UNIT I INTRODUCTION TO

ECONOMICS
R.Vinoth Kumar
Assistant Professor/Mehacnical Engineering
Nehru Institute of Engineering & Technology,
Coimbatore
 ECONOMICS
Definition : Prof. Lionel Robbins defines economics as
“ Science which studies human behavior as a relationship
between ends and scarce means which have alternative
means”
Alfred Marshall defined economics as “ A study of mankind in
the ordinary business life, it examines that part of individual
and social actions which is most closely connected with the
attainment and with the use of material requisites' of well
being.

Simple Definition : A study of how limited resources are used

to satisfy unlimited human wants
OBJECTIVES OF ECONOMICS

•A high level of employment

•Price stability
•Efficiency
•An equitable distribution of
income
•Growth
 FLOW IN AN ECONOMY
1. The flow of goods, services, resources and money
payments results in a simple economy
2. Households and business firms are the two major
entities in a simple economy.
3. Business organizations use various economic
resources such as land, labour and capital which are
provided by households to produce consumer goods
and services which will be used by them.
4. Business firms make payment to the money to the
households for receiving various resources
5. The households in turn make payments to the
business organizations
FLOW IN AN ECONOMY
LAW OF SUPPLY AND DEMAND
Demand : The desire for a commodity
backed by necessary purchasing power.

Supply : It represents how much a market

can offer. It refers to the amount of certain
producers willing to supply when receiving
a certain price.
LAW OF SUPPLY AND DEMAND
 LAW OF DEMAND
1. The law of demand states that if all the other factors
remain equal the higher the price of good the less
people will demand that goods.

2. The amount of goods the buyers purchase at higher

price is less because as the price of a good goes up, so
does the opportunity cost of buying that good.

3. As a result people will naturally avoid buying a product

that will force them to forgo the consumption of
something else they value more.
 LAW OF SUPPLY
1. The supply relationship shows that if the price is
low the producers restrain from releasing more
quantities of the product in the market.
2. Hence the supply of the product is decreased.
3. From the above fig the point of intersection of
supply curve and demand curve is called
equilibrium point.

4. At this particular point the quantity of supply is

equal to the quantity of demand
FACTORS INFLUENCING DEMAND
•The shape of the demand curve is influenced by the
following factors
a) Income of the people
b) Prices of related goods
c) Tastes of consumers.
• If the income of the people increases the purchasing
power increases.
• For eg. If the cost of TV set is lowered its demand will
go up, as a result the demand for its associated
products such as VCD would increase.
• Over a peirod of time the preference of the people
for a particular product may increase, which in
turn will affect the demand.
FACTORS INFLUENCING SUPPLY
1. The shape of the supply curve is influenced by the following factors
• Cost of the inputs
• Technology
• Weather
• Prices of related goods
2. If the prices of fertilizers and cost of labour increases the Profit margin per
bag of paddy will be reduced.
3. Hence the farmers will reduce the area of cultivation and the supply of
paddy will be reduced.
4. If there is an advancement in technology used to Manufacture the product
then there will be reduction in the production cost of the product. Hence
more quantity will be supplied.
5. Weather also plays a major role. During winter the demand for woolen
products will increase.
6. So the producers will supply more woolen products during winter.
 CONCEPT OF ENGINEERING ECONOMICS
Engineering Economics
It is defined as “A set of principles , concepts,
techniques and methods by which alternatives within a
project can be compared and evaluated for the best
monetary return”.
Principles of Engineering Economics:
Develop the alternatives : Decisions are made from the
alternatives. The alternatives need to be identified and
then defined for the subsequent analysis.
Focus on the differences : Only the differences in
expected future outcomes among the alternatives are
relevant and should be considered for decision.
 CONCEPT OF ENGINEERING ECONOMICS
Use a consistent view point: The prospective outcomes of the
alternatives, economic and other, should be consistently
developed from a defined perspective.
Use of common unit of measure : Common unit of measure to
enumerate as many of the prospective outcomes as possible will
make easier the analysis and comparison of alternatives.
Consider all relevant criteria: Selection of preferred alternative
requires the use of criteria.
Make uncertainty explicit: Uncertainty is inherent in projecting
the future outcomes of the alternatives and should be recognized
in their analysis and comparison.
Revisit your decisions : Improved decision making results from an
adaptive process, the initial projected outcomes of the selected
alternatives should be subsequently compared with actual results
achieved.
ENGINEERING ECONOMICS ANALYSIS PROCEDURE
1. Problem recognition, formulation and
evaluation.
2. Development of feasible alternatives.
3. Development of the cash flows for each
alternative.
4. Selection of criterion.
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post evaluation
results
ENGINEERING EFFICIENCY ECONOMIC EFFICIENCY

ENGINEERING EFFICIENCY : It is defined as the ratio of

output to the input of a physical system. The physical
system may be a diesel engine, shop floor, machine
working etc
OUTPUT
ENGINEERINGEFFICIENCY  100
INPUT
ECONOMIC EFFICIENCY : It is defined as the ratio of
output to the input of a business system.
OUPUT WORTH
ECONOMICEFFICIENCY  100  100
INPUT COST
Worth is the annual revenue generated by the way of
operating business and cost is the total annual expenses
incurred in carrying out the business.
 SCOPE OF ENGINEERING ECONOMICS
1. Engineering economics plays a very major role in all
engineering decisions.
2. It is concerned with the monetary consequences, financial
analysis of the projects, products and processes that
engineers design.
3. Engineering economics helps an engineer to assess and
compare the overall cost of available alternatives for
engineering projects.
4. According to the analysis an engineer can take decision from
the alternative which is more economic.
5. Engineering economics concepts are used in the fields for
improving productivity, reducing human efforts, controlling
and reducing cost.
 SCOPE OF ENGINEERING ECONOMICS
6. Engineering economics helps to understand
the market conditions general economic
environment in which the firm is working.

7. It helps in allocating the resources.

8. Engineering economics helps to deal with the

identification of economic choices, and is
concerned with the decision making of
engineering problems of economic nature.
 ELEMENTS OF COST
Cost is defined as the amount, measured in money or cash expended or other
property transfer capital stock issued, service performed, or liability incurred
in consideration of goods or services received or to be received.
Cost may be defined as the total of all expenses incurred whether paid or
outstanding in the manufacture and sale of a product
 SELLING PRICE OF A PRODUCT
1. Prime cost = Direct material cost + Direct labour
cost+ Direct Expenses.
2. Factory Cost = Prime cost + Factory overhead.
3. Cost of production = Factory cost + Office &
Administrative overhead.
4. Cost of Sales = Cost of goods sold +Selling &
Distribution overhead.
5. Sales = Cost of sales+ profit.
6. Selling price/Unit = Sales/Quantity sold
 OTHER COST AND REVENUE
MARGINAL COST : It is cost of producing an additional
unit of that product.
MARGINAL REVENUE : It is the incremental revenue of
selling an additional unit of that product.
SUNK COST : It is the past cost of an equipment/asset.
This cost is not considered for any analysis.
OPPORTUNITY COST : The expected return or benefit
foregone in rejecting one course of action for another.
When rejecting one course of action the rejected
alternative becomes the opportunity cost for the
alternative accepted.
 CONTRIBUTION & P/V RATIO

CONTRIBUTION : It is the difference between the sales

and marginal cost of sales.

CONTRIBUTION = FIXED COST+PROFIT

CONTRIBUTION = SALES-MARGINAL COST
CONTRIBUTION = SALES-VARIABLE COST

PROFIT VOLUME RATIO = CONTRIBUTION/SALES

PROFITVOLUME RATIO= FIXED COST/BREAK EVEN POINT
 BREAK EVEN ANALYSIS
Break even analysis : It implies that the total revenue equals the
total cost at some point of operation.
Break even point : It is where there will be neither profit nor loss.
BREAK EVEN CHART : It shows the relation between costs and
revenue at a given time.
TC = Total cost
FC = Fixed cost
VC = Variable cost
Q= Volume of production
s = selling price/unit
v = variable cost per unit
Total cost = Fixed cost + Variable cost
TC = FC + vQ
The total revenue (S) is given by S = s Q
 BREAK EVEN ANALYSIS
The linear plots of the total cost and total sales
revenue are shown in the fig.
The intersection point of the above two lines is called
break even point & the corresponding quantity in the X
axis is the break even quantity.
For any production quantity which is less than the
break even quantity the firm will make loss because
total cost > total revenue.
For any production quantity which is more than the
break even quantity the firm will make profit because
total revenue > total cost.
 BREAK EVEN ANALYSIS
PROFIT = SALES – (FIXED COST + VARIABLE COST)
= s Q – ( FC +vQ)
FIXEDCOSTS FC
BREAKEVENQUANTITY  
SELLINGPRICE / UNIT  VARIABLECOST / UNIT s  v

MARGIN OF SAFETY: It is defined as the difference

between the actual sales and sales at the break even
point.
Margin of safety = Actual sales – Sales at BEP
(OR) = PROFIT
P / VRATIO
(OR) = Pr ofit
 Sales
contribution
BREAK EVEN CHART
 ELEMENTARY ECONOMIC ANALYSIS

• In manufacturing engineering economic decision

making is involved in each and every stage of
production from the design to shipping stage.
• The primary tasks for engineers is to plan for
(a) Material selection for a product
(b) Design selection for a product
(c) Building material selection for
constructions.
(d) Process Selection.
MATERIAL SELECTION FOR A PRODUT
Material : materials are commodities which are used
directly or indirectly in producing a product.
Material Selection:
(a) Material Properties : Expected level of
performance from the material
(b) Material Cost : Material must be available at a
cheaper price
(c) Material availability: Should be easily available
(d) Processing : Should be easily machinable.
(e) Environment : The environmental factors
should not affect the raw material
 MATERIAL SELECTION
PROCEDURE
Translation : Express design requirements as constraints
and objectives.
Example : Tie rod
Function : Support the tensile load
Objective : Minimize mass
Constraints : Required length, load
carrying capacity.
Screening : Eliminate materials that cannot do the job.
Ranking : Find the materials that can do the job best.
Selection : Select and verify the supporting materials
 PROCESS PLANNING
Process : It is defined as a group of actions instrumental to the
achievement of the output of an operating system
Process Planning : It is the systematic determination of the
methods by which a product is to be manufactured
economically and competitively.
Process Planning procedure:
1. Analyze the part drawing to get an overall picture on what
is required.
2. Consult with product engineers on product design changes.
3. List the basic operations required to produce the part to the
drawing or specifications
4. Determine the most economical manufacturing method
and form or tooling required to complete the product.
5. Devise the best way of combine the operations and put
them in sequence.
6. Specify the gauging required for the process.
 UNIT II

VALUE ENGINEERING INTEREST FORMULAS

AND ITS APPLICATIONS

BY
R.Vinoth Kumar& M.Kaviarasu
Assistant Professor/ Mechanical Engineering
Nehru Institute Of Engineering & Technology,
Coimbatore
 INTRODUCTION
 Value analysis is a special type of cost reduction
technique developed in USA in the year 1947.

 It critically investigates the different aspects of materials,

design cost and production of each component

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 DEFINITION OF VALUE ANALYSIS

 According to Society of American Value Engineers

“Value analysis is the systematic application of recognized
techniques which identify the function of a product or
service, establish a monetary value for the function and
provide the necessary function reliability at the lowest
overall cost”.

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 VALUE
 Value may be defined as the cost proportionate to the
function.
 Value is also defined as the ratio of utility to the cost
 It is expressed mathematically as
Value =

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 TYPES OF VALUES
 Economic value can be subdivided into four types
 They are
 Cost Value
 Exchange Value
 Use Value
 Esteem Value

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 TYPES OF VALUES
 Cost Value : As the name suggests it is the cost of manufacturing a
product/component.
It is the summation of the material, labour, overheads and other
costs incurred in producing a product.
 Exchange Value: A product is said to possess exchange value if
the same can be exchanged for another product or for money.
 Usage Value : It is known as the function value.
The use value is equal to the value of the functions performed.
It is the price paid by the buyer or the cost incurred by the
manufacturer in order to ensure that the product performs
its intended functions

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 TYPES OF VALUES
 Esteem Value : It creates the qualities and appearance of a
product which attracts persons and create in them a
desire to possess the product.

 It is the price paid by the buyer or the cost incurred by

the manufacturer beyond the use value.

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 FUNCTION
 Function may be defined as the purpose for which the
product is made.

 Types of functions
1. Primary Function
2. Secondary Function
3. Tertiary Function

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 TYPES OF FUNCTIONS

1. Primary Function : They are the basic

functions for which the product is specially
designed to achieve.
2. For Eg :A fluorescent tube gives light
3. Secondary Function : Secondary functions are
those which if not in built would not prevent
the device from performing its primary
functions.
4. For Eg : The arms of a chair provides support
for the hands.
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 TYPES OF FUNCTIONS

 Tertiray Function : These functions are related to the

esteem appearance.
 For Eg : Sun mica top of a table gives esteem appearance
for the table.

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 WHEN TO DO VALUE ANALYSIS
 Company's products show a decline in sales
 Company's prices are higher than those of the competitors.
 Raw materials cost has grown disproportionate to the
volume of production.
 New designs are being introduced.
 The cost of manufacturing is disproportionate to the volume
of production.
 Rate of return on investment has a falling trend.
 Inability of the firm to meet its delivery commitments.
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DIFFERENCE BETWEEN VALUE ANALYSIS
AND VALUE ENGINEERING

S. VALUE ANALYSIS VALUE ENGINEERING

No.
1. Value analysis is the applications of a Value engineering is the
set of techniques to an existing application of exactly the same
product with a view to improve its set of techniques to a new
value product at a design stage,

2 Value Analysis is thus a remedial Value engineering is thus a

process. preventive process

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AIMS AND OBJECTIVES OF VALUE ANALYSIS

 Simply the product

 Reduce the cost of the product
 Use cheaper and better materials
 Modify and improve the product design so as to make it
acceptable to the customer.
 Use efficient processes
 Increase the utility of the product by economical means.
 Ensure greater return on investment
 Improve organizational efficiency

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 ADVANTAGES OF VALUE ANALYSIS/VALUE
ENGINEERING
 Value analysis identifies and reduces the product cost.
 It modifies and improves the product design
 It increases the performance/utility of the product by
economical means.
 It helps to generate new ideas.
 It creates quality consciousness and cost consciousness
among the employer.
 It helps to save money and increase the profits.
 Value engineering improves the ability to manage project,
solve problems, innovate and communicate.
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 VALUE ANALYSIS/VALUE ENGINEERING
PROCEDURE
 The basic steps of value engineering are as follows:
(a) Blast (i) Identify the product
(ii) Collect relevant information
(iii) Define different functions
(b) Create (iv) Different alternatives
(v) Critically evaluate the
alternatives
(c) Refine (vi) Develop the best alternative
(vii) Implement the alternative

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 INTEREST FORMULAS AND ITS
APPLICATIONS

 Interest rate is the renal value of money.

 It represents the growth of capital per unit period.

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 INTEREST FORMULA
 P = Principal Amount
 N = no of periods
 i = Interest periods
 F = Future worth of the amount at the end of the
interest period
 A = equal amount deposited at the end of the interest
period
 G = Uniform amount which will be added/subtracted
period after period from the amount of deposit A1.

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 TIME VALUE OF MONEY
 If an investor invests a sum of Rs 100 in a fixed deposit
for 5 years with an interest rate of 15% compounded
annually, the accumulated amount at the end of every
year is as shown below
 The formula to find the future worth is
F = P (1+i)n
Year End Interest (Rs) Compound
Amount
0 - 100.00
1 15.00 115.00
2 17.25 132.25
3 19.84 152.09
4 22.81 174.90
5 26.24 201.14 48
 SINGLE PAYMENT COMPOUND AMOUNT
 The objective is to find the future sum (F) of the initial
payment (P) made at time 0 after n periods at an interest
rate i compounded every period.
 The formula to obtain single payment compound amount
F = P (1+i)n = P(F/P,i,n)
F

P 1 2 n

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 PROBLEM
 A person deposits a sum of Rs 20,000 at the interest
rate of 18% compounded annually for 10 years. Find the
maturity value after 10 years
 Solution
P = Rs 20,000
i = 18%, n= 10 years
F = P(F/P,i,n) = 20,000 x 5.234
F = Rs 1,04,680/-

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 SINGLE PAYMENT PRESENT WORTH
AMOUNT
 The objective is to find the present worth (P) of a single
future sum (F) which will be received after n periods at an
interest rate i compounded at the end of every interest
period.
 The formula to obtain the present worth is

= F(P/F, i, n)

F(P/F, i, n) is the single payment present worth factor

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 PROBLEM
 A person wishes to have a future sum of Rs 1,00,000 for his sons education after 10 years
from now. What is the single payment that he should deposit now so that he gets the
desired amount after 10 years.The bank gives 15% interest rate compounded annually.
 Solution
F = Rs 1,00,000
i = 15% n= 10 years
P = F(P/F, i, n)
P = 1,00,000 x 0.2472
P = Rs 24,720/-
The person has to invest Rs 24,720/- now so that he will get a sum of Rs 1,00,000 after 10
years at i= 15%

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UNIFORM GRADIENT SERIES METHOD
 Suppose a person wants to deposit a sum A1 at the end
of the first year and increase this amount with an equal
amount (G) for each of the following (n-1) years with an
interest rate i compounded annually.
 What would be the annual amount he should deposit at
the end of every interest period.

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 CASH FLOW DIAGRAM
 The corresponding cash flow diagram is
as follows
0 1 2 3 4 N

A1

A1 +G

A1 +2G

A1 +3G
A1 +(n-1)G

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 FORMULA TO COMPUTE THE ANNUAL EQUIVALENT
AMOUNT

 A = A1+ G

 Using Table the formula to be used is

A = A1 + G (A/G, i ,N )

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 EXAMPLE
 A person would like to invest Rs 5000/- at the
end of the first year and thereafter he wishes to deposit
the amount with an annual increase of Rs 300/- for the
following 9 years with an interest rate of 10%. Find the
total amount at the end of the 10th year of the above
series.

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 SOLUTION
 The formula to compute the value of A is
A = A1 + G (A/G, i ,N )
A = 5000 + 300 (3.7255)
A = Rs 6117.65/-
 The future sum of the “A” at the end of the 10 years is
calculated using the formula
F = A (F/A ,i, N)
F = 6117.65 x 15.937
F = Rs 97,496.99/-

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 EFFECTIVE INTEREST RATE
 Generally nominal interest rate are compounded
annually.
 When the interest rate is compounded less than a year
i.e. monthly, quarterly, half yearly.
 Under such situations we need to calculate the effective
interest rate.

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DEFINITION OF EFFECTIVE INTEREST RATE

 Effective interest rate may be defined as a

percentage which is periodically applied
to measure the cost of money when the
interest rates compounded for less than a
year i.e. monthly, quarterly and half yearly.
 Effective interest rate ( R ) =
where i = Nominal interest Rate -1
C = No of interest periods
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 EXAMPLE
 Mr John deposits a sum of Rs10,000 in a bank at a
nominal interest rate of 12% for 10 years. The
compounding is quarterly. Find the maturity value of the
deposit after 10 years.

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 SOLUTION
 No of interest periods per year C = 4

 Effective interest rate (R ) =

-1

 R = [ 1 + 12%/4]4 – 1 = 12.55%
compounded annually
 The formula to find the maturity value
(F) = P (1+R)N
F = 10,000 (1 + 0.1255)10
= Rs 32,617.82
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EQUAL PAYMENT SERIES PRESENT WORTH AMOUNT

 The objective is to find the present worth of

an equal payment made at the end of every
interest period at an interest rate of i
compounded at the end of every interest
period
 P = Present worth
A = Annual equivalent payment
i = Interest rate, n= interest periods

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CASH FLOW DIAGRAM

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 PROBLEM
 A company wants to set up a reserve which will help it is
have an amount equivalent amount of Rs 15,00,000 for
the next 20 years towards its employees welfares
measures. The reserve is assumed to grow at the rate of
15% annually. Find the single payment that must be made
as the reserve amount

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 SOLUTION
 A = Rs 15,00,000
n = 20 years
i = 15%
P=?
P = A (P/A, i,n)
= 1500000 x 6.2593
= Rs 93,88,950/-

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 EQUAL PAYMENT SERIES CAPITAL
RECOVERY AMOUNT
 The objective is to find the annual equivalent amount (A)
which is to be recovered at the end of every interest
period for n interest periods for a loan (P) sanctioned at
an interest rate of i compounded at the end of every
interest period.

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CASH FLOW DIAGRAM

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 PROBLEM
 A company takes a loan of Rs 20,00,000 to
modernize its boiler sections. The loan is to be
repaid in 20 equal installments at 12 % interest
rate compounded annually. Find the equal
installment amount that should be paid for the
next 20 years.

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 SOLUTION
 P = Rs 20,00,000
n = 20 years
i = 12%
P=?
A = P(A/P, i,n)
= 2000000 x 0.1339
= Rs 2,67,800/-

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 PROBLEM
 A bank gives loan to a company to purchase
an equipment which is worth of Rs 5,00,000 at
an interest rate 11% compounded annually.
This amount is to be repaid in 25 equal
installments. Find the installment amount that
the company has to pay to the bank

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MG 6863- Engg Economics
UNIT III
CASH FLOW
BY
R.Vinoth Kumar& M.Kaviarasu
Assistant Professor/Mechanical Engineering
Nehru Institute of Engineering & Technology
Coimbatore
 CONTENTS OF CASH FLOW
• Present Worth Method
(1) Revenue dominated cash flow diagram
(2) Cost Dominated cash flow diagram
• Future Worth Method
(1) Revenue dominated cash flow diagram
(2) Cost Dominated cash flow diagram
• Annual Equivalent Method
(1) Revenue dominated cash flow diagram
(2) Cost Dominated cash flow diagram
• Rate of Return Method
PRESENT WORTH METHOD OF COMPARISON
• Among the different alternative the best
alternative is selected based on the value of
the present worth of different alternatives.
• In revenue/profit dominated cash flow
diagram :
(a) all inflows to the organization such as
profit, revenue, salvage value is (+)
(b) The cost (Outflows) will be assigned
with (-)
 PRESENT WORTH METHOD OF
COMPARISON
• In the cost dominated cash flow diagram:
(a) The cost (Outflows) will be assigned with (+)
(b) All inflows to the organization such as
profit, revenue, salvage value is (-)
 DECISION ON PRESENT WORTH
METHOD OF COMPARISON
• To select an alternative with minimum cost then the
alternative with least present worth amount will be
selected.

• To select an alternative with maximum profit then the

alternative with maximum present worth amount will be
selected
REVENUE DOMINATED CASH FLOW
DIAGRAM
S

R1 R2 R3 R4

Rn

0 1 2 3 4 n

PW (i) =
 COST DOMINATED CASH FLOW
S
DIAGRAM

0
1 2 3 4 n

C1 C2 C3 C4 Cn
P

PW (i) =
 PROBLEM
• A project involves an initial cost of Rs 30,00,000 and with
the following transactions for the next five years. The
salvage value at the end of the life of the project is Rs
2,00,000. Draw a cash flow diagram for the project and
find its present worth assuming i = 15% compounded
annually
End of Maintenance and Revenue (Rs)
year Operating expense (Rs)
1 2,00,000 9,00,000
2 2,50,000 10,00,000
3 3,00,000 12,00,000
4 3,00,000 13,00,000
5 4,00,000 12,00,000
SOLUTION
FUTURE WORTH METHOD
 FUTURE WORTH METHOD
• Future worth method is used particularly in an investment
situation where we need to compute the equivalent worth
of the project at the end of its investment period
• For Eg : Building a nuclear power plant, where it is time
consuming. In such situation it is more common to
measure the worth of the investment at the time of
commercialization
 THE ACCEPT AND REJECT
RULE
• The accept and reject decision rule for a single project
evaluation is as follows:

If FW(i) > 0, accept the investment

If FW(i)= 0, Remain indifferent to the investment
If FW(i) < 0, Reject the investment
 REVENUE DOMINATED CASH
FLOW DIAGRAM S

R1 R2 R3 R4

Rn

0 1 2 3 4 n

P
 SIGN CONVENTION
• In revenue/profit dominated cash flow
diagram :
(a) all inflows to the organization such as
profit, revenue, salvage value is (+).
(b) The cost (Outflows) will be assigned
with (-).
• The formula for computing the future worth of
the above diagram
FW(i) =
• The alternative with maximum future worth
amount should be selected as the best
alternative.
COST DOMINATED CASH FLOW
DIAGRAM
S

0
1 2 3 4 n

C1 C2 C3 C4 Cn
P
 SIGN CONVENTION
• In the cost dominated cash flow diagram:
(a) The cost (Outflows) will be assigned
with (+)
(b) All inflows to the organization such
as profit, revenue, salvage value is (-)
• The formula for computing the future worth of
the diagram is
•
• The alternative with minimum future worth
amount should be selected as the best
alternative.
 PROCEDUE TO CALCULTE ANNAUL
EQUIVALENT REVENUE
• Step 1 : Calculate the present worth value of the
given alternatives

• Step 2 : Calculate the annual equivalent revenue

using the present worth value
 ANNUAL EQUIVALENT METHOD

• REVENUE DOMINATED CASH FLOW

DIAGRAM
PW(i)

• COST DOMINATED CASH FLOW

DIAGRAM
PW(i) =
 TO CALCULATE ANNUAL
EQUIVALENT REVENUE
• Using the formula

• Using the Tables :

A = PW(i) (A/P , i, n)
 DECISION ON ANNAUL EQUIVALENT METHOD

• For various alternative if it is a revenue dominated method

choose the alternative with maximum annual equivalent
revenue.

• For various alternatives if it is a cost dominated method

choose the alternative with minimum annual equivalent
revenue.
 RATE OF RETURN METHOD
• The rate of return of a cash flow pattern is the rate of
interest at which the present worth of the cash flow
reduces to zero.
• The rate of return for each alternative is computed.
• The alternative which has the highest rate of return is
selected as the best alternative.
 PROCEDURE
• Step 1 : To find the present worth of the
given alternative using some i value
PW(i)=

• Step 2 : The above procedure is repeated

till the present worth value changes from
positive to negative.
• Step 3 : Then the value of i is obtained
using the method of interpolation
PRESENT WORTH FUNCTION
GRAPH
UNIT – IV REPLACEMENT AND
MAINTENANCE ANALYSIS

BY
R.Vinoth Kumar & M.Kaviarasu
Assistant Professor/Mechanical Engineering
Nehru Institute of Engineering & Technology
Coimbatore
 MAINTENANCE
• Definition : Maintenance is defined as the
action taken by the user to maintain an
existing facility in operating condition.

103
 OBJECTIVES OF MAINTENANCE
• To achieve minimum break down
• To keep a plant in good working condition at
the lowest possible cost.
• To keep machines at their optimum cost
without any hindrance.
• To ensure the availability of machineries,
buildings and services.
• To achieve efficient functioning of machines.
• To reduce operation and maintenance cost.

104
 TYPES OF MAINTENANCE
• Corrective (or) Break down Maintenance
• Scheduled Maintenance
• Preventive Maintenance
• Predictive Maintenance

105
 CORRECTIVE (OR) BREAK DOWN
MAINTENANCE
• This implies that repairs are made after the
equipment is out of order and it can not perform
its normal functions any longer.
• Production Dept Maintenance Dept to
rectify the fault.
• Maintenance Dept checks into the difficulty
and makes the necessary repairs
• After removing the fault the maintenance
engineers do not attend the equipment until
another failure occurs

106
 CAUSES FOR EQUIPMENT BREAK
DOWN
• Failure to replace the worn out parts.
• Lack of lubrication
• Neglected cooling system.
• Not attending minor faults.
• External factors such as low or high voltage, wrong
fuel
• Not attending unusual sounds, vibrations etc.

107
 SCHEDULED MAINTENANCE
• Scheduled maintenance is concerned with the time
schedule to avoid breakdown.
• This maintenance includes inspection, repair,
overhaul etc which if neglected can result in serious
issues.

108
 PREVENTIVE MAINTENANCE
• It is defined as an action performed in an
attempt to keep the machine in a specified
operating condition by means of systematic
inspection, detection and prevention of
failures.
• It works on the principle of “Prevention is
better than cure”
• It locates weak spots in all equipments
provides them with regular inspection and
minor repairs and thereby reduces the danger
of unanticipated breakdown

109
OBJECTIVES OF PREVENTIVE MAINTENANCE
• To keep the equipment always available.
• To maintain the value of the equipment by
periodic inspection, repairs and overhauls.
• To maintain optimum production ᶯ of the
equipment.
• To ensure safety of the workers
• To reduce the work content of maintenance
jobs.

110
 FF==Fault Detection

Preparation for maintenance

LoLLocalisation and isolation of

Preventive maintenance
fault

Disassembly

Remove fault
Repair
item

Reinstallation and Reassembly

Ffinal adjustments
Repair over
CChecking
111
 PROCEDURE OF PREVENTIVE MAINTENANCE

• Inspection or checkups
• Lubrication
• Planning and scheduling
• Record keeping and analysis
• Training of maintenance personnel
• Storage of spare parts
• Control and evaluation of preventive maintenance.

112
ADVANTAGES OF PREVENTIVE MAINTENANCE

• Reduction in production down time.

• Less overtime pay for maintenance
personnel
• Lesser expenditure on repairs
• Fewer repetitive repairs
• Better product quality and fewer
rejections.
• Lesser number of standby equipments
are needed
113
 PREDICTIVE MAINTENANCE
• Newer maintenance technique
• It uses human sense organs or some
sensitive instruments such as audio gauges,
vibration analysers, amplitude meters etc to
predict troubles before the equipment fails.
• Equipment conditions are monitored
periodically and thus enables the
maintenance men to take timely action such
as repairs and overhauls.
• Extends the service life of an equipment
without the fear of failure
114
 REPLACEMENT
• Replacement can be defined as the
decision problems involving the
replacement of existing obsolete or
worn out assets
• Causes of replacement :
1. Deterioration
2. Obsolescence
3. Inadequacy
4. Working conditions
115
 TYPES OF REPLACEMENT
PROBLEM
• Replacement of assets with deteriorate with time
(a) Economic Life of an asset
(b) Replacement of an existing asset with a
new asset
• Simple probabilistic model for assets which fail
completely.(replacement due to sudden failure)

116
 PROBLEM
• The following table gives the operation
and maintenance cost and salvage
value at the end of the every year of a
machine whose purchase price is Rs
20,000. Find the economic service life
of the machine assuming interest rate
i = 15%

117
 PROBLEM
END OF OPERATING MAINTENANCE SALVAGE
YEAR COST (RS) COST (RS) VALUE (RS)
1 3000 300 9000
2 4000 400 8000
3 5000 500 7000
4 6000 600 6000
5 7000 700 5000
6 8000 800 4000
7 9000 900 3000
8 10000 1000 2000
9 11000 1100 1000
10 12000 1200 0

118
SOLUTION

119
 PROBLEM
• A firm is considering replacement of an machine
whose cost price is Rs 1,20,000 and the scrap value
is Rs 10,000 at the end of the first year and declines
each year by rs 1000 from the previous years scrap
value. The operating cost is as follows

Year 1 2 3 4 5 6 7 8
Operating cost 2000 5000 8000 12000 18000 25000 32000 40000

120
 SOLUTION
End of Operating Cumulative Scrap Total cost Average
year cost operating value FC + COC-S cost =
cost TC/n
1 2000 2000 10000 112000 112000

2 5000 7000 9000 118000 59000

3 8000 15000 8000 127000 42333.33

4 12000 27000 7000 140000 35000

5 18000 45000 6000 159000 31800

6 25000 70000 5000 185000 30833.33

7 32000 102000 4000 218000 31142.85

8 40000 142000 3000 259000 32375

121
 REPALCEMENT OF EXISTING ASSET WITH NEW
ASSET
• Annual equivalent cost of existing asset and the new
asset is calculated.
• The alternative which gives the least value is
considered as the best alternative.
• The formula to calculate the annual equivalent cost is
AE = (P-F)(A/P , i, n) + F x i +A

122
 PROBLEM
Two years ago a machine was purchased at
a cost of Rs 2,00,000 to be useful for eight
years. Its salvage value at the end of the life
is Rs 25,000. The annual maintenance cost
is Rs 25,000. The market value of the
present machine is Rs 1,20,000. Now a new
machine to cater to the need of the present
machine is Rs 1,50,000 to be useful for six
years. The annual maintenance cost is Rs
14,000. The salvage value of the new
machine is Rs 20,000. Using the rate of 12%
find whether it is worth replacing the present
machine with the new machine
123
SIMPLE PROBABILISTIC MODEL FOR ASSETS
WHICH FAIL COMPLETELY
• A system usually consists of a large no
of low cost items that are increasing
liable to failure with age.
• The cost of failure is > the cost of item
itself.
• Two types of replacement policies are
considered
a. Individual replacement policy
b. Group replacement policy
124
 SIMPLE PROBABILISTIC MODEL FOR ASSETS
WHICH FAIL COMPLETELY
• For a given problem the individual & group
replacement policies are evaluated and the most
economical policy is selected for implementation.

125
 PROBLEM
• The failure rates of transistors in a
computer are summarized in the
following table. The cost of replacing
an individual failed transistor is Rs 8/-.
If all the transistors are replaced
simultaneously it would cost Rs 4 per
transistor. Find the optimum
replacement policy
End of 1 2 3 4 5 6 7
week
Probability 0.09 0.17 0.27 0.50 0.65 0.90 1.00
of failure

126
 SOLUTION
• Let Ni = The number of transistors
replaced at the end of the ith week.
• N0 = Number of transistors replaced at
the end of the week 0.
N1 = N0 x P1 = 100 x 0.09 = 9
N2 = N0 x P2 + N1 x P1
= 100 x 0.08 + 9 x 0.09 = 8.81
N3 = N0 x P3 + N1 x P2 + N2 x P1
= 100 x 0.1 + 9 x 0.08 + 8.81 x 0.09
= 11.51

127
 SOLUTION
N4 = N0 x P4 + N1 x P3 + N2 x P2 + N3 x P1
= 100 x 0.23 + 9 x 0.1 + 8.81 x 0.08 + 11.51 x 0.09
= 25.63
N5 = N0 x P5 + N1 x P4 + N2 x P3+ N3 x P2 + N4 x P1
= 100 x 0.15 + 9 x 0.23 + 8.81 x 0.1 + 11.51 x 0.23 +
25.63 x 0.09
= 21.17
N6 = N0 x P6 + N1 x P5 + N2 x P4+ N3 x P3 + N4 x P2 + N5 x P1
= 100 x 0.25 + 9 x 0.15 + 8.81 x 0.23 + 11.51 x 0.1 + 25.63 x
0.08 + 21.17 x 0.09
= 33.47
N7 = N0 x P7 + N1 x P6 + N2 x P5+ N3 x P4 + N4 x P3 + N5 x P2 +
N6 x P1
= 100 x 0.1 + 9 x 0.25 + 8.81 x 0.15 + 11.51 x 0.23 + 25.63 x
0.1 + 21.17 x 0.08 + 33.47 x 0.09
= 23.47
128
 SOLUTION
• Expected life of the transistor =

= 1 x 0.09 + 2x 0.08 + 3 x0.1+ 4 x 0.23 + 5 x 0.15 + 6x

0.25 + 7x 0.1
= 4.42 weeks

• Average number of failure per week = 100/4.42

= 23
• Cost of individual replacement
= Number of failures/week x Individual replacement cost/transistor
= 23 x 8
= Rs 184

129
 SOLUTION
• GROUP REPLACEMENT COST
End Group Cost of individual replacement Total Average
of replacement Cost Cost
Week cost (Rs) (Rs)
1 4 x 100 = 400 9 x 8 = 72 472 472

2 400 (9 + 8.81) x 8 = 142.48 542.48 271.24

3 400 (9 + 8.81+11.51) x 8 = 234.56 634.56 211.52

4 400 (9 + 8.81+11.51+25.63) x 8 = 439.60 839.60 209.90

5 400 (9 + 8.81+11.51+25.63+21.17) x 8 1008.96 201.79

= 608.96
6 400 (9 + 8.81+11.51+25.63+21.17+ 1276.72 212.78
33.47) x 8 = 876.72
7 400 (9 + 8.81+11.51+25.63+21.17+ 1464.48 209.21
33.47+ 23.47) x 8 = 1064.48

130
 SOLUTION
• Individual replacement cost /week = Rs. 184/-

• Group replacement cost /week = Rs. 201.79/-

Since the individual cost/week is < group

replacement cost the individual replacement
cost is adopted

131
UNIT V DEPRECIATION
R.Vinoth Kumar& M.Kaviarasu
Assistant Professor/Mechanical
Engineering
Nehru Institute of Engineering
& Technology
Coimbatore
 DEPRECIATION

Definition :
Carter defines : Depreciation is the gradual and permanent
decrease in the value of an asset from any cause
Accounting point of view : Depreciation is an annual charge
reflecting the decline in value of an asset due to causes such as
wear and tear action of elements obsolescence.
 CAUSES OF DEPRECIATION
• Wear and tear : Results from friction, resistance and
chemical reaction.
• Depletion : Decrease in the value of the assets such
as oils wells, mines, forests
• Obsolescence : The assets getting out of use due to
new invention and loss of demand due to change in
technology.
• Lapse of time : The value of the asset goes down
whether utilized or not.
 METHODS OF DEPRECIATION

• Straight line method of

depreciation
• Declining balance method
• Sum of years digits method
• Sinking fund method
• Service output method
 STRAIGHT LINE MEHTOD OF DEPRECIATION

• In this method of depreciation a fixed sum is charged as

depreciation amount throughout the life time.
• At the end of the life of an asset the accumulated sum of
the asset is exactly equal to the purchase value of the
asset.
• Assumption : Inflation is absent
 STRAIGHT LINE MEHTOD OF DEPRECIATION
• P = First cost of the asset
• F = Salvage value of the asset
• n = Life of the asset
• Bt = Book value of the asset at the end of the period ti
• Dt = Depreciation amount for the time period t
[P  F ]
Dt 
n
PF
Bt  Bi 1  Dt  P  t[ ]
n
 PROBLEM 1

• A company purchased a machinery for Rs 8000, the useful life of

the machinery is 10 years and the estimated salvage value of the
machinery at the end of the lifetime is Rs800. Determine the
depreciation charge and book value at the end of the various
years using the straight line method of depreciation.
 SOLUTION

• P = Rs 8000
• F = Rs 400
• Dt = (P-F)/n = (8000 – 800)/10 = 720
• Rate of Deprecation = Dt / P * 100
= (720/8000)*100
= 9%
 SOLUTION
End of Year Depreciation ( Dt ) Book Value Bt = Bt-1 - Dt
0 - 8000
1 720 7280
2 720 6560
3 720 5840
4 720 5120
5 720 4400
6 720 3680
7 720 2960
8 720 2240
9 720 1520
10 720 800
 PROBLEM 2

• A machine costing Rs 24,000 was purchased on 1st December

1985. The installation and erection charges were Rs 1000 and its
useful life is expected to be 10 years. The scrap value of the
machine at the end of the useful life is Rs 5000. Compute the
depreciation and the book value for the period 6
 SOLUTION

• P = Rs 24,000 + Rs 1000 = 25000

• F = Rs 5000/-
• n = 10 years
• Dt = (P-F)/n = (25000-5000)/10 = 2000
• Bt  Bi 1  Dt  P  t[
PF
]
n

• Bt = 25,000 – 6 × (25000-5000)/10
• Bt = Rs. 13,000/-
 DECLINING BALANCE METHOD
• A constant % of book value of the previous period of the asset
will be charged as the independent amount for the current
period.
• The book value at the end of the life of the asset may not be
exactly equal to the salvage value of the asset.
• P = First cost of the asset
• F = Salvage value of the asset
• n= Life of the asset
• Bt = Book value of the asset at the end of the period t
• K = a fixed percentage
• Dt = Depreciation amount at the end of the period “t”
FORMULA FOR DECLINING BALANCE METHOD

Dt  K  Bt 1
Bt  Bt 1  Dt
Bt  (1  K ) Bt 1
FORMULA FOR DECLINING BALANCE
METHOD
Dt  K  Bt 1 t 1
Dt  K (1  K )  P
Bt  Bt 1  Dt
Bt  (1  K )  P
t

Bt  (1  K ) Bt 1
•If k = 2/n then it is called as
double declining balance method
 PROBLEM 1
• Glaxo company has purchased a machine for Rs
1,50,000. The plant engineer estimates that the
machine has a useful life of 10 years and a salvage
value of Rs 25,000 at the end of the useful life.
Demonstrate the calculations of the declining
balance method of depreciation by assuming 0.2 for
K
• P = Rs 1,50,000.
Using the formula
• F = Rs 25,000
• n= 10 years Dt  K  Bt 1
• K = 0.2
Bt  Bt 1  Dt
 SOLUTION
End of year (n) Depreciation ( Dt) Book Value (Bt)
0 - 1,50,000.00
1 30,000.00 1,20,000.00
2 24,000.00 96,000.00
3 19,200.00 76,800.00
4 15,360.00 61,440.00
5 12,288.00 49,152.00
6 9830.40 39,321.60
7 7864.32 31,457.28
8 6291.45 25,165.83
9 5033.16 20,132.67
10 4026.53 16,106.14
 PROBLEM 2
• Calculate the depreciation and book value for
the period 5 using the declining balance method
of depreciation by assuming 0.2 for K and Rs
1,20,000 for P and salvage value Rs 10,000. The
useful life of the machinery is 10 years.
• P = Rs 1,20,000
• F = Rs 10,000
• n= 10 years
• K = 0.2
 SOLUTION

• Using the formula

t 1
Dt  K (1  K )  P
Bt  (1  K )  P
t

• Dt = 0.2 (1-0.2)(5-1) × 1,20,000 = Rs 98,430.40/-

• Bt = (1-0.2)5 × 1,20,000 = Rs 39,321.60
 SUM OF YEARS DIGITS METHOD
• The scrap value of the asset is deducted from its original cost
and it is assumed that the book value of the asset decreases
at a decreasing rate.
• Sum of the years = n (n+1)/2
• Dt = Rate × (P-F)
• Bt = Bt-1 – Dt
• The formula for Dt and Bt for a specific year “t” are as follows
n  t 1
Dt  (P  F )
n(n  1) / 2
n  t (n  t  1)
Bt  ( P  F ) F
n (n  1)
 PROBLEM 1

• ABC company has purchased an equipment whose first cost is Rs

2,00,000 with an estimated life of eight years. The estimated scrap
value of the equipment at the end of the lifetime is Rs
40,000/-. Determine the depreciation charge and book value at
the end of various years using sum of the years digits method of
depreciation.
 SOLUTION
• P= Rs. 2,00,000
• F = Rs.40,000
• n = 8 years
• Sum = (8 × 9)/2 = 36
End of Year (n) Depreciation ( Dt) Book Value (Bt)
0 - 2,00,000
1 35,555.55 1,64,444.44
2 31,111.11 1,33,333.33
3 26,666.67 1,06,666.66
4 22,222.22 84,444.44
5 17,777.77 66,666.67
6 13,333.33 53,333.34
7 8888.88 44,444.46
8 4444.44 40,000.02
 PROBLEM 2
• Consider problem 1 and find the depreciation
and book value for the 5th year.
• P= Rs. 2,00,000 Using the formula
• F = Rs.40,000 n  t 1
Dt  (P  F )
n(n  1) / 2
• n = 8 years n  t (n  t  1)
Bt  ( P  F ) F
n ( n  1)
8  5 1
Dt  (2,00,000  40,000)  Rs.17,777.78
8(8  1) / 2
8  5 8  5 1
Bt  (2,00,000  40,000)  40,000  Rs.66,666.67
8 8 1
 SINKING FUND METHOD

• In this method of depreciation a depreciation fund equal to actual

loss in the value of the asset is estimated for each year.
• This amount is invested outside the business in a separate account
sinking fund investment account and interest will be earned on
the fund.
• The sinking fund will rise year after year.
 FORMULA USED
• P= first cost of the asset
• F= salvage value of the asset
• n= life of the asset
• i = Rate of return compounded annually
• A = Annual equivalent amount
• Bt = Book value of the asset at the end of the period ‘t’
• Dt = Depreciation amount at the end of the period ‘t’.
• The loss of value of the asset (P-F) is made available in the form of
cumulative depreciation amount
• A = (P-F)[A/F, i, n]
• The fixed sum depreciated at the end of every time period earns an interest
at the rate of i% compounded annually
• Dt = (P-F)(A/F, i ,n)(F/P,i,t-1)
• Bt = P-(P-F)(A/F, i, n)(F/P,i,t-1)
 PROBLEM 1

• Find the depreciation annuity by annuity method after three years

when the initial cost of the machine is Rs.8,00,000 and the salvage
value at the end of three years is Rs. 4,00,000. Rate of interest is
10%.
 SOLUTION
• P = Rs. 8,00,000
• F = Rs. 4,00,000
• n = 3 years
• i = 10%
• A = (P-F)[A/F, i, n]
• A = (8,00,000-4,00,000) [A/F,10%,3] value from interest
table is substituted
• A = (8,00,000-4,00,000) x 0.3021 = Rs. 1,20,840
• Dt = (P-F)(A/F, i ,n)(F/P,i,t-1)
• Bt = P-(P-F)(A/F, i, n)(F/P,i,t)
 SOLUTION
• Dt = (P-F)(A/F, i ,n)(F/P,i,t-1)
• D2 at the end of the second year (D2) =
• D2 = 1,20,840 + 1,20,840 x 0.10 = Rs. 1,32,924.
End of the year ‘t’ Fixed Dt Net Dt Book Value Bt
0 1,20,840 - 8,00,000.00
1 1,20,840 1,20,840.00 6,79,160.00
2 1,20,840 1,32,924.00 5,46,236.00
3 1,20,840 1,46,216.40 4,00,019.60
 PROBLEM 2
• ABC & Co has purchased a machinery and its first cost
is Rs. 2,00,000 with an estimated standard life of 8
years. The salvage value is Rs. 40,000 find D6 and B7,
rate of interest 12% compounded annually.
• Solution :
• P = Rs. 2,00,000 F = Rs. 40,000 n = 8 years i = 12%
• D6= (P-F)(A/F,12%,8)(F/P,12%,5)**
** - From interest table
• D6= (2,00,000-40,000) (0.0813)(1.762) = Rs. 22,920
• B7 = P-(P-F) (A/F,12%,8)(F/A,12%,7)**
• B7 = 2,00,000-(2,00,000-40,000)(0.0813)(10.089)
= Rs. 68,762.29
 SERVICE OUTPUT METHOD
• In this method the life of the machine is
expressed in terms of number of units that a
machine is expected to produce over the
estimated life
• P= first cost of the asset
• F = Salvage value of the asset
• X = Maximum capacity of service of the asset
during its lifetime
• x = Quantity of service rendered in a period
• Depreciation/unit of service = (P-F)/X
(P  F )
• Depreciation for x unit of service period = ( x)
X
 PROBLEM
• The first cost of a road laying machine is Rs 60,00,000/-.
Its salvage value after 5 years of service is Rs. 40,000/-.
The length of road that can be laid by the machine
during the lifetime is 55,000km. In its third year of
operation the length of road laid is 1500 km. Find the
depreciation of the equipment for that year
Solution:
• P = 60,00,000 F = 40,000 X = 55,000 km, x = 1500 km
• Depreciation for x unit of service in year 3 =
60,00,000  40,000
D3   (1500)  Rs.1,62,545.45
55,000
 EVALUATION OF PUBLIC ALTERNATIVES

• Evaluation of public alternatives is selection of best alternative

from the available alternatives.
• The factor considered in selection is profit maximization.
• For the evaluation of public alternatives the benefit – cost ratio is
used
• BC ratio =
EquivalentBenefits
EquivalentCosts
 EVALUATION OF PUBLIC ALTERNATIVES
• P = initial investment
• C= Early cost of operation and maintenance
• PA = Annual equivalent of the initial investment
• PF = Future worth of the initial investment
• BP = Present worth of total benefits
• BF = Future worth of total benefits
• BA = Annual equivalent of total benefits
• CP = Present worth of yearly cost of operation
and maintenance.
• CF = Future worth of yearly cost of operation
and maintenance.
BP BF BA
BCRATIO   
P  CP PF  CF PA  C
 PROBLEM
• Project A1 and Project A2 are being considered
for investment. Project A1 requires an initial
investment of Rs 40,00,00 and net receipts
estimated as Rs10,00,000 per year for the next 5
years. The initial overlay for the A2 is Rs
70,00,000 and the net receipts have been
estimated as Rs. 16,00,000 per year for the next
seven years. There is no salvage value associated
with either of the projects. Using the benefit to
cost ratio which project would you select?
Interest rate = 10%
 SOLUTION
Alternative 1 :
• P = Rs 40,00.000 B = Rs. 10,00,000 n = 5 Years
i= 10%
AnnualequivalentBenefits
BCRATIO 
AnnualequivalentCosts
• Annual equivalent of initial cost = P(A/P,10%,5)
=40,00,000 x 0.2638
= Rs. 10,55,200
10,00,000
BCRATIO   0.9476
10,55, 200
 SOLUTION
Alternative 2 :
• P = Rs 70,00.000 B = Rs. 15,00,000 n = 7 Years
i= 10%
AnnualequivalentBenefits
BCRATIO 
AnnualequivalentCosts
• Annual equivalent of initial cost = P(A/P,10%,7)
=70,00,000 x 0.2054 = Rs. 14,37,800

15,00,000
BCRATIO   1.0432
14,37,800
• The benefit cost ratio of alternative 2 (i.e 1.0342 >1) is
more than alternative 1. Hence alternative 2 is selected