ENGR 3360U Winter 2014

Unit 5.2-3
Present Worth Analysis
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 5 Present Worth Analysis

Change Record
2014-I-01 Initial Creation
Text Chapter 5

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

5.2 Equal Lives

When selecting between two alternatives
using present worth analysis:

Maximize:

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Net Present Worth = Present worth benefits

Present worth of costs
NPW = PW of benefits PW of costs

The alternative with the higher NPW is

selected

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Present Worth Approach: Mutually

Exclusive Projects
Alternatives must be of equal service, that is, evaluate all
alternatives over the same number of years.
For a single project, project is financially viable if PW 0 at
the MARR

For 2 or more alternatives, select the one

with the (numerically) larger PW value

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Examples:

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PW1

PW2

Select

$-1500 $-500
$+2500 $-500
$-1200 $ +25

Alt 2
Alt 1
Alt 2

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

PW method for independent projects

Select all projects with PW 0 when the
MARR is used in calculating the PW values
This assumes no restriction of how much is
invested during a given time period.
If investment limit exists, which it usually does,
use the techniques of chapter 8 and 9

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Example 5.1
A firm is trying to decide
which of 2 machines to buy.
Both have useful lives of 5
years with no salvage value.
Machine A costs $1,000 and
will save $300 annually.
Machine B costs $1,350 and
will save $300 the first year,
$350 the second, $400 the 3rd
and so on, If the interest rate
is 7%, which should be
chosen?
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PWA = -1000 + 300(P/A, 7%, 5)

= $230
PWB = -1000 + 300(P/A, 7%, 5)
+ 50(P/G, 7%,5) = $262.5
CHOOSE B

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

5.3 Unequal Lives

It is NOT correct to analyse alternatives
using PW with different lives.

Methods to handle this problem:

Examine the alternatives using a Least

Common Multiple of lives (LCM).
Decide on an analysis period if the LCM
method is too onerous or doesnt make sense.

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(e.g., 7 and 13 years gives an LCM = 91 years)

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

LCM
E.g., 10 year project life versus a 5 year project
life
Least common multiple is 10 years
Reformulate 5 year life to 10 year life:

including the cash flows in years 0 to 5 and also in years

5 to 10
the alternatives can now be compared
6

Original 5 year project

20

0
30

1
5

32

20

10

20

0
30

1
5

32

20

10

10
20

9
32

20

10

30

5 year project now a 10 year project

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

LCM Example 5.2

An engineer needs to rent an office. Here
are her two choices.
A: First cost, - $15,000, yearly lease -3,500
Deposit return 1,000, length 6 years
B: First cost, - $18,000, yearly lease -3,100
Deposit return 2,000, length 9 years

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

PW Analysis using LCM Approach

This is a good illustration of LCM method
at i = 15% per year
Location A has nA = 6 years and B has nB = 9
o
o
o
o

LCM = 18 years; determine both PW values over 18 years

Assume two re-purchases of A at the end of years 6 and 12
Assume one re-purchase of B at end of year 9
All cash flow estimates are assumed to continue for 18 years,
including the end-of-lease return deposit

PWA = $-45,036 and PWB = $-41,384

Select location B with the (numerically) larger PW, which has
the smaller equivalent PW cost

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

PW Calculation for 18 years

PWA =-15,000 +1000(P/F,15%,6)
-15,000(P/F,15%,6) + 1,000(P/F,15%,12)
-15,000(P/F,15%,12) + 1,000(P/F,15%,18)
-3,500(P/A,15%,18)
= -$45,036

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Present Worth Analysis of Different-Life

Alternatives
For alternatives with un-equal lives the rule is:

PW of the alternatives must be compared over the same

number of years
Called Equal Service requirement
Approach 1 of 2 approaches
LCM -- Evaluate the alternatives over the lowest common multiple of
lives, e.g., lives of 4 and 6, use n = 12 and assume re-investment at
same cash flow estimates
Study period -- assume a planning horizon and evaluate the
alternatives over this number of years

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco