Chapter 4 and 5

Application of Money-Time
Relationship

Topic Outcome (TO)

Illustrate cash flow diagrams to show
project costs and benefits
Explain and provide examples of the time
value of money
Discuss and apply the present worth criteria
(PW)
Compare two competing alternatives
choices using PW

Topic Outcome (TO)

Discuss equivalent uniform annual cost (EUAC) and

equivalent uniform annual benefits (EUAB)
Analyze an engineering economic analysis problems
into its annual cash flow equivalent
Apply future worth, benefit-cost ratio, payback period,
breakeven and sensivity analysis methods in
engineering economics calculation
Evaluate project cash flows using the internal rate of
return (IRR) methodology
Apply EUAC and EUAB to compare alternatives with
equal, common multiple or continuos lives, or over
some fixed study period in engineering economics
calculation

Present Worth Analysis

Topic to be covered
-Minimum Attractive Rate of Return
-Present Worth Analysis
Present worth analysis for equal life alternatives
Present worth analysis for different life alternatives
Infinite Analysis Period: Capitalized Cost
Multiple Alternatives

Types of Projects

Two types of projects

Mutually exclusive projects

Only one of the viable projects can be selected
Projects compete with one another

Independent Projects

More than one viable project may be selected. A donothing (DN) option is considered one of the alternatives
These projects do not compete with each other. Each
project is evaluated separately and comparison is
between one or groups of projects and a do-nothing
(DN) option
If there are m independent projects, there will be 2 m
alternatives available

Minimum Attractive
Rate Of Return ( MARR )

An interest rate used to convert cash flows into equivalent

worth at some point(s) in time
Usually a policy issue based on:
amount, source and cost of money available for investment
number and purpose of good projects available for
investment
amount of perceived risk of investment opportunities and
estimated cost of administering projects over short and long
run
type of organization involved
MARR is sometimes referred to as hurdle rate

Present Worth Analysis

(PW)

Based on concept of equivalent worth of all cash

flows relative to the present as a base
All cash inflows and outflows discounted to present
at interest -- generally MARR
PW is a measure of how much money can be
afforded for investment in excess of cost
PW is positive if dollar amount received for
investment exceeds minimum required by investors

Economic Criteria Restated

Present Worth Technique
Situation

Criterion

Fixed Input

Amount of
Maximize
capital available present worth of
fixed
benefits

Fixed Output

$ amount of
benefit is fixed

Maximize
present worth of
costs

Neither Fixed

Neither capital
nor $ benefits
are fixed

Maximize net
present worth
(NPV)

Economic Criteria Restated

Present Worth Technique
Situation

Example

Criterion

Fixed Input

$150,000
max.

Maximum
square feet of
building for
the price

Fixed Output

20,000 ft2
building
available

Negotiate for
minimum
cost/ft2

Neither Fixed

$150,000
max 1520,000 ft2

Simultaneous
ly negotiate
for maximum
building size
and minimum
cost/ft2

Present Worth Analysis

(PW)

PRESENT WORTH (PW) ANALYSIS FOR EQUAL LIFE

ALTERNATIVES
If there is one alternative, calculate PW at MARR. If
PW>0, accept project
If there are two or more alternatives, calculate PW at
MARR. Select project with highest numerical PW
For independent projects, select all projects with PW>0
at the MARR

Useful Lives Equal to the

Analysis Period
Situation

Example

Criterion

Fixed Input

Amount of money
or other input
resources are fixed

Maximize present
worth of benefits
or other outputs

Fixed Output

There is a fixed
task, benefit or
other output to be
accomplished

Minimize present
worth of costs or
other inputs

Neither input nor

output is fixed

Neither amount of
money, or other
inputs, nor amount
of benefits, or
other output, is
fixed

Maximize (present
worth of benefits
minus present
worth of costs),
that is, maximize
net present worth

Present Worth Analysis

(PW)

PRESENT WORTH (PW) ANALYSIS FOR DIFFERENT

LIFE ALTERNATIVES

When projects have different lives (e.g. 3 years

and 5 years), the PW of the alternatives must
be compared over the same numbers of years
This can be achieved by:
Comparing alternatives over a time period equal to
the least common multiple (LCM) of their lives
Comparing alternatives using a study period of say, x
years

Appling Present Worth

Technique

Analysis period must be considered

Useful life of the alternative equals the analysis
period
Alternatives have useful lives different from the
analysis period
The analysis period is infinite, n=

Practice 1
A firm is considering which of two mechanical
device to install to reduce costs in a particular
situation. Both devices cost $1000 and have
useful lives of 5 years and no salvage value.
Device A can be expected to result in $300
savings annually. Device B will provide cost
savings of $400 the first year but will decline $50
annually, making the second year saving $350,
the third-year saving $300, and so fourth. With
interest at 7%, which device should the firm
purchase?

Practice 2
Wayne Country will build an aqueduct to bring
water in from the upper part of the state. It can
be built at a reduced size now for $300 million
and be enlarged 25 years hence for an additional
$350 million. An alternative is to construct the
full-sized aqueduct now for $400 million. Both
alternative would provide the needed capacity for
the 50-year analysis period. Maintenance costs
are small and maybe ignored. At 6% interest,
which alternative should be selected?

Practice 3
Perform a present worth analysis of equal-service
machines with the cost shown below, if the MARR is
10% per year. The salvage life is 5 years and revenues
for all three alternatives are expected to be the same.
ElectricPowered

GasPowered

Solar-Powered

First Cost, $

-2500

-3500

-$6000

Annual Operating
Cost, $

-900

-700

-50

Salvage Value, $

200

350

100

Practice 4
A purchasing agent is considering the purchase of
some new equipment for the mailroom. Two
different manufacturers have provided quotation as
indicates the following table. Assuming MARR of
10%, which of the alternatives is more preferred.
Alternatives

Cost

Uniform
Annual
Benefit

Useful
Life
(years)

End-of-UsefulLife
Salvage Value

Altas Scale

$2000

$450

$100

Tom Thumb
Scale

$3000

$600

$700

Useful Lives Different from

the Analysis Period

Practice 5
A diesel manufacturer is considering the two alternative
production machines graphically depicted in Figure 5.1. Specific
data are as follows:
Alternative 1

Alternative 2

Initial Cost

$50000

$75000

Estimated salvage value at

the end of useful life

$10000

$12000

Useful life of equipment, in

years

13

The manufacturer uses an interest rate of 8% and wants to use

the PW method to compare these alternatives over an analysis
period of 10 years

Estimated marker value, end of 10year analysis period

Alternative 1

Alternative 2

$20,000

$15000

Practice 6

A project engineer with EnviroCare is assigned to start a new

office in a city where a 6-year contract has been finalized to take
and to analyze ozone-level readings. Two lease options are
available, each with a first cost, annual lease cost and depositreturn estimates shown below.
Location A

Location B

First Cost, $

-15,000

-18,000

Annual lease cost, $

-3,500

-3,100

Deposit return, $

1,000

2,000

Lease term, years

By taking MARR as 15% per year

a) EnviroCare has a standard practice of evaluating all projects
over a 5-year period. If a study period of 5 year is used and the
deposit returns are not expected to change, which location
should be selected?
b) Determine which lease option should be selected on the basis of
present worth comparison if 5-year period is neglected.

Infinite Analysis Period:

Capitalized Cost

For:
n=
A = Pi

Then:
Capitalized Cost, P = A/i
This requires first computing the future cost
into an equivalent A

Practice 6
How much should one set aside to pat $50
per year for maintenance on a gravesite if
interest is assumed to be 4%? For perpetual
maintenance, the principle sum must
remain undiminished after making the
annual disbursement

Practice 7
A city plants a pipeline to transport water
from a distant watershed area to the city.
The pipeline will cost $8 million and will
have an expected life of 70 years. In
addition, it will need $35,000 yearly
maintenance. The city anticipates it will
need to keep the water line in service
indefinitely. Compute the capitalized cost,
assuming 7% interest.

Multiple Alternatives

When more than one alternatives

exists, we generally want to compare
the alternatives in a single table

The goal is to develop a single table

that automates as many of the
calculations as possible.

Practice 8
A purchasing agent is considering the purchase of new pipes. The
analysis came up with different pipe size alternatives as shown
below
Pipe Sizes (in.)
2

Installed cost of
pipeline and pump

$22000

$23000

$25000

$30000

Cost per hour for

pumping

$1.20

$0.65

$0.50

$0.40

The pipe and pump will have a salvage value at the end of 5 years,
equal to the cost to remove them. The pump will operate 2000 hours
per year. The lowest interest rate at which the contractor is willing
to invest money is 7%. (the minimum required interest rate for
invested money is called the minimum attractive rate of return, or
MARR). Select the alternative with the least present worth of cost.

Practice 9
An investor paid $8000 to a consulting firm to analyze what he might
do with a small parcel of land on the edge of town that can be bought
for $30,000. In their report, the consultants suggested four
alternatives:
Alternatives

Total
Investment
Including
Land*

Uniform Net
Annual
Benefit

Terminal
Value at End
of 20 years

Do nothing

$0

$0

$0

Vegetable Market

50000

5100

30000

Gas Station

95000

10500

30000

Small Motel

350000

36000

150000

*includes the land and structures but does not include the $8000 fee
to the consulting firm
Assuming 10% is the minimum attractive rate of return, what should
the investor do?

Practice 10
Two pieces of construction equipment are being
analyzed. Based on an 8% interest, which
alternative should be selected?
Cost

Alternative A

Alternative B

-$2000

-$1500

+1000

+700

+850

+300

+700

+300

+550

+300

+400

+300

+400

+400

+400

+500

+400

+600