Engineering Economy – Assignment # 3

Dr. Araby Ibrahim

1) RAB General Hospital is evaluating three contractors to manage its emergency
ambulance for 5 years. Using the present value approach, which of these contractors
should be selected if interest rate is 10% per year?

Solution
PW(A) = NPV (A) = -15000 + 3000 (P/F, 10%, 5) + 6400 (P/A, 10%, 5) = $ 11123.80
PW(B) = NPV (B) = -20000 + 4500 (P/F, 10%, 5) + 9000 (P/A, 10%, 5) = $16911.23
PW(B) = NPV (C) = -25000 + 6000 (P/F, 10%, 5) + 12100 (P/A, 10%, 5) = $24594.05

Contractor C is the best

2) A certain industrial firm desires an economic analysis to determine which of two

different machines should be purchased. Each machine is capable of performing the same
task in a given amount of time. Use the following data to determine which machine you
would choose (Assume the interest rate is 8%). You have to use the present worth method
to solve.

Alternative Machine X Machine Y

First cost ($) 50,000 90,000
Annual maintenance cost ($) 1,800 1,200
Salvage value ($) 15,000 25,000
Estimated life (Years) 3 6

Using LCM = 6
Machine X: 15000 15000

0 6

1800 1800

50000
50000
PW(X) = NPV(X) = -50000 – 1800(P/A, 8%, 6) -35000(P/F,8%,3) + 15000(P/F,8%,6)
= -76652.77
 Machine Y:
25000

0 6

1200

90000

PW(Y) = NPV(Y) = -90000 – 1200(P/A, 8%, 6) + 25000(P/F,8%,6)

= -79793.21
Machine X is better

3) A company is currently considering the addition of a new process to its activities. Two
alternatives (A and B) are available for the equipment needed to establish this new
process as follows:

A B

Purchasing Price (LE) 26,000 39,000

Productivity (Units /hour) 42 63

Expected Life (years) 6 8

Salvage Value (LE) 3,000 5,000

The company operates 8 hours per day for 300 working days per year. The profit per unit
regardless of the equipment cost is LE 0.32, and all quantities produced are expected to
be sold regardless of their volume. For an annual interest rate of 8%, define the
alternative to be chosen. (Use both PW and AW methods)

Solution
Annual Profit for type A per year = 300 * 8 * 42 * 0.32 = $32256
Annual Profit for type B per year = 300 * 8 * 63 * 0.32 = $48384
AW(A) = NAV (A) = -26000 (A/P, 8%, 6) + 32256 + 3000 (A/F, 8%, 6) = $27040.75
AW(B) = NAV (B) = -39000 (A/P, 8%, 8) + 48384 + 5000 (A/F, 8%, 8) = $42067.50
Select B

For the present worth method use LCM = 24 and solve the same as in problem 2
 4) The following costs are associated with three tomato-peeling machines that are being
considered for use in a canning plant.

Machine A Machine B Machine C

First Cost ($) 52,000 63,000 67,000

Annual Maintenance and Operating Cost ($) 15,000 9,000 12,000

Annual Benefits ($) 38,000 31,000 37,000

Salvage Value ($) 13,000 19,000 22,000

Useful Life (Years) 4 6 12

If the canning company uses an interest rate of 12%, what is the best alternative?

Solution
Machine A
NAV = -52000(A/P, 12%, 4) + 23000 + 13000(A/F, 12%, 4) = 8599.86
Machine B
NAV = -63000(A/P, 12%, 6) + 22000 + 19000(A/F, 12%, 6) = 9018.07
Machine C
NAV = -67000(A/P, 12%, 12) + 25000 + 22000(A/F, 12%, 12) = 15095.34
Machine C is the correct choice.

5) A suburban taxi company is considering buying taxis with diesel engines instead of
gasoline engines. The cars average 50,000 km a year, with a useful life of 3 years for the
taxi with the gas engine and 4 years for the diesel taxi. Other comparative information is
as follows:
Vehicle Fuel cost Mileage, in Annual Annual End-of-useful-
cost per liter km/liter repairs insurance cost life resale value

Diesel $13,000 $0.48 35 $300 $500 $2,000

Gasoline $12,000 $0.51 28 $200 $500 $3,000

Determine the more economical choice if interest is 6%.

Solution
Annual Cost of Diesel Fuel = [$50,000km/(35 km/l)] x $0.48 = $685.71
Annual Cost of Gasoline = [$50,000km/(28 km/l)] x $0.51 = $910.71

NAVdiesel = $-13,000 (A/P, 6%, 4) + $2,000(A/F, 6%, 4) - $685.71- $300- $500

= $-4,780.31

NAVgasoline = $-12,000(A/P, 6%, 3) + $3,000 (A/F, 6%, 3) - $910.71- $200- $500

= $-5,157.61
The diesel taxi is more economical.
6) As groundwater wells age, they sometimes begin to pump sand (and they become known
as “sanders”), and this can cause damage to downstream desalting equipment. This
situation can be dealt with by drilling a new well at a cost of $1,000,000 or by installing a
tank and self-cleaning screen ahead of the desalting equipment. The tank and screen will
cost $230,000 to install and $61,000 per year to operate and maintain. A new well will
have a pump that is more efficient than the old one, and it will require almost no
maintenance, so its operating cost will be only $18,000 per year. If the salvage values are
estimated at 10% of the first cost, use a present worth relation to (a) calculate the
incremental rate of return and (b) determine which alternative is better at a MARR of 6%
per year over a 20-year study period.

Solution

7) An oil company plans to purchase a piece of vacant land on the corner of two busy streets
for $70,000. On properties of this type, the company may install businesses of four
different types.
 Cost of Improvements
Plan (Does not include the $70,000 Type of Business
cost of land)

Conventional gas station with service facilities for

A $ 75,000
lubrication, oil changes, etc.

Automatic car wash facility with gasoline pump

B 230,000
island in front

C 30,000 Discount gas station (no service bays)

D 130,000 Gas station with low cost, quick car wash facility

In each case, the estimated useful life of the improvements is 15 years. The salvage value
for each is estimated to be the $70,000 cost of the land. The computed ROR % and the
net annual income, after paying all operating expenses, are projected as follows:

Plan Net Annual Income Computed ROR %

A $23,300 15

B 44,300 12.9

C 10,000 9

D 27,500 12

If the oil company expects a 10% minimum attractive rate of return on its investments,
which plan (if any) should be selected? You have to use the Incremental ROR method.
Solution
Plan Cost of Net Annual Salvage Computed Decision
Improvements Income Value Rate of
and Land Return
A $145,000 $23,300 $70,000 15% Accept
B $300,000 $44,300 $70,000 12.9% Accept
C $100,000 $10,000 $70,000 9% Reject - fails to meet
the 10% criterion
D $200,000 $27,500 $70,000 12% Accept

Rank the three remaining projects in order of cost and examine each separable increment of
investment.

A versus DN
i= 15% then accept A
Plan D rather than Plan A

∆ Investment ∆ Annual Income ∆ Salvage Value

$55,000 $4,200 $0
 $55,000 = $4,200 (P/A, i%, 15)

(P/A, i%, 15) = $55,000/$4,200 = 13.1

From interest tables: i = 1.75%

This is an unacceptable increment of investment. Reject D and retain A.

Plan B rather than Plan A

∆ Investment ∆ Annual Income ∆ Salvage Value

$155,000 $21,000 $0

$155,000 = $21,000 (P/A, i%, 15)

(P/A, i%, 15) = $155,000/$21,000 = 7.38
From interest tables: i = 10.5%
This is a desirable increment of investment. Reject A and accept B.

Conclusion: Select Plan B.

8) A company that manufactures amplified pressure transducers is trying to compare
between the machines shown below. Compare them on the basis of rate of return, and
determine which should be selected if the company's MARR is 12% per year.

Solution
Variable – Dual

NPV = 0
-25000 + 4000 (P/A, i*, 6) + 26000 (P/F, i*, 3) – 39000 (P/F, i*, 4) + 40000(P/F, i*, 6) = 0
Then trial and error to get i* and then decide which is better
i* is between 17% and 18% so it is more than MARR

Variable speed is better

 9)

Solution

10) The five alternatives shown here are being evaluated by the rate of return method.
Solution
 11) A metal plating company is considering four different methods for recovering byproduct
heavy metals from a manufacturing site’s liquid waste. The investment costs and incomes
associated with each method have been estimated as in the following table. All methods
have an 8-year life. The MARR is 12 % per year. (a) If the methods are independent,
because they can be implemented at different plants, which methods are acceptable? (b)
If the methods are mutually exclusive, determine which method should be selected, using
a ROR evaluation.

Solution
Easy to solve but only a negative salvage value for method D

12) A group of engineers responsible for developing advanced missile detection and tracking
technologies, such as shortwave infrared, thermal infrared detection, target tracking radar,
etc., recently came up with six proposals for consideration. The present worth (in $
billions) of the capital requirements and benefits is shown for each alternative in the
table. Determine which one(s) should be undertaken, if they are (a) independent and (b)
mutually exclusive.

Solution
 13) Four alternatives are available to establish a public project. Based on the information
given below, which alternative should be selected using the incremental benefit-cost
analysis?

Alternative Annual Benefits ($) Annual Costs ($)

A 260,000 50,000
B 270,000 60,000
C 250,000 35,000
D 290,000 65,000
Solution
The order is: C, A, B, D

A-C
BC (A-C) = (260000-250000) / (50000-35000) < 1 reject A and keep C

B-C
BC (B-C) = (270000-250000) / (60000-35000) < 1 reject B and keep C

D-C
BC (D-C) = (290000-250000) / (65000-35000) > 1 reject C and keep D

Select D
14) A large food corporation is considering the development and production of four types of
beverages. The type of markets, margins of profit, sales volume and technology needed
are quite different in each case. The following table summarizes the economic aspects of
the alternative projects.

Alternatives

Type 1 Type 2 Type 3 Type 4

Equipment Costs $ 597,500 446,100 435,700 249,800

Installation Costs $ 250,000 150,000 200,000 100,000

Expected Annual Profits $ 212,000 145,000 168,000 100,000

Individual ROR % 13 12 15 18

Project Life (Years) 6 6 6 6

If MARR is 13% per year, which alternative is the most profitable using the incremental
ROR method?
Solution
Reject type 2 because its ROR is less than MARR
Initial cost = equipment cost + installation cost
The order depending on the initial cost is type 4, type 3, and then type 1
Type 3 – type 4
285900 = 68000 (P.A, i*, 6) i* = 11.2% < MARR so keep type 4
Type 1 – type 4
497700 = 112000 (P.A, i*, 6) i* = 9.3% < MARR so keep type 4
Type 4 is the most profitable

When you solve you have to show all details

15) Consider the following two mutually exclusive alternatives, which alternative should be
selected? If the MARR is 8% using the ROR method.

Year 0 1 2 3 4

X -$5000 -3000 4000 4000 4000

Y -$5000 2000 2000 2000 2000

Solution
Year X Y X- Y
0 -$5,000 -$5,000 $0
1 -$3,000 +$2,000 -$5,000
2 +$4,000 +$2,000 +$2,000
3 +$4,000 +$2,000 +$2,000
4 +$4,000 +$2,000 +$2,000
Computed
ROR 9.7% >
8%
Since X- Y difference between alternatives is desirable, select Alternative X.

16) Three mutually exclusive alternatives are being considered.

A B C

Initial investment ($) 50,000 22,000 15,000

Annual net income ($) 5,093 2,077 1,643

Computed ROR % 7 8 9

Each alternative has a 20-years useful life with no salvage value. If the minimum
attractive rate of return is 7%, which alternative should be selected (if any)? You have to
use the Incremental ROR method.

Solution
The ROR of each alternative >= MARR. Proceed with incremental analysis. Examine
increments of investment.

C B B- C
Initial Investment $15,000 $22,000 $7,000
Annual Income $1,643 $2,077 $434

$7,000 = $434 (P/A, i%, 20)

(P/A, i%, 20) = $7,000/$434 = 16.13
ΔRORB- C = 2.1%
Since ΔRORB-C < 7%, reject B.

C A A- C
Initial Investment $15,000 $50,000 $35,000
Annual Income $1,643 $5,093 $3,450

$35,000 = $3,450 (P/A, i%, 20)

(P/A, i%, 20) = $35,000/$3,450 = 10.14
ΔRORA-C = 7.6%
Since ΔRORA-C > 7%, reject C.

Select A.