CE22 - 11 - Comparison of Alt 1

CE22: Comparison of Alternatives 
- Ranking Approach using Equivalent Worth Methods
MA. BRIDA LEA DIOLA

CE 22: Engineering Economics
UP Institute of Civil Engineering
2nd sem AY 19-20
Objectives
 to identify different methodologies of economic
analysis for comparing alternatives
 to compare mutually exclusive alternatives for
an engineering project with equal and different
project lives
 to select the best alternative out of a set of
mutually exclusive alternatives
© M.D. Diola 2020. All Rights Reserved. 2

Discussion Topics
 Mutually Exclusive (and collectively exhaustive) vs

Independent Alternatives
 Revenue vs Service Projects
 Analysis (or Study) Period vs Service Period
 Comparison of Alternatives:
 Ranking Approach and Incremental Analysis
 PW/FW
 AW/CW
 SPBP and DPBP
 BC Ratio
 IRR
REVIEW:
Evaluation of a Single Project
 PW(MARR), FW(MARR), AW(MARR)
 a single alternative is considered viable (better than do-nothing) if
EW(MARR) ≥ 0
 PW/FW/AW analyses will always be consistent with each other
 CW(MARR)
 simply the PW of an infinite life alternative
 Payback Period Method
 for two alternatives, one with a shorter PBP is better
 supplementary method, not always consistent with EW methods
 IRR
 a single alternative is considered viable if IRR ≥ MARR
 Consistent with EW method under certain conditions, Recall issues
with multiple roots
 B/C Ratio
 a single alternative is considered viable if B/C ≥ 1.0
Classification of Alternatives
Mutually Exclusive Independent

 Only one of the  None, one or more
viable projects can than one viable
be selected projects maybe
selected
DOING NOTHING (status quo) is also an
alternative!

Example
Mutually Exclusive Alternatives Independent Alternatives

 Problem: Public Transportation  Problem: Means of
inside UP Campus Transportation from Melchor
 DN (Jeepneys Ikot/Toki) Hall to UP ICE
 E-jeepneys  Walking
 AGT (Automated Guideway  Ikot/Toki

Transit)  Car
 AGT with Ikot-Toki  AGT
 AGT with E-jeepneys These alternatives can co-exist at the
same time
Only one alternative can be applied.
combination of alternatives is treated as another set
of alternative that needs to be analyzed
Additional Notes
 For CE 22, alternatives are mutually exclusive, unless stated
otherwise
 Resources are limited (budget, space allocation, etc.) so
normally only one alternative can be pursued → supposedly
the best alternative after comparison analysis
 All alternatives should be collectively exhaustive → All
feasible and possible alternatives should be included in the
list to be analyzed from the start.
 Before doing comparison of alternatives, make sure that all
alternatives have passed project evaluation. No need to
include in the comparison those who have been initially
rejected.

Engineering Economic Analysis
General Approach
1. Define the set of mutually exclusive and collectively
exhaustive alternatives
2. Define the planning horizon
3. Develop the cash flow profiles for each alternative
4. Specify the MARR to be used
5. Compare alternatives using a specified measure of

worth
6. Perform supplementary analysis
7. Select preferred alternative

Revenue vs Service Projects
Private or Revenue Public or Service (Cost)
(Investment) Projects Projects
 Projects whose revenues  Projects whose revenues do not
depend on the choice of depend on the choice of
alternatives alternatives
 Revenue and cost streams
 Fixed (or constant) revenues for all
vary with the choice of
alternatives. alternatives → can be excluded in
the Cash Flow Diagrams
All alternatives evaluated in an engineering economy study must be of

the same type

Analysis Period vs Required Service Period
Required Service Period
Analysis Period, T (Useful Life), n
 The time span over which  The time span over which
the economic effects of an the service of an
investment will be equipment (or investment)
evaluated (study period or will be needed.
planning horizon).
Analysis period, denoted by T, may be the same, shorter or longer than the useful
life of a project

Comparison Approaches
 Ranking (Total Investment) Approach –

usually applied using PW, AW, FW Methods
 Incremental Investment Analysis – usually
applied using B/C ratio and IRR Methods

Road Map of Making a Choice among Mutually
Exclusive Alternatives

Comparing Mutually Exclusive
Alternatives
PRINCIPLE: Projects must be

compared over an equal time
span.

GENERAL CASES
 Case 1: EQUAL – useful life

Alternatives = study period
 Case 2: DIFFERENT – useful life
Alternatives

RANKING APPROACH:
Case 1: Equal – life Alternatives
What to do: Compute the EW for each project over its life
and select the project with the largest EW (PW, AW, FW)
Principle:
❑Cost projects – minimization of costs
❑Revenue projects – maximization of profit

Example
❑ Example: Two alternatives with

the following cash flows and i =
10%, n = 3 yrs
❑ Revenue Projects
❑ Select Alternative B, PWB > PWA

Case 2: Different – life Alternatives
Equal-service
requirement can be
satisfied by :
a. LCM approach
(repeatability)
b. Study period
approach (co-
terminated)

LCM Approach

Example
Machine A Machine B
First Cost $11,000 $18,000
Annual Operating Cost 3,500 3,100
Salvage Value 1,000 2,000
Life 6 years 9 years
MARR = 15%
Choose the best alternative using PW Method.
Different-life Alternatives
Machine A F6=$1,000
0 1 2 3 4 5 6
A 1-6
$11,000 =$3,500
F6=$2,000
0 1 2 3 4 5 6 7 8 9
A 1-9
Machine B
=$3,100
i = 15% per year

$18,000
LCM (6,9) = 18 year planning horizon, T

EXAMPLE 1: PW Method – LCM Approach
Machine A
6 years 6 years 6 years
Cycle 1 for A Cycle 2 for A Cycle 3 for A
Machine B
9 years 9 years
Cycle 1 for B Cycle 2 for B
18 years
Take note of the year when 1 cycle ends and the new cycle begins.
For example: in Machine A CFD, at the end of year 6, Salvage Value for the 1st cycle and First Cost for 2nd
cycle will be present
LCM = 18 years
Calculate the present worth for 18 yrs for alternative A
PWA = -11,000 - 3,500 (P|A, 15%, 18) + (1,000-11,000)
(P|F, 15%, 6) + (1,000-11,000) (P|F, 15%, 12) + 1,000
(P|F, 15%, 18)
= -11,000 - 3,500 (6.1280) - 10,000 (0.4323) -

10,000 (0.1869) +1,000 (0.0808)
PWA= $ -38,559

Calculate the Present Worth of a
9-year cycle for alternative B
PWB = -18,000-3,100(P|A, 15%, 9) + 2,000(P|F, 15%, 9)
= -18,000 - 3,100(4.7716) + 2,000(.2843)
= $ - 32,223 which occurs at time 0 and 9
0 9 18
$32,223 $32,223
Now, for the 18 years:

PWB = - 32,223 – 32,223(P|F, .15, 9)
= - 32,223 - 32,223(.2843) = $ - 41,384
PWA > PWB, service type project, so the company
should choose machine A.
Study Period (co-terminated) Approach
• Study period, T, can be less or greater than useful life (n). One technique is to assign the study
period equal to the useful life of one of the alternatives (one less modification of CFD).
• Study period approach is often used in replacement analysis.
• Usually applied in feasibility studies.
• The time horizon chosen may be relatively short
• Also useful when LCM of alternatives yields unrealistically long time horizons (i.e LCM of 7 and
10 years)
Case A: Study Period > Useful Life
Procedure: The cash flows of the alternatives
need to be adjusted to terminate at the end of Example: n = 6 yrs, T = 10 yrs
the study period.
Machine A F6=$1,000
✓ Cost alternatives: Assuming repeatability, 0 1 2 3 4 5 6
repeat part of the useful life of the original A 1-6

=$3,500
alternative, and then use an estimated $11,000
market value (MV) to truncate it at the end • Service must continue for cost projects.
of the study period. Without repeatability, Additional cash flows need to be
estimated for remaining years.
we must purchase/lease the service/asset T
for the remaining years.
✓ Investment alternatives: Assume all cash n

flows will be reinvested at the MARR to the
• No modification in CFD for revenue
end of the study period (i.e., calculate FW at projects
end of useful life and move this to the end of
the study period using the MARR).
A. Service Projects
➢ Come up with replacement
projects that match or exceed
the required service period.
➢ Compute the PW/AW/FW for
each project over the required
service period.
➢ Example:
Model A useful life – 3 yrs
Model B useful life – 4 yrs
Study period: 5 years
PW(15%)A = -$34,359
PW(15%)B = -$31,031
Select Model B, least cost
B. Revenue Projects
Example:
➢ Analysis Period coincides
with the project with the
longest life in the Mutually
Exclusive Group
➢ Drill option useful life – 5 yrs
➢ Lease option – 3 yrs
➢ PW(15%)Drill =
$2,208,470
➢ PW(15%)Lease =
$2,180,210
➢ Select Drill Option
Practice Problem 1
A B
Investment -$3,500 -$5,000
Annual Revenue 1,900 2,500
Annual Expenses 645 1,020
Useful Life (years) 4 6
Market Value at EO useful 0 0
life
If the MARR is 10%

a) Using the repeatability assumption and PW method, which alternative is more
desirable? PWA = $1,028 PWB = $2,262 ---> Select Alt. B
b) Perhaps the reasonable manager wanted a six-year analysis period because it is
the planning horizon used in the company for small investment projects. Which
alternative should be chosen? PWA = $478 PWB = $1,446 ---> Select Alt. B
Practice Problem 2
A company requires 4 additional forklift trucks to support a regional warehouse.
The shutdown of this warehouse is 8 years and MARR is 15% per year. The
following estimated info is based on the requirement of four forklifts (excluding
labor expenses which are the same for each model)
Stackhigh (A) S-2000 (B)

Investment -$184,000 -$242,000
Annual Expenses 30,000 26,700
Useful Life (years), n 5 7
Market Value at n 17,000 21,000
Future leasing of four forklifts would have a total cost of $104,000 per year based
on a 3-year lease and a total cost of $134,000 per year based on a 1-yr lease. Which
model should be selected assuming that leasing would be used to provide a full 8
years of comparable service? PWA = $-394,175 PWB = $-388,993 ---> Select Alt. B
Case B: Study Period < Useful Life
When the study period is explicitly stated to be shorter than the

useful life, use the co-termination assumption.
Procedure: The cash flows of the alternatives need to be adjusted to

terminate at the end of the study period.
✓ Truncate the alternative at the end of the study period using an

estimated Market Value (can be estimated using actual MV at end
of useful life or computed using Imputed Market value Technique)
Estimated MV
Machine A F6=$1,000 at EOY 4. cash
Example: n = 6 yrs, T = 4 yrs flows after
0 1 2 3 4 5 6 EOY 4 will be
ignored
A 1-6
$11,000 =$3,500
© M.D. Diola 2020. All Rights Reserved. T 30
Annual Worth Analysis
 Principle: Measure an
investment worth on annual
basis
❑ Benefits: By knowing the annual
equivalent worth, we can:
❑ Seek consistency of report
format
❑ Determine the unit cost (or unit
profit)
❑ Facilitate the unequal project
life comparison

Comparing Mutually Exclusive Alternatives:
 Service projects: select the alternative with the

minimum annual equivalent cost (AEC).
 Revenue projects: select the alternative with the

maximum AW(MARR).

❖ Ideal approach for comparing
alternatives with different lives
under LCM assumptions
❖ AW value has to be calculated

for only one life cycle
❖ LCM comparison is implicit as,
AWLCM = AWplanning horizon

EXAMPLE 3 – AW Method
The following costs are estimated for two equal-service
machines to be evaluated by a canning plant manager.
Machine A Machine B
First Cost, $ 26,000 36,000
Annual maintenance cost, $ 800 300
Annual labor cost, $ 11,000 7,000
Extra annual income taxes, $ - 2,600
Salvage value, $ 2,000 3,000
Life, years 6 10
If the minimum required rate of return is 15% per year, help the
manager decide which machine to select. Use AW and LCM
Method.
Solution
Machine A:
AWA = -11,800 – [26,000(A/P,15%,6) - 2,000 (A/F,15%,6)]
= -11,800 - 26,000 (0.26424) + 2,000 (0.11424)
= $-18,442
AWA over 6 years = AWA over LCM 30 yrs = -18,442
Machine B:
AWB = - 9,900 - [36,000(A/P,15%,10) - 3,000 (A/F,15%,10)]
= - 9,900 - 36,000 (0.19925) + 3,000 (0.04925)
= $-16,925
AWB over 10 years = AWB over LCM 30 yrs = -16,925
Select machine B since AWB > AWA.

Example 3 (Modified)
Assume the company in previous example is planning to
exit the business in 4 years. At that time, the company
expects to sell machine A for $12,000 or machine B for
$15,000. All other costs are expected to remain the same.
Which machine should the company purchase under
these conditions? Use AW Method.
NOTE:
This is a study period problem. So we must consider all
cash flows only for the study period (4 years), and use
the estimated market values.

Solution:
AWA = – 11,800 - [26,000(A/P,15%,4) -12,000 (A/F,15%,4)]

= – 11,800 -26,000 (0.35027) + 12,000 (0.20027)
= $-18,504
AWB = – 9,900 - [36,000(A/P,15%,4) -15,000 (A/F,15%,4)]

= – 9,900 -36,000 (0.35027) + 15,000 (0.20027)
= $-19,506
Select machine A as AWA > AWB.
Here is an example where study period decision differs from LCM decision.
Hence, the choice of planning horizon is important!

Imputed Market Value Technique
 Implied Market Value
 To estimate the market value of a piece of equipment at the
end of year T when T is less than the useful life n
MVT = (PW at the end of year T of remaining capital recovery
amounts) + (PW at end of year T of original salvage value at
end of useful life)
MVT = CR (P/A, i , n-T) + SV (P/F, i, n-T)
CR – Capital Recovery Amount
PW – present worth at i = MARR
T – study period
n – useful life
Additional notes
SV
=
CR
I
Compute for CR:
Example: n – 10 years, T = 6 years CR(i%) = I (A/P, i%,N) - SV (A/F, i%,N)
To compute for MVT :
Get the PW at EOY 6 of SV
Get the PW at EOY 6 of remaining CR SV
I
MVT = CR (P/A, i , n-T) + SV (P/F, i, n-T)
EXAMPLE
Two chocolate factories are on sale. One is located in London
and produces chocolate truffles and chocolate bars. The other
one is located at Rio de Janeiro and produces chocolate squares
and bars. You have gathered the following details from the
factories:
London Rio de Janeiro
Investment $15 M $8 M
Annual Net Revenues $3.62 M $1.78 M
Factory Life (years) 15 20
Salvage Value at n $6 M $2.5 M
If you plan be a chocolatier for only 15 years and you have set
your MARR to be 20%, which chocolate factory should you buy?
Use IMV technique and PW Method.
PWL = 2.31 M PWR = 0.7 M → Select London
SOLUTION

Comparison of Perpetual Alternatives
If an investment has infinite life, it is called a

perpetual (permanent) investment
 RECALL:
 Capitalized Worth (CW) for a uniform series A of end-
of-period cash flows: CW = A/i
 If P is the present worth of that investment, then:
AW= P*i

Example
Two alternatives are considered for covering a

football field. The first is to plant natural grass and
the second is to install AstroTurf. Discount rate is
10%. Cost structure for each alternative is given in
the following slides. Use AW method to choose the
best alternative.

Alternatives:
Natural Grass - Replanting will be required each 10 years at

a cost of $10,000. Annual cost for maintenance is $5,000.
Equipment must be purchased for $50,000 which will be
replaced after 5 years with a salvage value of $5,000
5K 5K
0 1 2 3 4 6 10
10K 5K + 10K
5K 5K 5K 5K 5K 5K
50K 50K 50K
AstroTurf - Installing AstroTurf cost $150,000 and it is

expected to last indefinitely. Annual maintenance cost is
expected to be $5,000
5K 5K
Solution: 0 1 2 3 4 6 10
10K
AW of Alternative A 5K
10K
5K 5K 5K 5K 5K
Cycle = 10 years 50K 50K 50K
Planting: -10,000 (A|P, 10%, 10) = $-1,627 Excluded- belongs to

the next cycle
1st Set Equipment (first 5 years):
[-50,000 - 45,000(P|F,10%,5) + 5,000(P|F,10%,10)] (A|P,10%,10)
= $-12,367
Maintenance : -5,000 annually
Total : -1,627 – 12,367 – 5,000 = $-18,994

AW of Alternative B:
(AstroTurf - Installing AstroTurf cost $150,000 and it is expected to last
indefinitely. Annual maintenance cost is expected to be $5,000)
Annual Cost of Installation : -150,000 (0.10) = $-15,000
Maintenance: $-5,000 annually
Total : -15,000 - 5,000 = $-20,000
➔ Choose A

Practice Problem 3
 Mr. Y is the project engineer assigned to start up a new office
for JV Builders Corp. Two lease options are available:
Location A Location B
First Cost, $ 15,000 18,000 *Deposit return is an
Annual lease cost, $ 3,500 3,100 amount that is given
per year back to the lessee by
the lessor after the
Deposit return, $ 1,000 2,000
lease term period.
Lease term, years 6 9
MARR 10% per year
 Which location should be selected if a 6-year study period is

used? Use PW Method, and IMV Technique to estimate the
needed deposit returns. ANS: PWA = -$29,678
PWB = -$26,472
© M.D. Diola 2020. All Rights Reserved. So, choose location B 47
Practice Problem 4 (CW Method)
CW(6%) of TRUSS BRIDGE = - $40.78M

CW(6%) of SUSPENSION BRIDGE = -$52.71M
© M.D. Diola 2020. All Rights Reserved. Choose TRUSS bridge 48
Additional self-assessment
 Answer Problem 2 in the CE 22 Problem Set
uploaded in UVLê


Thank You!
mddiola

CE22 - 11 - Comparison of Alt 1

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CE22: Comparison of Alternatives 

- Ranking Approach using Equivalent Worth Methods

MA. BRIDA LEA DIOLA

© M.D. Diola 2020. All Rights Reserved. 2

 Mutually Exclusive (and collectively exhaustive) vs

Mutually Exclusive Independent

© M.D. Diola 2020. All Rights Reserved. 5

Mutually Exclusive Alternatives Independent Alternatives

 AGT (Automated Guideway  Ikot/Toki

© M.D. Diola 2020. All Rights Reserved. 7

2. Define the planning horizon

3. Develop the cash flow profiles for each alternative

4. Specify the MARR to be used

5. Compare alternatives using a specified measure of

6. Perform supplementary analysis

7. Select preferred alternative

All alternatives evaluated in an engineering economy study must be of

© M.D. Diola 2020. All Rights Reserved. 9

© M.D. Diola 2020. All Rights Reserved. 10

 Ranking (Total Investment) Approach –

© M.D. Diola 2020. All Rights Reserved. 11

© M.D. Diola 2020. All Rights Reserved. 12

PRINCIPLE: Projects must be

© M.D. Diola 2020. All Rights Reserved. 13

 Case 1: EQUAL – useful life

© M.D. Diola 2020. All Rights Reserved. 14

© M.D. Diola 2020. All Rights Reserved. 15

❑ Example: Two alternatives with

❑ Select Alternative B, PWB > PWA

© M.D. Diola 2020. All Rights Reserved. 16

© M.D. Diola 2020. All Rights Reserved. 17

© M.D. Diola 2020. All Rights Reserved. 18

i = 15% per year

LCM (6,9) = 18 year planning horizon, T

© M.D. Diola 2020. All Rights Reserved. 20

Cycle 1 for A Cycle 2 for A Cycle 3 for A

Cycle 1 for B Cycle 2 for B

= -11,000 - 3,500 (6.1280) - 10,000 (0.4323) -

© M.D. Diola 2020. All Rights Reserved. 22

Now, for the 18 years:

✓ Cost alternatives: Assuming repeatability, 0 1 2 3 4 5 6

repeat part of the useful life of the original A 1-6

✓ Investment alternatives: Assume all cash n

If the MARR is 10%

Stackhigh (A) S-2000 (B)

When the study period is explicitly stated to be shorter than the

Procedure: The cash flows of the alternatives need to be adjusted to

✓ Truncate the alternative at the end of the study period using an

© M.D. Diola 2020. All Rights Reserved. 31

Comparing Mutually Exclusive Alternatives:

 Service projects: select the alternative with the

 Revenue projects: select the alternative with the

© M.D. Diola 2020. All Rights Reserved. 32

❖ AW value has to be calculated

❖ LCM comparison is implicit as,

AWLCM = AWplanning horizon

© M.D. Diola 2020. All Rights Reserved. 33

Select machine B since AWB > AWA.

© M.D. Diola 2020. All Rights Reserved. 36

AWA = – 11,800 - [26,000(A/P,15%,4) -12,000 (A/F,15%,4)]

AWB = – 9,900 - [36,000(A/P,15%,4) -15,000 (A/F,15%,4)]

© M.D. Diola 2020. All Rights Reserved. 37

Get the PW at EOY 6 of remaining CR SV