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# &

TODAY:
Seatwork
Present Worth Analysis
Formulating Alternatives
Single and equal-life alternatives
Different-life alternatives

## Seatwork (15 mins)

The DX III refuse truck has an energy recovery system
developed by DexCorp LLC that is expected to reduce fuel
consumption by 50%. Pressurized fluid flows from carbon
fiber-reinforced accumulator tanks to two hydrostatic motors
that propel the vehicle forward. (The truck recharges the
accumulators when it brakes.) The fuel cost for a regular
refuse truck is Php 35,000 per month. How much can a private
waste-hauling company afford to spend now on the recovery
system, if it wants to recover its investment in 3 years plus a
return of 14% per year, compounded semiannually? Assume
no interperiod compounding.

A per 6 months = 17,500(6) = Php
105,000 semiannually
P = 105,000 (P/A,7%,6)
= 105,000 (4.7665) = Php 500,487

## Thought for the Day:

FORMULATING ALTERNATIVES
Types of alternatives
Mutually exclusive (ME) - only

## one viable project can be

accepted. Do-nothing (DN)
alternative is selected if none
are justified economically
Independent - more than one
project can be selected. DN is
one of the projects
Do-nothing maintain status
quo/current approach

## Types of cash flow

estimates for an
alternative
Revenue estimates include

## costs, revenues and (possibly)

savings
Cost only cost estimates

## included; revenues assumed

equal for all alternatives

PW OF A SINGLE ALTERNATIVE
Single Project
Analysis
Calculate PW at stated MARR
Criterion: If PW 0,
project is economically justified

## Example 1: MARR = 10%

First cost, P = Php -2500
Annual revenue, R = Php 2000
Annual cost, AOC = Php -900
Salvage value, S = Php 200
Life, n = 5 years
PW = P +S(P/F,10%,5)
+ (R-AOC)(P/A,10%,5)
= -2500 + 200(P/F,10%,5)
+ (2000-900)(P/A,10%,5)
= Php 1794

PW > 0; project is
economically justified

## Example 2: Bond Investment

Bond like an IOU; issued by corporations and all levels of
government to raise capital
Face value, V Value of bond; this amount is returned at
end of bonds life. Purchase price may be discounted
Life, n years to bond maturity, e. g., 5, 10, 20+
Dividend, I periodic interest payments to purchaser
based on coupon rate, b

## Example 2: Bond Investment

A 10-year Php 10,000 6%
coupon rate bond is purchased
at 5% discount. Bond dividend
is paid semi-annually. Will the
investor make 7% per year
compounded semiannually?

period

## I = (10,000)(0.06)/2 = Php 300

PW = - 10,000(0.95)
+ 10,000(P/F,3.5%,20)
+ 300(P/A,3.5%,20)
= Php-210.62

0 1

n = 20
periods

19 20

## Bond will not make the

required return

EQUAL-LIFE ME ALTERNATIVES
Calculate PW of each alternative at MARR
Equal-service of alternatives is assumed
Selection criterion: Select alternative with most
favorable PW value, that is, numerically largest

PW value
PW1
Php -1,500
-2,500
2,500

PW2
Php -500
500
1,500

Select

Example 3:
Two ME cost alternatives for traffic analysis.
Revenues are equal. MARR is 10% per year.
Select one.
Estimate
P, Php /unit

Electricpowered

Solarpowered

-2,500

-6,000

## AOC, Php /year

-900

-50

S, Php

200

100

n, years

Example 3:
Determine PWE and PWS; select larger PW
PWE = -2500-900(P/A,10%,5)+200(P/F,10%,5)
= Php -5788
PWS = -6000-50(P/A,10%,5)+100(P/F,10%,5)
= Php -6127
Conclusion: PWE > PWS; select electricpowered

DIFFERENT-LIFE ALTERNATIVES

## PW evaluation always requires equal-service

between all alternatives
Two methods available:
Study period (same period for all alternatives)
Least common multiple (LCM) of lives for
alternatives
Study period method is recommended
Evaluation approach: Determine each PW at stated
MARR; select alternative with numerically largest PW

DIFFERENT-LIFE ALTERNATIVES

## Study Period of length n years (periods)

n is same for each alternative
If life > n, use market value estimate in year n
for salvage value
If life < n, estimate costs for remaining years
Estimates outside time frame of the study
period are ignored

DIFFERENT-LIFE ALTERNATIVES
LCM Method
Assumptions (may be unrealistic at times)
Same service needed for LCM years (e.g., LCM of 5
and 9 is 45 years!)
Alternatives available for multiple life cycles
Estimates are correct over all life cycles (true only if
cash flow estimate changes match
inflation/deflation rate)
Evaluation approach: obtain LCM, repeat purchase
and life cycle for LCM years; calculate PW over LCM;
select alternative with most favorable PW

DIFFERENT-LIFE ALTERNATIVES

Example 4:

## Use PW to select lower-cost alternative:

For 5-year study period
Using LCM of alternatives lives
Assume MARR = 15% per year

DIFFERENT-LIFE ALTERNATIVES
F = 1,000
PWA = ?
Location A
P = -15,000

A = -3,500
F = 2,000

PWB = ?

P = -18,000

A = -3,100
Location B

## Select Location A with lower PW of costs

DIFFERENT-LIFE ALTERNATIVES

LCM evaluation
LCM is 18 years
Repurchase A twice (years 6 and 12)
Repurchase B once (year 9)
Assume all cash flow estimates (including first cost
end-of-lease deposit return) are correct for
repeated life cycles to total 18 years

## For 18 years at MARR = 15%: PWA = \$-45,036

For 18 years at MARR = 15%: PWB = \$-41,384

Select location B
Note: Selection changed from 5-year study period

TRY THIS!
1. The manager of a canned food processing
plant (Corny Corned Beef) must decide
between two different labeling machines.
Machine A will have a first cost of P5,200,000,
an annual operating cost of P 380,000, and a
service life of 4 years. Machine B will cost
P6,100,000 to buy and will have an annual
operating cost of P150,000 during its 4-year
life. At an interest rate of 10% per year, which
should be selected on the basis of a present
worth analysis?

TRY THIS!
2. A chemical processing corporation (Kemika) is
considering three methods to dispose of a nonhazardous chemical sludge: land application, fluidizedbed incineration, and private disposal contract. The
estimates for each method are shown. Determine which
has the least cost on the basis of a present worth
comparison at 10% per year for the following scenarios:
(a) The estimates as shown
(b) The contract award cost increases by 20% every 2year renewal.
(c) Do you have any other comments for the options
given?

TRY THIS!

## First cost, Php

Annual operating
cost, Php per
year
Salvage value,
Php
Life, years

Land
Application
-6,500,000

Incineration
-45,000,000

-4,750,000

-3,000,000

-6,000,000

130,000
3

15,000,000
6

0
2

Contract
0

TRY THIS!
3. A mechanical engineer is considering two
robots for purchase by a laptop-assembly
company. Robot X will have a first cost of
P8,000,000, an annual maintenance and
operation (M&O) cost of P3,000,000, and a
P400,000 salvage value. Robot Y will have a
first cost of P9,700,000, an annual M&O cost of
P2,700,000, and a P500,000 salvage value.
Which should be selected on the basis of a
present worth comparison at an interest rate of
15% per year? Use a 5-year study period.

REFERENCES:
Blank, Leland & Anthony Tarquin. Engineering
Economy (7th Edition). New York: The
McGraw-Hill Companies, Inc., 2012.
METU Open Courseware (Engineering
Economy and Cost Analysis)
http://ocw.metu.edu.tr/course/view.php?id=80