Engineering

Economics
Module No. 09
Future Worth Method

By Muhammad Shahid Iqbal

Introduction

Besides the technical, manufacturing, and marketing decisions that are needed, an engineer must become familiar with the necessity of economic decision making. It is used to analyze the economics of a situation so that combined with all the other issues, an intelligent decision can be made. Like most aspects of a decision making process, there are many alternatives to the economic decisions. In this method of comparison, the future worth of various alternatives will be computed. The alternative with the maximum future worth of net revenue or With minimum future worth of cost will be selected as the best alternative for implementation.

Revenue-Dominated cash flow analysis

Revenue-dominated cash flow analysis is given as: FW = - P(1 + i)n + R1(1 + i)n-1 + R2(1 + i)n-2 + .+ Rj(1 + i)n-j +.+ Rn + S P = Initial investment Rj = Net revenue at the end of jth year. S = Salvage value at the end of nth year. In this formula expenditures are assigned negative sign and revenues are assigned positive signs. If there are more alternatives which are to be compared, then FW amount computed and compared, the alternative with the maximum Future worth amount should be selected as the best alternative.

Cost-Dominated cash flow analysis

Cost-dominated cash flow analysis is given as: FW = P(I + i)n + C1(1 +i)n-1 + C2(1 +i)n-2 + .+ Cj(1 +i)n-j +.+ Cn - S P = Initial investment Cj = cost of operation &maintenance at the end of jth year. S = Salvage value at the end of nth year. In this formula expenditures are assigned positive sign and revenue a negative sign. If there are more alternatives which are to be compared, FW amounts are computed and compared, the alternative with the minimum Future worth amount should be selected as the best alternative.

Practice Questions
Consider the following two mutually exclusive alternatives
End of the year Alternative A B 0 -5000 -4500 1 2000 1800

2 2000 1800

3 2000 1800

4 2000 1800

at i = 18%, select the best alternative based on future worth method of comparison.

Practice Questions

A man owns a corner plot. He must decide which of the several alternatives to select in trying to obtain a desirable return on his investment. After much study and calculation, he decides that the two best alternatives are given in the following table:
Build Gas Station First cost Ann. Property Tax Annual Income Life of building Salvage value 20,00,000 80,000 8,00,000 20 0 Soft Ice Cream Stand 36,00,000 1,50,000 9,80,000 20 0

Evaluate the alternatives based on the future worth method at i = 12%

Practice Questions

The cash flows of two mutually exclusive alternatives are given as: all figures in (000)
0 1 50 70 2 100 140 3 150 210 4 200 280 5 250 350 6 300 420

Option A Option B

-500 -700

Select the best alternative based on future worth method at i = 8%

Practice Questions
M/S Krishna Castings Ltd. is planning to replace its annealing furnace. It has received tenders from three different original manufacturers of annealing furnace. The details are as follows: 1 Initial cost Life (years) 80,00,000 12 2 70,00,000 12 3 90,00,000 12

Annual Operation & Maintenance cost

Salvage value after 12 years

8,00,000
5,00,000

9,00,000
4,00,000

8,50,000
7,00,000

Which is the best alternative based on future worth method at i = 20%

Practice Questions

A company must decide whether to buy machine A or machine B:

Machine A Initial cost Life (years) Annual Operation & Maintenance cost Salvage value 4,00,000 4 40,000 2,00,000 Machine B 8,00,000 4 0 5,50,000

At 12% interest rate, which machine should be selected?