC = 0
• PW Benefit = PW Cost
8
Calculating IRR
• PWB/PWC = 1
• 1252.28(P/A,i,5)/5000 = 1
• (P/A,i,5) = 5000/1252.28 = 3.9927
•From Compound Interest Tables
•Example 7-1•Interest •(P/A,i,5)
rate
•7% •4.100
•8% •3.993
•9% •3.890
9
Calculating IRR
•EUAB - EUAC = 0
•100 + 75(A/G,i,4) - 700(A/P, i, 4) = 0
•Look up and
•Example 7-2 iterate, book answer is
Year
7%
Cash flow
Unrecovered
investment at
Return on
unrecovered
Investment Unrecovered
repayment at investment at
beginning of
year
0 ($700.00)
1 $100.00 $700.00 $48.37 $51.63 $648.37
2 $175.00 $648.37 $44.81 $130.19 $518.18
3 $250.00 $518.18 $35.81 $214.19 $303.99
4 $325.00 $303.99 $21.01 $303.99 $0.00
5 $0.00 $0.00 $0.00 $0.00 $0.00
IRR 6.91% Total $150.00 $700.00
0
0
Calculating IRR
•Example 7-3 Year Cash flow
Unrecovered
investment at
beginning of
Return on
unrecovered
Investment Unrecovered
repayment at investment at
year
•The 0
1
($100.00)
$20.00 $100.00 $13.47 $6.53 $93.47
iterations 2
3
$30.00
$20.00
$93.47
$76.07
$12.59
$10.25
$17.41
$9.75
$76.07
$66.32
may be 4
5
$40.00
$40.00
$66.32
$35.25
$8.93
$4.75
$31.07
$35.25
$35.25
($0.00)
graphed
IRR 13.47% Total $50.00 $100.00
and the
true IRR Trial
interest NPW $60.00
will be rates $50.00
0 $50.00 $40.00
indicated
Net Present Value
5 $26.46 $30.00
10 $9.24 $20.00
at the point 15 ($3.49) $10.00
20 ($12.97) $0.00
where the 25 ($20.06) ($10.00) 0 5 10 15 20 25 30 35 40 45 50
30 ($25.37) ($20.00)
NPW 35 ($29.36) ($30.00)
40 ($32.34) ($40.00)
curve = 0. 45 ($34.54) ($50.00)
50 ($36.16)
0
1
Calculating IRR - Bond
•Example 7-4a
•Period rate
•1000 = 40(P/A,i,2) + 950(P/F,i,2)
•By lookup and interpolation i*  1.5%
•Nominal rate = 2 x 1.5% = 3%
•An •Effective •7-4a2 &- 17b= 3.02%
easier wayrate = (1 + 1.5%)
>
0
2
Rate of Return (ROR) Analysis
• Most frequently used measure of merit in

industry
• More accurately called Internal Rate of
Return (IRR)
0
3
Calculating ROR
• Where two mutually exclusive alternatives will

provide the same benefit, ROR is performed
using an incremental rate of return-DROR-on
the difference between the alternatives.
Two-alternative situation Decision
DROR MARR Choose higher-cost alternative
DROR <MARR Choose lower-cost alternative
0
4
ROR on Alternatives with
Equivalent Benefits
•Example 7-5 Cash flow on difference
Unrecovered
Cash flow - Cash flow - Cash flow - investment at
Year unrecovered repayment at investment at
alternative A alternative B alternative B-A beginning of
year
0 ($1,000.00) ($2,783.00) ($1,783.00)
1 $200.00 $1,200.00 $1,000.00 $1,783.00 $142.83 $857.17 $925.83
2 $200.00 $1,200.00 $1,000.00 $925.83 $74.17 $925.83 ($0.00)
3 $1,200.00 $1,200.00 $0.00 ($0.00) ($0.00) $0.00 ($0.00)
4 $1,200.00 $1,200.00 $0.00 ($0.00) ($0.00) $0.00 ($0.00)
•MARR 5 $1,200.00 $1,200.00 $0.00 ($0.00) ($0.00) $0.00 ($0.00)
= 10% IRR/period 48.72% 32.60% 8.01% Total $217.00 $1,783.00
Trial interest
NPW
rates $300.00
0 $217.00 $200.00
5 $72.77 Net Present Value
$100.00
10 ($43.15)
15 ($136.77) $0.00
0 5 10 15 20 25 30 35 40 45 50
20 ($212.69) ($100.00)
25 ($274.40) ($200.00)
30 ($324.66)
($300.00)
35 ($365.60)
40 ($398.94) ($400.00)
45 ($426.01) ($500.00)
50 ($447.93)
0
5
Criterion Is to Maximize Return
Not ROR
•Examples 7- 6, 7 & 8 Cash flow on difference
•What Year
Cash flow - Cash flow - Cash flow -
alternative A alternative B alternative B-A
Unrecovered
investment at
beginning of
Return on
unrecovered
investment
Investment
repayment at
end of year
Unrecovered
investment at
end of year
year
happens 0
1
2
($10.00)
$15.00
$0.00
($20.00)
$28.00
$0.00
($10.00)
$13.00
$0.00
$10.00
$0.00
$3.00
$0.00
$10.00
$0.00
$0.00
$0.00
3 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00
to NPW 4
5
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
when IRR/period
MARR =
NPW =
50.00%
6.00 %
$4.15
40.00%
$6.42
30.00%
$2.26
Total $3.00 $10.00
MARR is Trial interest

rates
0
NPW
$3.00
$3.50
$3.00
5 $2.27 $2.50
varied?
Net Present Value
10 $1.65 $2.00
15 $1.13 $1.50
20 $0.69 $1.00
Try 6, 30 25
30
35
$0.32
$0.00
($0.27)
$0.50
$0.00
($0.50) 0 5 10 15 20 25 30 35 40 45 50
40 ($0.51) ($1.00)
& 35%. 45
50
($0.71)
($0.89)
($1.50)
0
6
Fixed Input and Differing Outputs
•Example 7-9 Cash flow on difference
•Choose
Unrecovered
Cash flow - Cash flow - Cash flow - investment at
Year unrecovered repayment at investment at
alternative A alternative B alternative B-A beginning of
year
the 0
1
2
($1,000.00)
$400.00
$350.00
($1,000.00)
$300.00
$300.00
$0.00
($100.00)
($50.00)
$0.00
$100.00
$0.00
($0.00)
($100.00)
($50.00)
$100.00
$150.00
ranking 3
4
5
$300.00
$250.00
$200.00
$300.00
$300.00
$300.00
$0.00
$50.00
$100.00
$150.00
$150.00
$100.00
($0.00)
($0.00)
($0.00)
$0.00
$50.00
$100.00
$150.00
$100.00
($0.00)
so that IRR/period
MARR =
17.47%
7.00 %
15.24% 0.00% Total ($0.00) $0.00
NPW = $257.75 $230.06 ($27.69)
the Trial interest

rates
NPW
$0.00
difference 0
5
10
$0.00
($20.10)
($32.72) Net Present Value
($10.00)
($20.00)
0 5 10 15 20 25 30 35 40 45 50
represent 15
20
25
($40.40)
($44.80)
($47.00)
($30.00)
($40.00)
30 ($47.75)
s an 35
40
($47.52)
($46.66)
($50.00)
45 ($45.40) ($60.00)
increment 50 ($43.90)
of 0
7
Analysis Period
• Just as in PW and AW analysis, the analysis

period must be considered:
• Useful life of the alternative equals the analysis
period
• Alternatives have useful lives different from the
analysis period
• The analysis period is infinite, n = ¥
0
8
9th Edition
Chapter Appendix 7A
Difficulties Solving for an Interest Rate
0
9
Multiple IRR
•Example 7A-1
Unrecovered
investment at
•Occurs
beginning of
year
0 $19.00
when a 1
2
$10.00
($50.00)
($19.00)
($30.95)
($1.95)
($3.17)
$11.95
($46.83)
($30.95)
$15.88
3 ($50.00) $15.88 $1.63 ($51.63) $67.51
cash flow 4
5
$20.00
$60.00
$67.51
$54.43
$6.91
$5.57
$13.09
$54.43
$54.43
$0.00
Guess
produces IRR/period
IRR/period
10.24%
47.30%
10.00%
50.00%
Total $9.00 ($19.00)
more than Trial interest

rates
NPW
$10.00
one point 0
5
10
$9.00
$3.28
$0.11
Net Present Value $8.00
$6.00
at which 15
20
($1.50)
($2.14)
$4.00
$2.00
25 ($2.20)
NPW = 0 30
35
($1.91)
($1.44)
$0.00
($2.00)
0 5 10 15 20 25 30 35 40 45 50
40 ($0.88)
45 ($0.28) ($4.00)
50 $0.32
1
0
Cash Flow Rule of Signs
• May be converted to a polynomial
• Then, by Descartes’ rule
•Number of •Number of
sign positive values
•0 m
changes, •0 of X
•1 •1
•2 •2 or 0
•3 •3 or 1
•4 •4, 2 or 0
1
1
Cash Flow Rule of Signs Expands
on This Notion
• There may be as many positive values of “i”
as there are sign changes in the cash flow.
• Sign changes are counted when:
• + to -
• - to +
• A zero cash flow is ignored
1
2
Cash Flow Rule of Signs
- Possibilities -
•Number of sign •Number of positive

changes, m values of “i”
•0 •0
•1 •1 or 0
•2 •2, 1 or 0
•3 •3, 2, 1 or 0
•4 •4, 3, 2, 1 or 0
1
3
Zero Sign Changes
• Receiving a gift
• Giving your friend a loan and not being paid
back
•In either case, no “i” can be computed.
1
4
One Sign Change
The Normal Situation
Year A B C D E F
0 ($50.00) ($50.00) ($50.00) $50.00 $50.00 $50.00
1 $20.00 $20.00 $20.00 ($20.00) ($20.00) ($20.00)
2 $10.00 $20.00 $20.00 ($10.00) ($20.00) ($20.00)
3 $11.00 $20.00 ($11.00) ($20.00)
4 $12.00 ($12.00)
5
Sign
change 1 1 1 1 1 1
Guess IRR IRR IRR IRR IRR IRR

0 NPV 1.09% 17.64% NPV 1.09% 17.64%
10 NPV 1.09% 17.64% NPV 1.09% 17.64%
20 NPV 1.09% 17.64% NPV 1.09% 17.64%
30 NPV 1.09% 17.64% NPV 1.09% 17.64%
40 NPV 1.09% 17.64% NPV 1.09% 17.64%
50 NPV 1.09% 17.64% NPV 1.09% 17.64%
60 NPV 1.09% 17.64% NPV 1.09% 17.64%
70 NPV 1.09% 17.64% NPV 1.09% 17.64%
80 NPV 1.09% 17.64% NPV 1.09% 17.64%
90 NPV 1.09% 17.64% NPV 1.09% 17.64%
100 NPV 1.09% 17.64% NPV 1.09% 17.64%
1
5
Two or More Sign Changes
• More than one IRR may exist
• Use an NPW plot to determine how many exist
Unrecovered
investment at
beginning of
year
0 $19.00
1 $10.00 ($19.00) ($1.95) $11.95 ($30.95)
2 ($50.00) ($30.95) ($3.17) ($46.83) $15.88
3 ($50.00) $15.88 $1.63 ($51.63) $67.51
4 $20.00 $67.51 $6.91 $13.09 $54.43
5 $60.00 $54.43 $5.57 $54.43 $0.00
Guess
IRR/period 10.24% 10.00% Total $9.00 ($19.00)
IRR/period 47.30% 50.00%
Trial interest
NPW
rates $10.00
0 $9.00 $8.00
5 $3.28
Net Present Value
10 $0.11 $6.00
15 ($1.50) $4.00
20 ($2.14)
25 ($2.20) $2.00
30 ($1.91) $0.00
35 ($1.44) 0 5 10 15 20 25 30 35 40 45 50
($2.00)
40 ($0.88)
45 ($0.28) ($4.00)
50 $0.32
1
6

Engineering Economics

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Engineering Economics

Загружено:

Авторское право:

Доступные форматы

Engineering Economic Analysis

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle 1

The problems are often not

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle. 2

• Do we make part A or B • Would a mechanized or

Decisions concerning these opportunities may be

• Can generally be worked in one’s head

• Such problems represent a mixture of 3 elements:

• A problem exists when:

In the beginning the problems are a given.

• A goal or objective is the standard or

• Information may be Example 1-1

• The best alternative should be implemented.

• Requires merging the various elements:

• When choosing the best alternative both economic

• Compare the results of changes to the

• Some short time period Example 1- 2, 3 & 4

• Breakeven: total revenue = total costs

Profit-loss breakeven chart

• Sunk cost: money spent due to a past decision. We

• Recurring expense: anticipated and occur at regular

•Sometimes we attempt to plan for

• An incremental cost is the difference between the

•Example 2-4 Costs

• Cash costs: movement of money from one

• Life-cycle: all the time from conception to

• Economic analysis is future based.

• Rough: gut level, inaccurate

• Where economic decisions are immediate we need to

• Cash flows have:

• Money has value

•Original amount to be returned

• Interest that is computed only on the original

• Amount of money due at the end of a loan

•I2 = $100 x (1+.09)2 - $100 = $18.81

• Amount of money due at the end of a loan

•If you loaned a friend money Interest = 9.00%

for short period of time the •Check Simple Compound

difference between simple differen 8

If you complete the 2

calculator you can 7

points for your 5

1 5,000 500 5,500 -500 0

• When an organization is indifferent as to whether it

•Each of the plans on the

the same 10% interest rate. 6

•To make a choice the cash

comparison may be made. 7

• Determine a single equivalent value at a point

•Both at the same

2. Amount repaid Interest paid over time 1,200

•Pick an Comparing alternatives

interest P $1,306.63 ($1,306.63) ($1,341.57) $1,341.57

• To understand equivalence, the underlying

Beginning Interest for Ending

2 P(1+i) iP(1+i) P(1+i)2

3 P(1+i)2 iP(1+i)2 P(1+i)3

n P(1+i)n-1 iP(1+i)n-1 P(1+i)n

•P at time 0 increases to P(1+i)n at the end

•Or a Future sum = present sum (1+i)n

Examples 10.00% Single Amount Factor

• 18% interest: Assume a yearly rate if not stated

Effective vs Nominal Interest Comparator

Nominal Interest rate 9.00% @ 365 Periods/year