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CHAPTER V
PRESENT WORTH
ANALYSIS
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LEARNING OBJECTIVES
PURPOSE OF THIS CHAPTER
Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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CHAPTER TOPICS
Formulating Alternatives
PW of Equal-Life Alternatives
PW of Different-Life alternatives
Future Worth Analysis
Capitalized Cost Analysis
Payback Period
Life-Cycle Costs
PW of Bonds
Spreadsheet Applications
Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 5 Authored By: Dr. Don Smith, Texas A&M University.
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5.1 Alternatives
Do
Nothing
Analysis
Alt.
1
Problem
Alt.
2
Alt.
m
Selection
Execution
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Problem
Alt.
Selected
Execution
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Alt. 2
N = for all
alternatives
Alt. N
Find PW(i%) for each alternative then compare
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MA
0
A = $900
$2,500
F5=$200
MB
0
$3,500
A = $700
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A common mistake is to
compute the present
worth of the 6-year
project and compare it to
the present worth of the
9-year project.
NO! NO! NO!
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F6=$1,000
A 1-6
F6=$2,000
=$3,500
$11,000
2
Machine B
A 1-9
=$3,100
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6 years
Cycle 1 for A
Cycle 2 for A
6 years
Cycle 3 for A
Machine B
9 years
9 years
Cycle 1 for B
Cycle 2 for B
18 years
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$23,813
12
$23,813
18
$23,813
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A 1-9
=$3,100
$18,000
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$32,508
18
$32,508
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Alt-1: N = 5 yrs
LCM = 35 yrs
Alt-2: N= 7 yrs
Could assume a study period of, say, 5 years.
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Commercial Buildings
Marine Vessels
Power Generation Facilities
Public Works Projects
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(1 i) 1
P A
N
i(1 i)
N
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1 (1 i ) N
P A
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1 A
P A
i i
Or,
CC(i%) = A/i
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5 ..
..
N=inf.
A=$50/yr
P=?
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5 ..
..
N=inf.
A=$50/yr
P=?
(1 i ) N 1
P A
, let N
N
i(1 i)
(1 i ) N 1 1
lim N
N
i(1 i) i
P0=A(1/i)
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P0 = $50[1/0.04]
P0 = $50[25] = $1,250.00
Invest $1,250 into an account that
earns 4% per year will yield $50 of
interest forever if the fund is not
touched and the i-rate stays constant.
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EXAMPLE
Calculate the Capitalized Cost of a
project that has an initial cost of
$150,000. The annual operating cost is
$8,000 for the first 4 years and $5000
thereafter. There is an recurring
$15,000 maintenance cost each 15
years. Interest is 15% per year.
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15
30
$4,000
$8,000
$150,000
$15,000
$15,000
$15,000
$15,000
N=
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15
30
45
60 ..
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15
30
45
60 ..
$15,000
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investment.
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0 P NCFt ( P / F , i, t )
t 1
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i = 15%
Machine 1: N=7
Machine 2: N=14
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Payback
is
between
6 and 7
yeas
(6.57 yrs)
PW(15%)= +$481.00
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9.52 years
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Payback for B at
0% is 6 years!
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Undiscounted
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Military/Defense Projects
New Product Lines
Large construction projects
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Cost-$
Cumulative Life Cycle
Costs
Acquisition Phase
Operation Phase
TIME
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Needs Assessment
Conceptual Design
Detailed Design
Acquisition Phase
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Economically sound
Functional
Safe
Perform as expected
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Issued by Corporations
Secured by the firms assets
Money received by the firm is used to fund
projects
Referred to a Debt Capital
Buyers of these bonds are not owners they
are lenders to the firm
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Issued by Corporations
Not backed by specific assets
Backing good faith of the firm
Pays higher interest rates
Higher risks involved
Bond interest rate may float
Could be convertible to common stock
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Investment Bankers
The Firm
Proceeds from
The sale
Commissions/Fees
Bondholders
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0.045
I $5, 000(
) $5, 000(0.0225)
2
I $112.50 every 6 months
The bondholder, buys the bond and will receive
$112.50 every 6 months for the life of the bond
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interest rate
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$5,000
i=4.04%/6 months
A = 112.50/6 months
0
P=??
..
19
20
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Capitalized Cost
Life-cycle cost analysis application
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