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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.

Answer Key (10 mins)


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

Php 300 per 6-months

0 1

Calculate PW at i = 3.5% per 6month period for


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

For 5 years at i = 15%: PWA = $-26,236 and PWB = $-27,397

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