(5-1) Economical Comparison of Engineering Projects:-: 1-Present Worth Methods (P.W.M)

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Chapter 5

(5-1) Economical Comparison of Engineering Projects:-


The economical comparison is used as a tool to compare two or more projects as a
accomplished to same work to reach to a decision that justify which of these projects is
better economically.

Facility investment decisions represent major commitments of corporate resources and


have serious consequences on the profitability and financial stability of a corporation. It is
important to evaluate facilities rationally with regard to both the economic feasibility of
individual projects and the relative net benefits of alternative and mutually exclusive
projects

(5-2) Basic Methods:


1- Present worth (P.W.M)

2- Annual worth (A.W.M)

3- Future worth (F.W.M)

1- Present worth Methods(P.W.M):

Present worth is one of the ways to compare alternatives. It is most frequently used to
determine the present value of future money receipts and disbursements. In the future,
income and costs are known, and then using a suitable interest rate, the present worth can
be calculated. In present worth analysis, careful consideration must be given to the time
period covered by the analysis. Usually, the task to be accomplished has a time period
associated with it. Accordingly, the analysis of each alternative must be considered for this
period of time, which is named as described before the analysis period of the planning
horizon.
In present worth analysis, the alternative with the maximum present worth (PW) of benefits
minus present worth of cost is always selected. This criterion is called the net present worth
criterion (NPW).

NPW = PW of benefits – PW of costs

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Engineering economics Shang Asmat Mohammed
Initial investment (P): this is the total first cost required to initiate the alternative.
When portions of these investments take place over several years, their present worth is an
equivalent initial investment

Salvage value (S): this is the estimated value of assets at the end of their useful life

Example:
An equipment has been proposed to increase the productivity of a certain operation. The
initial investment (initial cost or purchase value) is 25000 $ and the equipment will have a
salvage value of 5000$ at the end of it’s expected life (useful life or economical life) 5
years., increase productivity will amount 8000 $ per year.

1-Draw the cash flow diagram for this equipment.

2- If the rate of return is 20 %, Show if the equipment is economically justified using


present worth method?

Sol.

8000 $ 8000 $ 8000 $ 8000 $ 8000 $

0 S=5000 $
1 2 3 4 5
i = 20%, n = 5 yrs.
25000 $

(𝟏+𝐢)𝐧 −𝟏 (1+0.2)5−1
P1 = A [ 𝟎.𝟐(𝟏+𝟎.𝟐) 𝐧 ] = 8000 [ 0.2(1+0.2) 5 ] = +23924.9 $

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Engineering economics Shang Asmat Mohammed
𝟏 1
P2 = F [(𝟏+𝐢) 𝐧 ] = 5000 [(1+0.2) 5 ] =+2009.4 $

P3=-25000$

N.P.W. = Inflow – outflow

= (23924.9 + 2009.4) – 25000 = 934.3 $

2) The equipment is economically justified.

Example:
An investment of 10000 $ can be made in a project that will produce a uniform annual
revenue of 5310 $ for 5 year, and then has a salvage value of 2000 $, and the annual
operation and maintenance cost 3000 $, the rate of return is 10%. Show weather this is a
desirable investment using present worth method?

Sol.
(𝟏+𝐢)𝐧 −𝟏
P1= A [ ]
𝐢(𝟏+𝐢)𝐧

(1+0.1)5 −1 5310 $ 5310 $ 5310 $ 5310 $ 5310 $


= 5310 [0.1(1+0.1) 5 ] (+) In
S=2000
0 1 2 3 4 5
P1= +20129.1 $
(-) out
𝟏
P2= F [(𝟏+𝐢)𝐧 ]
10000 $ 3000 3000 3000 3000 $ 3000 $
1
= 2000 [(1+0.1)5 ]

P2=+ 1241.8 $
(1+0.1)5 −1
P3=3000 [0.1(1+0.1) 5 ]

P3=-11372.4 $

P4=-10000

N.P. W= Inflow-outflow

N.P.W =-1.5

The project is not justified.


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Engineering economics Shang Asmat Mohammed
2-Annual Worth Method (A.W.M):-
Equivalent Uniform Annual Worth Analysis Instead of computing equivalent present
sum, in this section alternatives could be compared based on their equivalent annual costs
(cash flows). Based on particular situation, the equivalent uniform annual cost (EUAC),
the equivalent uniform annual benefits (EUAB), or their difference could be calculated.

The techniques to convert money, at one point in a time, to sum equivalent sum or series
were presented. In this section, the goal is to convert money into an equivalent uniform
annual cost or benefits. The major advantage of this method is that it is not necessary to
make the comparison over the same number of years when the alternatives have different
lives. The reason for that, it is an equivalent annual cost over the life of the project.

Example:-
An equipment has been proposed to increase the productivity of a certain operation. The
initial investment (initial cost or purchase value) is 25000 $ and the equipment will have a
salvage value of 5000$ at the end of it’s expected life (useful life or economical life) 5
years., increase productivity will amount 8000 $ per year.

1-Draw the cash flow diagram for this equipment?

2- If the rate of return is 20 %, Show if the equipment is economically justified using


Annual worth method?

Sol.

(𝟏+𝐢)𝐧 −𝟏 (1+0.2)5 −1
1-F =A [ ] 5000= A [ ]
𝐢 0.2

A1=+ 671.9 8000 8000 8000 8000 8000


(𝟏+𝐢)𝐧 −𝟏 $ $ $ $ $
P =A [𝟎.𝟐(𝟏+𝟎.𝟐) 𝐧 ]
0 S=5000
3 4 5 $
(1+0.2)5−1 1 2
25000=A [0.2(1+0.2) 5 ]
i = 20%, n =
A2=-8359.5 25000 $ 5 yrs.

A3=+8000$

N.A. W = 8000 + 671.9 - 8359.5= 312.4$

2- The equipment is economically justified.

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Engineering economics Shang Asmat Mohammed
Example:
An investment of 10000 $ can be made in a project that will produce a uniform annual
revenue of 5310 $ for 5 year, and then has a salvage value of 2000 $, and the annual
operation and maintenance cost 3000 $, the rate of return is 10%. Show weather this is a
desirable investment using (A.W.M)?

Sol.
5310 $ 5310 $ 5310 $ 5310 $ 5310 $
𝐢(𝟏+𝐢)𝐧 (+) In
A= p [ ] S=2000
(𝟏+𝐢)𝐧 −𝟏 0 1 4
2 3 5
𝟎.𝟏(𝟏+𝟎.𝟏)𝟓
=10000 [ ] (-) out
(𝟏+𝟎.𝟏)𝟓 −𝟏

10000 $ 3000 3000 3000 3000 $ 3000 $


A1=-2638
𝐢
A=F [ (𝟏+𝐢)𝐧−𝟏 ]

𝟎.𝟏
A2=2000 [ (𝟏+𝟎.𝟏)𝟓−𝟏 ]

A2=+327.6

A3=5310-3000=+2310$

N.A. W= Inflow-outflow

N.A.W =-0.4

The project is not justified.

3-Future worth method (F.W.M):


Is comparable to P.W.M that all cash inflows and outflows are compounded to a reference
in time called future.

(F.W.V) of an alternative may be determined directly from the cash flows, or by


multiplying the P.W value by the F/P factor

Analysis of alternatives using FW values is especially applicable to large capital


investment decisions when a prime goal is to maximize the future wealth of a corporation’s
stockholders. Future worth analysis over a specified study period is often utilized if the
asset (equipment, a building, etc.) might be sold or traded at some time before the expected
life is reached.

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Engineering economics Shang Asmat Mohammed
Example:

An equipment has been proposed to increase the productivity of a certain operation. The
initial investment (initial cost or purchase value) is 25000 $ and the equipment will have a
salvage value of 5000$ at the end of it’s expected life (useful life or economical life) 5
years., increase productivity will amount 8000 $ per year.

1-Draw the cash flow diagram for this equipment?

2- If the rate of return is 20 %, Show if the equipment is economically justified using Future
worth method?

Sol.

8000 $ 8000 $ 8000 $ 8000 $ 8000 $

0 S=5000 $
1 2 3 4 5
i = 20%, n = 5 yrs.
25000 $

(𝟏+𝐢)𝐧 −𝟏 (1+0.2)5−1
F 1=A [ ] F= 8000 [ ]
𝐢 0.2

F1=59532.8$

F2 = p (1+i) n F=25000(1+0.2)5

F2=-62207.5$

F3=+5000

N.A. W =5000-62207.5+59532.8

=2325.3$

2- The equipment is economically justified.

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Engineering economics Shang Asmat Mohammed
Example:
An investment of 10000 $ can be made in a project that will produce a uniform annual
revenue of 5310 $ for 5 year, and then has a salvage value of 2000 $, and the annual
operation and maintenance cost 3000 $, the rate of return is 10%. Show weather this is a
desirable investment using (F.W.M)?

Sol.

5310 $ 5310 $ 5310 $ 5310 $ 5310 $


(+) In
2000$
0 1 2 3 4 5

(-) out

10000 $ 3000 3000 3000 3000 $ 3000 $

F = p (1+i) n
F 1= 10000(1+0.1) 5
F1=-16105
(𝟏+𝐢)𝐧 −𝟏
F2 = A [ ]
𝐢

A=5310-3000=2310$
(1+0.1)5 −1
F2 = 2310 [ ] =+14102.78
0.1

F3=+2000

N.F. W= Inflow-outflow

N.P.W =-2.219

The project is not justified.

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Engineering economics Shang Asmat Mohammed

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