FUNDAMENTALS

OF
ENGINEERING ECONOMICS

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 CHAPTER ONE

1. DEFINITION AND SCOPE OF ENGINEERING ECONOMICS

1.1 THE ENGINEERING PROCESS
The engineering process employed from time a particular need is recognised until it is satisfied
may be divided into number of phases that include the following:

a) Determination of objectives
This phase of engineering process involves the search for new objectives for engineering
application aim at finding what people need and want which can be supplied by engineers.
In the field of invention, success is not a direct result of the fabrication of new device rather
it depends upon the capacity of the invention to satisfy human wants. Thus market studies
seek to learn what the desires of the people are. It should be noted that the consideration
for physical and economic feasibility come only when what is wanted has been determined.
This aspect of the engineering process which seeks to learn of human wants requires not
only knowledge of the limitation of engineer capability but also a general knowledge of
sociology, psychology, political science, literature and other discipline related to the
understanding of human nature. This is why knowledge of the disciplines is recognised to
be essential in most branches of modern engineering discipline.
b) Identification of strategic factors
Those factors that stand in the way of attaining specified objectives are known as limiting
factors. An important element of the engineering process is the identification of limiting
factors restricting accomplishment of desired objectives. Once the limiting factors have
been identified; they examined to locate the strategic factors which comprise those factors
that can be altered to remove limitations restricting the success of an undertaking. The
identification of strategic factors is important because it focus concentration on areas in
which success is obtainable.
c) Determination of means
The determination of means is subordinate to the identification of strategic factors just as
the identification of strategic factors is necessarily subordinate to the determination of
objectives. Strategic factors can be altered in different ways and every possibility must be
evaluated to determine which will be successful in terms of overall economy. Knowledge of
the fact in a discipline is a necessity of creativeness in that discipline and engineers have
the opportunity to be creative by considering both human and economic factors in their
work.

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d) Evaluation of engineering proposals
This phase of engineering process evaluate the means identified in (3) above. Although
evaluation rely mainly on mathematical models, judgements and experience are pivotal
inputs. Any economic analysis or evaluation that primarily involves engineering and
technical project is refers to as Engineering Economic Study. This type of study is meant
to evaluate engineering proposals in terms of worth and cost before they are undertaken.
e) Decision making
Virtually all engineering problems can be solved in more than one way and in fact most
projects can be carried out in more than one way as well. Almost all business decisions
involve doing one thing or another even though one alternative is merely to do nothing.
Hence, economic study deals with the difference in economic results of alternatives. The
concept of economic differences between alternatives is basic and most important in
economic study. In fact where there is no alternative there is no need to venture into an
economic study. In general, steps involve in making engineering decisions are:
i. Define the problem;
ii. Establish alternative plans and designs;
iii. Evaluation of choice; and
iv. Implementation and control

Engineering economic studies are meant for the purpose of determining whether capital should
be invested in a project or whether it should be utilise in different manner than it is presently
being used. Therefore, engineering economic study provides information upon which
investment and managerial decision about future operations can be based. Thus an engineering
economist could be termed an alternative fortune teller.

1.2 MEANING AND DEFINITION OF ENGINEERING ECONOMICS

Any organization must have set objectives. The operations of the system should in turn further
the primary objective of the organisation. Usually, the primary objective of a business can be
stated as:
“To manufacture (provide) a product (service) in other to satisfy a demand”
All too often, however, the objectives of such organizations are stated in such terms as:
i. To maximise profits (minimise costs)
ii. To employ labour
iii. To provide a useful commodity/product.

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All of the above are simply secondary objectives, which can be satisfied if the primary objective
is vigorously pursued. Whether the primary objectives are realised on the long run depends on
the following:
i. Producing the right quality of product (service)
ii. Producing the right quantity of product (service)
iii. Producing both the above at the right time and cost.
Investment on technology should be justified on economics as well as technical grounds.
Projects selected should be such that meet the immediate as well as future needs of the
establishment. The technologies chosen should be such that will not be obsolete in a short
while; although they must necessarily be appropriate.

Engineering economics deals with the concepts and techniques of analysis useful in evaluating
the worth of systems, products and services in relation to their cost. In engineering, problem
solving involves both physical and economic aspects. Engineers have concerned themselves too
long with resolving the physical problems forgetting that any useful idea must of necessity be
economically viable for it to be worthwhile.

Engineering economics involves formulating, estimating and evaluating economics outcomes

when choices and alternatives are available. This involves using specific mathematical
relationship to compare the cash flows of the different alternatives. Knowledge of engineering
economics will have a significant impact on you personally. It will help you make good
decisions in your professional life (regardless of whether you go into the private or public
sector) and in your personal life. In essence, in deciding to invest money at all, the objective
must necessary be to either maximise profit (benefits) or minimise costs depending on
whether the firm is a production or service type. Remember, tools don’t make decisions. People
make decision based on values. Engineering economics is just a set of tools which can help in
decision making but it won’t make the decision for you. Which alternative is “best” is up to you!

1.3 SOME FUNDAMENTAL CONCEPTS OF ECONOMICS

Concepts are characterised taught that have withstand the test of time. They are usually
qualitative in nature but not necessarily universal in application. When economic concepts are
carefully related to facts, they may be useful in suggesting approaches in problem solving in
engineering economics. Most often the ability to arrive at correct decision depends jointly
upon a sound conceptual understanding and the ability to handle the quantitative aspect of the
problem. The following are concept identified for the purpose of this text:

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a) Concept of Value and Utility
In economics, the term value has a variety of meanings. By definition; Value is a measure of
the worth that a person ascribes to a good or service. Thus the value of an object is
inherent not in the object but in the regard that the person has for it. Value should not be
confined with the cost or price of an object.

The Utility that an object has for an individual is determine by him and Utility by definition
is the measure of the power of the good and service to satisfy human want. Thus the utility
of an object like its value inheres not in the object itself but in the regard that the person
has for it. Finally, the purpose of most engineering effort is to determine how physical
factor may be altered to create the most utility for the least cost in terms of utility that
must be given off.

b) Concept of Consumer and Producer goods

Economics recognised two classes of goods namely consumer goods and producer goods.
While consumer goods are those goods and services that directly satisfy human want;
producer goods are those goods and services that satisfy human want indirectly as part of
the production or construction processes. Examples of consumer goods are TVs, shoes,
houses etc. while examples of producer goods are factory equipment, industrial chemicals
and materials etc.

c) Economic Aspects of Exchange

Economic of exchange occurs when utility are exchange by two or more people. Utility can,
in this connection mean anything a person may receive in an exchange no matter the value
attached to it. A very important concept here is mutual benefit in exchange. Mutual
Benefit in Exchange is a situation whereby a buyer will purchase an object when money is
available and when he/she believes that the good has equal or greater utility than the
amount required to purchase it. Also a seller will sell a product/service when he/she
believes that the amount of money to be received for the product/service has greater
utility for the object. Therefore an exchange will not occur unless at the time of exchange
both parties believe they will benefit i.e. exchanges are made when they are thought to
result in mutual benefit. This is possible because the objects of exchange are not value
equally by the parties in the exchange.

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 CHAPTER TWO

2. INTEREST FORMULAE AND THEIR APPLICATIONS

2.1 TIME VALUE OF MONEY
If someone elects to invest his money today (e.g. in a bank or savings and loan association), by
tomorrow he will have accumulated money than he had originally invested. This accumulation
of money is called time value of money. Another example is, if a person or company borrow
money today, by tomorrow more money than the original loan will be owed.

Time value of money is defined as the time-dependent value of money stemming both from
changes in the purchasing power of money and from the real earning potential of alternative
investments over time. The following are the reasons for the concept of time value of money:
a) Inflation or deflation
b) Risk
c) Cost of money represented by
i. Money paid for the use of borrowed money
ii. Return in investment, ROI

2.1.1 Interest, Interest Rate and Minimum Attractive Rate of Return

The manifestation of the time value of money is called interest. This is the measure of the
increase between the original sum borrowed or invested and the final money owed or accrued
i.e.
Interest = Total amount accumulated (or owed) – original investment (or loan)

The original investment (or loan) is called principal. When interest is expressed as a percentage
of the original amount per unit time; it is called interest rate i.e.

Interest rate =

The effective interest rate is the annual interest rate that yields the same annual return as the
return obtained from an interest rate specified for a compounding period shorter than a year.
The nominal interest rate is the interest rate that yields the same annual return as the return
obtained from compounding periods per year.

Minimum Attractive Rate of Return (MARR) is one of the most important parameters in
engineering economics. The MARR is an interest rate that specifies a rate of return on
investments that is just acceptable to the investor. Within a firm, there may be different MARR
e.g. 10% new equipment, 20% for expansion projects and new products. The following are
reasons why MARR vary from project to project:
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 a) Project risks:
 Where there is greater risk: set higher MARR refers to as Risk – adjusted MARR.
 Higher cost of debt for risky projects.
b) Investment opportunities:
 If management wants to expand: set lower MARR and encourage investment in
desired areas.
c) Limited capital:
 Demand for capital exceed supply
 As debt and equity capital becomes limited, MARR increases.
 Opportunity cost plays a role in setting the MARR.
d) Rate of return at other companies:
 If competitors increase their MARR, a company may choose to follow suit and
vice versa.
 These variations are often based on changes in interest rates for loans and
charged to the bank by Central Bank of Nigeria.
 Companies with the low MARR will tend to invest more in competitiveness.
e) Tax structure:
 Rising corporate taxes due to increased profits, capital gains, changes in local tax
rates, etc. create pressure to increase the MARR.

2.1.2 Simple Interest

Simple interest is one of the ways by which capital change in value over time. Total interest
earned or charged is directly proportional to the initial amount of deposit or loan (principal),
interest rate and number of time periods of commitment. Mathematically,
Simple interest,
Where P = principal amount deposited/lent
n = number of interest periods
i = interest rate per period.
Simple interest should not be used in engineering economics problems. This is because no
interest is computed on the accrued interest.

2.1.3 Compound Interest

Compound interest is also one of the ways by which capital change over time. The standard
assumption is that interest is computed on the current balance which includes the accrued
interest that has been paid plus the principal amount (deposit/loan). In computing compound
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interest, interest earned or charged for a period is based on remaining principal plus
accumulated interest [unpaid interest] at the beginning of period. Mathematically expressed as:
Compound interest,
Where P = present sum of money
i = interest rate
n = number of compounding periods

2.1.4 The Concept of Equivalence

This means that different sums of money at different times can be equal in economic value.
Equivalence is defined with respect to some given interest rate e.g. if interest rate is 6% per
year, ₦100 today will be ₦106 after one year i.e.
Amount accrued = 100 + 100(0.06)
= 100(1 + 0.06)
= 100(1.06)
= ₦106
Therefore, we could say that equivalence assumes money is compounded with a given interest
rate and compounding period.

2.1.5 Cash Flows

Cash flow is the stream of monetary [Naira] values – cost [inputs] and benefits [outputs] –
resulting from a project/investment. Engineering projects generally have economic
consequences that occur over an extended period of time. Each project is described as cash
receipts or disbursements [expenses] at different points in time. The expenses and receipts due
to engineering projects usually fall into one of the following categories:
a) First cost: expenses to build or to buy and install.
b) Operations and maintenance [O & M]: annual expense, such as electricity, labour,
and minor repairs.
c) Salvage value: receipt at project termination for sale or transfer of the equipment
[can be salvage costs]
d) Revenues: annual receipts due to sale of products or services.
e) Overhaul: major capital expenditure that occur during the assets life.

Cash Flow Diagrams [CFD] is the graphical representation of cash flows drawn on a time
scale. In a CFD, we have three timing of cash flows namely beginning of period, time 0 and end
of period cash flows. Beginnings of period cash flows are: rent, lease and insurance payment;

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end-of-period cash flows are O & M, salvages, revenues, overhauls while the designation of time
0 is arbitrary. When analysing a project, time 0 could be stated as follows:

a) At the beginning of analysis,

b) When the project is expected to be approved,
c) When design is started,
d) When materials are first ordered,
e) When construction begins, and
f) When use begins.

Most often, the project start time is assumed to be short, and the first costs are assumed to
occur at time 0. Then operation is often assumed to begin in the first period, with the
associated costs and revenues occurring at the first period’s end.

In this text, the following assumptions are made:

Beginning-of-period payments: Most disbursements [cash outflows] occur at the beginning of

the period e.g. prepaid expenses, landlords and lessors insist that rent and lease payments are
made in advance, Insurance companies insist that insurance be paid for in advance and
universities require tuition to be paid at the start of the school session. When dealing with
beginning-of-period payments, it is necessary to make adjustments. One method of adjustment
for beginning-of-period payments is to calculate the set of factors separately. Another way is to
logically interpret the effect of beginning-of-period payments for a particular problem e.g.
treating the first payment as a present value. The important thing is to recognise that such
variation can affect economic analysis.

Time 0: First cost.

End-of-period payments: Most returns on investment [cash inflows] occur at the end of the
period during which they acquired. For example, a bank computes and pays interest at the end
of the interest period. Accordingly, interest tables are computed for end-of-year payments. For
example, the values of the capital recovery factor [A|P, i%, n] assume that the regular
payments, A, occur at the end of each period e.g. annual receipts and expenses such as O & M
costs. Other examples are overhauls and salvage value.

Furthermore, one person’s cash flow outflow [represented as a negative value] is another
person’s inflow [represented as a positive value].

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 Year 1 Year 4

____________________________________________________________________ Time Scale

0 1 2 3 4
+

________________________________________________
1 2 3
_ Positive and Negative cash flow

Example 2.1: A man borrowed ₦1000 from a bank at 8% interest. Two end-of-year
payment: at the end of the first year, he will repay half of the principal plus the interest that is
due. At the end he second year, he will repay the remaining half plus the interest for the second
year. Represent this on a CFD.
Solution:
Cash flow for this problem is:

EOY Cash flow

0 + ₦1’000
1 - ₦ 580 (-₦ 500 – ₦ 80)
2 - ₦ 540 (-₦ 500 – ₦ 40)

₦ 1’000

1 2 ₦ 540
₦ 580
2.1.6 Comparison of Alternative Projects
An alternative is a stand-alone solution to a given situation. Various forms of alternatives
exist in virtually everything we do, namely:
a. Selection of method of transportation we use to get to work/school every day.
b. Buying a house or renting one.

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Comparison of alternatives deals with situation in which one has more than one choice and
using engineering economic principles to decide between the alternatives so as to go with the
most economically justified one.
Evaluation criterion is the basis for judging the alternatives of accomplishing a given objective.
In this text, currency designation; NAIRA and DOLLAR is used as the basis for comparison.
Typically evaluation criterion includes:
a. Lowest overall cost
b. Highest overall revenue, etc.

2.2 INTEREST FORMULAE FOR DISCRETE CASH FLOW AND DISCRETE COMP0UNDING
Find below the terminology and notation symbols used in this section.
i= effective interest rate per compounding period
n= number of compounding periods
P= present sum of money (present value) i.e. equivalent value of cash flows at a
reference point in time called the present
F= future sum of money (future value) i.e. equivalent value of cash flows at a
reference point in the time called the future
A= end-of-period cash flows i.e. in a uniform series of payments continuing for a
specified time, starting at the end of the first period and continuing to the end of
the last period. It is refers to as annuity.

2.2.1 Interest Formulae relating Present and Future worth of Single Cash Flows
This determines the amount of money accumulated (F) after n years from a single investment
(P) when interest is compounded one time per year .i.e.
F1 = P + Pί
= P (1 + ί)
@ the end of year 2;
F2 = F1 + F1ί
= P (1 + ί) + P (1 + ί) ί
= P (1 + ί) 2
@ the end of year 3;
F3 = P (1 + ί) 3

By mathematical Induction, after n years,

= P (1 + ί)n express as F = P (F|P, ί %, n)

The factor, (1 + ί)n is refers to as single payment compound amount factor.

Similarly,
P = F( express as P = F (P|F, 1%, n)

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Where the factor; is refers to as single – payment present worth factor.

P =?

____________________________________________ ____________n
0 1 2 3 4 5 6 7 n–1

F = given

2.2.2 Interest Formulae relating Uniform Series (Annuity) to its Present and Future
Worth
The figure below depicts the cash flow diagram relating Uniform series and Present worth.

P =?
0 1 2 3 n–1 n

A = given

A = uniform series (annuity, a constant series amount)

The present worth of the uniform or constant series amount is determined by considering each
A value as a future worth F in the case of single payment present worth factor and then
summing all present worth value i.e.

[ ] [ ] [ ] [ ]

= * +
Divide both sides by , we have:
[ ]
Subtract equation (1) from equation (2), we have:
[ ]

( ) [ ]

( ) ( )( )

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 ( ) ( )( )

( )

( )

By rearranging, we have
( )

Where the factor;

The figure below depicts the cash flow diagram relating Uniform series and Future worth.

F = given

0 1 2 3 n-1 n
A =?

From ⁄

( )

( )

( )

By re-arranging, we have:
( )

Where the factor;

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Example2.2: If a woman deposit 600 now, N 300 two years from now and N 400 five
years after, how much will she have in her account 10 years after, if the interest rate is 5%?
Solution:
F =?

0 1 3 4 5 6 9 10
N 300
N 600 N 400

F = 600(F1|P1, 5%, 10) + 300(F2|P2, 5%, 8) + 400(F3|P3, 5%, 5)

= 600(1.6289) + 300(1.4775) + 400(1.2763)
= N1, 931.11

Example 2.3: How much money would a man have in his account after 8years if he
deposited 1000 per year at 5%?
Solution: F =?

0 1 2 3 7 8
N1000
F = A (F|A, 5%, 8)
= 1000(9.5491)
= N 9,549.10

Example 2.4: How much money would you be willing to pay now for a note that will
yield N6000 per year for nine years at 20%?
Solution:

1 2 3 8 9

N6000
P = A (P|A, 20%, 9)
= 6000(4.0310)
≌ ₦ 24, 200

2.2.3 Arithmetic Gradient Factors (P/G and A/G)

An arithmetic gradient series is a cash flow series that either increases or decreases by a
constant amount each period. The amount of the change is called the gradient. Define the
symbols G for gradient and CFn for cash flow in year n as follows.

= base amount ± (n - 1) G

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G= constant arithmetic change in cash flows from one time period to the next; G may be positive
or negative.

Base amount

Figure: Conventional arithmetic gradient series with the base amount (Leland Blank and
Anthony Tarquin, 2012).

Example2.5: Olabisi Onabanjo University has initiated a logo-licensing program with

the clothier Yomakie Inc. Estimated fees (revenues) are $80,000 for the first year with uniform
increases to a total of $200,000 by the end of year 9. Determine the gradient and construct a
cash flow diagram that identifies the base amount and the gradient series (Leland Blank and
Anthony Tarquin, 2012).
Solution:
The year 1 base amount is = $80,000 and the total amount increase over 9 years is
- = 200,000 – 80,000 = $120,000
Equation for arithmetic gradient is given below:

G=

Figure: Cash flow showing the base amount and the gradient series (Leland Blank and
Anthony Tarquin, 2012)

The cash flow diagram shows the base amount of $80,000 in years 1 through 9 and the $15,000
gradient starting in year 2 and continuing through year 9.

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 The total present worth PT for a series that includes a base amount A and conventional
arithmetic gradient must determine the present worth of both the base amount defined by A
and the arithmetic gradient series defined by G. The addition of the two results in PT:

PT = P/A ±P/G

The corresponding equivalent annual worth AT is the sum of the base amount series defined by
A and the annual worth of the arithmetic gradient series defined by G, that is:

AT = A ± A/G

The P/G and A/G factors determine the present worth and annual series of the gradient
amount.

Example 2.6: Neighbouring parishes of Anglican Churches in Ago-Iwoye have agreed to

pool road tax resources already designated for bridge refurbishment. At a recent meeting, the
engineers estimated that a total of $500,000 will be deposited at the end of next year into an
account for the repair of old and safety-questionable bridges throughout the area. Further, they
estimate that the deposits will increase by $100,000 per year for only 9 years thereafter, and
then cease. Determine the equivalent (a) present worth and (b) annual series amounts, if public
funds are earned at a rate of 5% per year (Leland Blank and Anthony Tarquin, 2012).
Solution:
a. From the cash flow diagrams shown below; we have a base amount of $500,000 and a
gradient amount of $100,000. So the Present worth amount is given below:
PT = -500000(P/A,5%,10) - 100000(P/G,5%,10)
= -500000(7.7217) - 100000(31.6520)
= -$7,026,050

Figure: Cash flow series with a conventional arithmetic gradient $100 in $1000 units (Leland
Blank and Anthony Tarquin, 2012)

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Figure: Partitioned cash flow diagram of base amount of $500 and gradient $100 in $1000 units
(Leland Blank and Anthony Tarquin, 2012).
b. The base amount is the annuity of $500,000 while the gradient amount remains $100,000.
So, the annual worth of the above cash flow diagram is given below:
AT = -500000 -100000(A/G,5%,10)
= -500000 - 100000(4.0991)
= -$909,910 per year

2.2.4 Geometric Gradient Series Factors

It is common for annual revenues and annual costs such as maintenance, operations, and
labour to go up or down by a constant percentage say for example, +5% or -3% per year. This
change occurs every year on top of a starting amount in the first year of the project. A definition
and description of new terms follow (Leland Blank and Anthony Tarquin, 2012):
A geometric gradient series is a cash flow series that either increases or decreases by a
constant percentage each period. The uniform change is called the rate of change.

g = constant rate of change, in decimal form, by which cash flow values increase or decrease
from one period to the next. The gradient g can be +ve or -ve.

A1 = initial cash flow in year 1 of the geometric series

Pg = present worth of the entire geometric gradient series, including the initial amount A1

The figure below depicts the cash flow diagram relating Present worth with geometric gradient
series (Leland Blank and Anthony Tarquin, 2012).

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 ( )

Multiply both sides by , we have:

( ) ( )

Subtract equation 1 from equation 2, we have:

( ) ( )

( ) ( )

Simplifying, we have:

If i.e. when substitute i for g in Pg equation above; observe that

the term 1/(1 + i) appears n times:
( )

The (P/A,g,i,n) factor determines the Pg value in period t = 0 for a geometric gradient series
starting in period 1 in the amount A1 and increasing by a constant rate of g each period. Once
Pg has been determined, the A and F values can be obtained by multiplying Pg with A/P and F/P
factors (Leland Blank and Anthony Tarquin, 2012).

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Note that the present worth of the geometric gradient series is not calculated separately in this
case but calculated with the base amount as will be shown in the foregoing example.

Example 2.7: A coal-fired power plant has upgraded an emission control valve. The
modification costs only $8000 and is expected to last 6 years with a $200 salvage value. The
maintenance cost is expected to be high at $1700 the first year, increasing by 11% per year
thereafter. Determine the equivalent present worth of the modification and maintenance cost
at 8% per year (Leland Blank and Anthony Tarquin, 2012).

Solution:
The cash flow diagram is shown below:

( )

2.3 INTEREST PROBLEMS WITH COMPOUNDING MORE-OFTEN-THAN-ONCE PER YEAR

This is a situation whereby nominal interest rate is compounded non – annually i.e. quarterly,
monthly, weekly etc. The amount of interest earned if it is compounded more frequently is
given as:
⁄

where i = effective rate for specified time period (say, semi-annual or annual)

r = nominal interest rate for same time period (semi-annual or annual)

m = number of times interest is compounded per stated time period (times per
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 6 months or annual)

Note that if the effective interest rate is charged on a semi-annual basis, the m value in the
expression is not the same as the m value when effective interest rate is charged on an annual
basis.

If the interest rate is 20% compounded quarterly, the effective annual interest rate is:
ί effective = (1 + 0.20/4)4 – 1
= (1 + 0.05)4 – 1
= (1.05)4 – 1 = 0.2155
And the effective semi-annual interest rate is:
ί effective = (1 + 0.10/2)2 – 1
= (1 + 0.05)2 – 1
= (1.05)2 – 1 = 0.1025
That is r = 20% per year = 10% per 6 months and m = 2 quarters per 6 months.

Exercises
1. Look up the numerical value for the following factors from the interest tables.
a. (P/F,6%,8)
b. (A/P,10%,10)
c. (A/G,15%,20)
d. (A/F,2%,30)
e. (P/G,35%,15)
2. Find the numerical value of the following factors using (a) interpolation and (b) the formula.
i. (A/P,13%,15)
ii. (P/G,27%,10)
3. How much can College of Engineering and Environmental Studies, OOU, Ibogun Campus
afford to spend now on an energy management system if the software will save the College
$21,300 per year for the next 5 years? Use an interest rate of 10% per year.
4. Yomakie Systems makes a panel milling machine with a 2.7-m-diameter milling head that
emits low vibration and processes stress-relieved aluminum panels measuring up to 6000 mm
long. The company wants to borrow money for a new production/warehouse facility. If the
company offers to repay the loan with $60,000 in year 1 and amounts increasing by $10,000
each year through year 5, how much can the company borrow at an interest rate of 10% per
year?
5. Determine the difference in the present worth values of the following two commodity
contracts at an interest rate of 8% per year. Contract 1 has a cost of $10,000 in year 1; costs
will escalate at a rate of 4% per year for 10 years. Contract 2 has the same cost in year 1, but
costs will escalate at 6% per year for 11 years.
6. Tesla Motors manufactures high-performance battery for electric vehicles. An engineer is on a
Tesla committee to evaluate bids for new-generation coordinate-measuring machinery to be
directly linked to the automated manufacturing of high-precision vehicle components. Three
bids include the interest rates that vendors will charge on unpaid balances. To get a clear
understanding of finance costs, Tesla management asked the engineer to determine the
effective semi-annual and annual interest rates for each bid. The bids are as follows:
Bid 1: 9% per year, compounded quarterly
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 Bid 2: 3% per quarter, compounded quarterly
Bid 3: 8.8% per year, compounded monthly
Which bid has the lowest effective semi-annual interest rate and effective annual interest
rate?

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 CHAPTER THREE

3. METHODS OF MAKING ENGINEERING ECONOMICS STUDY

3.1 COMPARING ALTERNATIVES: Relationship among Alternative projects
In Engineering Economics study, it is helpful to categorize investment opportunities (projects)
into major groups as follows:

a) Single project: It is also called the unconstrained project selection problem. There is no
comparison to competing or alternative projects. The acceptance or rejection of
alternative project is based upon comparison with the firm’s opportunity cost. A firm can
compare the single project to two alternatives namely

i. Do Nothing (reject the project) or,

ii. Accept the project

Do nothing involve the alternative use of the firm’s funds that could be invested in the
project. There is an implicit comparison with the firm’s MARR and investing outside of the
firm. The task involved here is to evaluate the single project’s worth at the firm’s MARR;
and if the worth > 0, the project is accepted; else, reject the project.

b) Mutually exclusive projects: Only one of the alternative projects can be selected from
the set. Once selected, the others in the set are excluded. Mutually exclusive alternative
projects compete with each other.

c) Independent projects: In this category; more than one alternative project can be
selected. Independent project deals with budget capacity; project dependencies and
relationships. Alternative project may or may not compete with each other and this
depends upon the conditions and constraints that define the set.

The following are common methods of making engineering economics study:

a) Present worth method,
b) Annual worth method,
c) Internal rate of return,
d) Benefit cost analysis (BCA) and
e) Capitalised cost evaluation.

22
3.2 PRESENT WORTH METHOD
Present worth analysis is a process of obtaining the equivalent worth of future, annual and
gradient cash flows back to time zero at an interest rate usually equal to or greater than the
organization’s established MARR. Converting all cash flows to present worth is often referred
to as discounting. If PW (i %) > 0; the project is accepted. If PW (i %) < 0 then the project is
rejected. If the net present worth = 0 then, the project earns exactly i% return.

3.2.1 Present worth analysis of alternative projects with equal-life

If alternative projects have the same capacities for the same life span, the equal-service life
requirement is met. Then we calculate the PW value at the stated MARR for each alternative
project. For mutually exclusive (ME) alternative projects; the economic criterion is stated
below (Leland Blank and Anthony Tarquin, 2012):

Single project (one alternative project): If PW˃0, the requested MARR is met or exceeded
and the alternative is economically justified. Otherwise it is rejected.

Two or more alternatives: Select the alternative project with the highest PW value, i.e. less
negative or more positive. This shows a lower PW for cost alternatives or a larger PW of net
cash flows for revenue alternatives.

For independent projects, each PW value is considered separately, that is, compared with the
do nothing (DN) alternative project, which always has PW = 0. The economic criterion is sated
below:

One or more independent projects: Select all projects with PW = 0 at the MARR. Then, a
budget constraint is applied

Example 3.1: Consider a case of 3 mutually exclusive alternatives with cash flow as
below if the interest rate is 20%, it is intended that the best alternative be found.

ALTERNATIVES
EOY A1 A2 A3
0 - ₦ 5’000 - ₦ 8’000 - ₦ 10’000
0 – 10 1’400 1’900 2’500
Solution:
Present worth of A1 {PW (A1)}
= -5000 + 1400 [P/A, 20%, 10]
= -5000 + 1400 [4.1925]
= ₦869.50

PW [A2] = -8000 + 1900 [P/A, 20%, 10]

= -8000 + 1900 [4.1925]

23
 = - ₦34.25

PW [A3] = -10000 + 2500 [P/A, 20%, 10]

= -10000 + 2500 [4.1925]
= ₦481.25

It can be seen that alternative A1 gives the best returns, so it is preferred. A significant
limitation of present worth analysis is that it cannot be used to compare alternatives with
unequal economic lives.

3.2.2 Present worth analysis of alternative projects with different-life

When the present worth method is to be used to compare mutually exclusive alternative
projects that have different service lives, the equal-service life requirement must be met. There
are two approaches whenever we have the unequal life situation (Leland Blank and Anthony
Tarquin, 2012):
a) Least common multiple (LCM) of service lives: Compare the alternative projects over
a period of time equal to the least common multiple (LCM) of their lives. The following
assumptions are taken when using the LCM approach:
i. The service provided will be needed over the entire LCM years or more.
ii. The selected alternative can be repeated over each life cycle of the LCM in exactly
the same manner.
iii. Cash flow estimates are the same for each life cycle (except when inflation or
deflation is given consideration).
b) The planning horizon approach: Compare the alternative projects using a study period
of length n years, which does not necessarily take into consideration the service lives of
the alternative projects. Only the cash flows occurring within that study period are
considered relevant

Note that you should not expect the same result with the LCM approach and the study period
approach.

Example 3.2: Haastrup Investment Company intends to invest in a press machine

required for a project. It has identified two models which are suitable for the work load
projected for the next few years. Given the expected economic data of the two options below:

a) Determine which press should be selected on the basis of a present worth comparison, if
the MARR is 20% per year.

24
b) The company management has a standard practice of evaluating all options over a 4-year
period. If a study period of 4 years is used and the salvage values are not expected to
change, which press should be selected?

Press A Press B
First Cost 25’000 40’000
Salvage Value [end of life] 5’000 7’000
Annual OαM 3’600 2’800
Life 4years 6years
Solution:

a) The LCM for economic life of the two presses = 12years (see the cash flow diagrams
below).
Press A

Press B

25
Select Press A
b) For a 4-year study period, no cycle repeats are necessary. So the PW analysis is:

We will still select Press A

3.3 ANNUAL WORTH METHOD

To compare alternatives by annual worth method, all cash flows are changed to a series of
uniform payments. Current expenditures, future costs or receipts and gradients must be
converted to annual costs. If a lump-sum cash flow occurs at some time other than the
beginning or end of the economic life, it must be converted in a two-step process: first moving
it to the present and spreading it uniformly over the life of the project.

Annual worth is also known by other nomenclatures namely equivalent annual worth
(EAW), annual equivalent cost (AEC), annual equivalent (AE), and equivalent uniform annual
cost (EUAC). The alternative selected by the AW method will always be the same as that
selected by the PW method, and all other alternative project evaluation methods, provided they
are performed correctly. An additional application of AW analysis is life-cycle cost (LCC)
analysis. This method considers all costs of a product, process, or system from concept to
disposal (Leland Blank and Anthony Tarquin, 2012).

There are two case scenarios of AW analysis, namely:

a) Alternative projects have equal economic life: Compute the AW for all alternative
projects and select the alternative project with the highest AW or lowest annual cost
(AC).
b) Alternative projects have different economic life: Compute the AW or AC for only
one life cycle and select the highest and lowest as the case may be.

Similarly, the economic criterion for AW analysis is stated below:

26
Single project (one alternative project): If AW˃0, the requested MARR is met or exceeded
and the alternative is economically justified. Otherwise it is rejected.

Two or more alternatives: Select the alternative project with the highest AW value, i.e. less
negative or more positive. This shows a lower AW for cost alternatives or a larger AW of net
cash flows for revenue alternatives.

3.3.1 Capital recovery (CR)

A project should have the following cash flow estimates:

a) Initial investment P: This is the total first cost of all assets and services required to
initiate the alternative. When portions of these investments take place over several years,
their present worth is an equivalent initial investment. Use this amount as P.
b) Salvage value S: This is the terminal estimated value of assets at the end of their useful life.
The S is zero if no salvage is anticipated; S is negative when it will cost money to dispose of
the assets. For study periods shorter than the useful life, S is the estimated market value or
trade-in value at the end of the study period.
c) Annual amount A: This is the equivalent annual amount (costs only for cost alternatives;
costs and receipts for revenue alternatives). Often this is the annual operating cost (AOC)
or M&O cost, so the estimate is already an equivalent A value.

Capital recovery (CR) is the equivalent annual amount that an asset, process, or system must
earn each year to just recover the first cost at a stated rate of return over its expected life.
Salvage value is considered when calculating CR.

CR = -P(A/P,i%,n) + S(A/F,i%,n)

Example 3.3: Haastrup Pizza, which is located in Ibogun Fasina, fares very well with its
competition in offering fast delivery. Many students at the area universities and community
colleges work part- time delivering orders made via the web. The owner, Femi, a mechanical
engineering graduate, plans to purchase and install five portable, in-car systems to increase
delivery speed and accuracy. The systems provide a link between the web order-placement
software and the On-Star system for satellite-generated directions to any address in the area.
The expected result is faster, friendlier service to customers and larger income.

Each system costs $4600, has a 5-year useful life, and may be salvaged for an estimated $300.
Total operating cost for all systems is $1000 for the first year, increasing by $100 per year

27
thereafter. The MARR is 10%. Perform an annual worth evaluation for the owner that answers
the following questions: (Leland Blank and Anthony Tarquin, 2012)
a) How much new annual net income is necessary to recover the investment at the MARR of
10% per year?
b) Femi estimates increased net income of $6000 per year for all five years. Is this project
financially viable at the MARR?
c) Based on the answer in part (b), determine how much new net income Haastrup Pizza
must have to economically justify the project. Operating costs remain as estimated.
Solution:

a) The annual net income necessary to recover the investment is the capital recovery amount
calculated below:
CR = -P(A/P,i%,n) + S(A/F,i%,n)
= -5(4600(A/P,10%,5)) + 5(300(A/F ,10%,5))
= - 5(4600(0.26380)) + 5(300(0.16380))
= $-5822
The five systems must generate equivalent annual new revenue of $5822 to recover the
initial investment plus a 10% per year return.
b) The cash flows over 5 years is shown below. The annual operating cost series, combined
with the estimated $6000 annual income, forms an arithmetic gradient series with a base
amount of $5000 (6000-1000) and G = $-100. The project is financially viable if AW ≥ 0 at i
= 10% per year.

AW = CR – A + R - G(A/G ,10%,5)(R is the annual income and G is the gradient amount)

= -5822 + 5000 - 100(A/G,10%,5)
= $-1003
The system is not financially justified at the net income level of $6000 per year.

28
c) Let the required income equal R, and set the AW relation equal to zero to find the minimum
income to justify the system.
0 = -5822 + (R - 1000) - 100(A/G, 10%, 5)
R = 5822 + 1000 + 100(1.8101)
= $7003 per year
Example 3.4: Haastrup Investment Company intends to invest in a press machine
required for a project. It has identified two models which are suitable for the work load
projected for the next few years. Given the expected economic data of the two options below,
identify the more economic press using AW method. [Assume capital costs 20%]
Press A Press B
First Cost ₦25’000 ₦40’000
Salvage Value [end of life] 5’000 7’000
Annual OαM 3’600 2’800
Life 4yrs 5yrs
Solution: Note that AW for one life cycle is the same for all life cycles. Therefore, the AW for
one life cycle for Press A and B are calculated below:
Annual worth [Press A]
= 25’000 [A/P, 20%, 4] – 5000 [A/F, 20%, 4] + 3600
= 25’000 [0.3863] – 5000 [0, 1863] + 3600
= 9657.5 – 931.5 + 3600
= ₦12’326.00

Press A 5’000

0 1 2 3 4
3600
25000

Annual worth [Press B]

7000

0 1 2 3 4 5
2800
25000

= 40’000 [A/P, 20%, 5] – 7000 [A/F, 20%, 5] + 2800

= 40’000 [0.3344] – 7000 [0.1344] + 2800
= 13376 – 940.8 + 2800
= ₦15,235.20
Press A is preferred.
29
Example 3.5: An asset has a first cost of ₦200,000, an annual operating cost of ₦80,000
and a salvage value of ₦50,000 after 3 years. Calculate the AW for one and two life cycles at i =
10%.

Solution:

AW (one life cycle) = -200,000(A/P, 10%, 3)–80,000+50,000(A/F, 10%, 3)

= ₦-145,320

AW (two life cycles) = -200,000(A/P, 10%, 6)–80,000 -150,000(P/F, 10%, 3) (A/P, 10%, 6)

+50, 000(A/F, 10%, 6)

= ₦-145,320

3.3.2 Life-Cycle Cost Analysis

Life-cycle cost (LCC) analysis utilizes AW or PW methods to evaluate cost estimates for the
entire life cycle of one or more projects. Estimates will cover the entire life span from the early
conceptual stage, through the design and development stages, throughout the operating stage,
and even the disposal stages. Both direct and indirect costs are included to the extent
possible, and differences in revenue and savings projections between alternatives are included.
To understand how a LCC analysis works, first we must understand the phases and stages of
systems engineering or systems development. Many books and manuals are available on
systems development and analysis. Generally, the LCC estimates may be categorized into a
simplified format for the major phases; namely acquisition, operation, and disposal, and their
respective stages are stated as follows (Leland Blank and Anthony Tarquin, 2012):

a) Acquisition phase: all activities prior to the delivery of products and services. This
include the following:
i. Requirements definition stage: Includes determination of user/customer needs,
assessing them relative to the anticipated system, and preparation of the system
requirements documentation.
ii. Preliminary design stage: Includes feasibility study, conceptual, and early-stage
plans; final go–no go decision is probably made here.
iii. Detailed design stage: Includes detailed plans for resources—capital, human,
facilities, information systems, marketing, etc.; there is some acquisition of assets, if
economically justifiable.
b) Operation phase: all activities are functioning, products and services are available.

30
 i. Construction and implementation stage: Includes purchases, construction, and
implementation of system components; testing; preparation, etc.
ii. Usage stage: Uses the system to generate products and services; the largest portion
of the life cycle.
c) Disposal phase: This covers all the activities from transition to a new system; that is,
removal/recycling/disposal of old system.

Disposal

Figure: Typical life-cycle cost distribution by phase (Leland Blank and Anthony Tarquin,
2012).
Example 3.6: In the 1860s, General Mills Inc. and Pillsbury Inc. both started in the flour
business in the Twin Cities of Minneapolis–St. Paul, Minnesota. In the decade of 2000 to 2010,
General Mills purchased Pillsbury for a combination cash and stock deal worth more than $10
billion and integrated the product lines. Food engineers, food designers, and food safety experts
made many cost estimates as they determined the needs of consumers and the combined
company’s ability to technologically and safely produce and market new food products. At this
point only cost estimates have been addressed; no revenues or profits. Assume that the major
cost estimates below have been made based on a 6-month study about two new products that
could have a 10-year life span for the company. Use LCC analysis at the industry MARR of 18%
to determine the size of the commitment in AW terms. (Time is indicated in product-years.
Since all estimates are for costs, they are not preceded by a minus sign) (Leland Blank and
Anthony Tarquin, 2012).

Consumer habits study (year 0) $0.5 million

Preliminary food product design (year 1) 0.9 million

31
Preliminary equipment/plant design (year 1) 0.5 million

Detail product designs and test marketing (years 1, 2) 1.5 million each year

Detail equipment/plant design (year 2) 1.0 million

Equipment acquisition (years 1 and 2) $2.0 million each year

Current equipment upgrades (year 2) 1.75 million

New equipment purchases (years 4 and 8) 2.0 million (year 4)

+10% per purchase
thereafter

Annual equipment operating cost (AOC) (years 3–10) 200,000 (year 3)

+4% per year thereafter

Marketing, year 2 $8.0 million

years 3–10 5.0 million (year 3) and
-0.2 million per year
thereafter
year 5 only 3.0 million extra

Human resources, 100 new employees for 2000 hours $20 per hour (year 3) + 5% per
year (years 3–10) year

Phaseout and disposal (years 9 and 10) $1.0 million each year

Solution:
LCC analysis can get complicated due to the number of elements involved. We calculate the PW
by phase and stage and add all PW values, and then we find the AW over 10 years. (Values are
in $1 million units).
Acquisition phase:
Requirements definition: Consumer study
PW = $0.5
Preliminary design: Product and equipment
PW = 1.4(P/F,18%,1) = $1.187
Detailed design: Product and test marketing, and equipment
PW = 1.5(P/A,18%,2) + 1.0( P/F ,18%,2) = $3.067

Operation phase:
Construction and implementation: Equipment and AOC

( )

Use: Marketing
PW = 8.0(P/F,18%,2) + [5.0(P/A ,18%,8) - 0.2( P/G,18%,8)](P/F ,18%,2)
+ 3.0(P/F,18%,5)
= $20.144
Use: Human resources: (100 employees) (2000 h/yr) ($20/h) = $4.0 million in year 3

32
 ( )

Phaseout phase:
PW = 1.0(P/A,18%,2)( P/F ,18%,8) = $0.416
The sum of all PW of costs is PW = $45.238 million. Finally, we determine the AW over the
expected 10-year life span.

AW = $45.238 million (A/P, 18%, 10) = $10.066 million per year

This is the LCC estimate of the equivalent annual commitment to the two proposed products.

3.4 RATE OF RETURN

ί = unknown

Two methods are available, these are:

a) Internal rate of return, IRR
b) External rate of return, ERR.
Rate of return is by definition, the interest rate at which the present worth of the net cash flow
is zero. Computationally, the method is the most complex method of comparison. It gets more
complicated when comparing multiple alternatives.

The calculated interest rate is compared with MARR to assess whether the alternative in
question is acceptable. If you are going to pick only one alternative from several alternatives,
we need to compare them against each other based on differences in cost – refers to as
incremental analysis.

Example 3.7: Find the internal rate of return for the following cash flow:

EOY Receipt/Disbursement
0 - ₦ 1000.00
1 250.50
2 250.50
3 250.50
4 250.50
5 250.50
Solution:
Present worth (Benefit) = Present worth (cost)
250.50 (P/A, IRR%, 5) = 1000
(P/A, IRR%, 5) =
(Look in P/A column, IRR%, look in year 5 row) = 3.9920
IRR = 8%

33
3.4.1 IRR incremental analysis for multiple alternative projects
When comparing alternative projects by analysing their IRR, it is possible to draw the
wrong conclusions. If we select the alternative with the highest IRR, we might miss a greater
investment that could give us a higher present worth. Also if we select the largest investment
that meets the MARR, we might miss a higher IRR.

We can avoid these mistakes by using IRR incremental analysis. Below are the steps
involved in IRR incremental analysis:
a) Identify all alternatives including ‘’Do Nothing‘’.
b) Rank alternatives in ascending order of initial investment [first cost].
c) Compare adjacent alternatives two-at-a-time with lower initial cost project
subtracted from the higher cost project.
d) Compute the IRR of the increment. If ∆IRR≥MARR, keep higher cost project and
reject the lower cost item. If ∆ IRR≤MARR, keep the lower cost project and refer the
other.
e) Make all comparisons until only the last one remains.
Example 3.8: A tool and die company is considering the purchase of an additional drill
press. The coy has the opportunity to buy a slightly used m/c for 150’000naira or a new one for
210’000. Because the new machine is a more sophisticated model with automatic features, its
operating cost is 70’000naira/per year, while the used m/c is expected to cost 82’000/yr. each
m/c is expected to have a 25yr life with a 5% salvage value. Tabulate the incremental cash flow
for the two alternatives.
Solution:
Cash flow Incremental Cash
Year Used Press New Press Flow
(New - Used)
0 ₦ - 150’000 ₦ - 150’000 ₦ - 60’000
1 - 25 - 82’000 - 70’000 + 12’000
25 + 7500 + 10500 + 3000
₦ - 2’192’500 ₦ - 1’949’500 ₦ + 243’000

Example 3.9: Four different shopping mall building locations have been suggested, of
which only one will be selected. Cost and annual net cash-flow information are shown below. If
MARR is 10%, use IRR analysis to select the one economically-best location.
Location A B C D
Building Costs, ₦ - 200’ - 275’ - 190’ - 350’
Annual Cash Flow, ₦ + 22’ +35’ + 19.5’ + 42’
Life, Years 30 30 30 30

34
Solution:
The alternatives are ordered by increasing Building cost as shown below:
Location 1 2 3 4
C A B D
Building costs, ₦ - 190’ - 200’ - 275’ - 350’
Cash Flow, ₦ + 19.5’ + 22’ +35’ + 42’
Project Compared C to D.N. A to D.N. B to A D to B
Increment Cost ₦ - 190’ - 200’ - 75’ - 75’
Increment CF, ₦ + 19.5’ + 22’ + 13’ + 7’000
(P/A, IRR%, 30) 9.7436 9.0909 5.7692 10.7143
IRR % 9.63* 10.49+ 17.28 8.55
Increment Justified No Yes Yes No
Project Selected Do Nothing A B B
*Comparing C to Do Nothing (DN)
PW (benefit) = PW (Cost)
19.5’ (P/A, IRR%, 30) = 190’000
Solving for IRR% gives 9.63% < MARR. So Location C is rejected while alternative DN is
accepted.
+Next we compare A to DN
0 = -75’000 + 13’000 (P/A, IRR%, 30)
By trial and error, IRR% = 10.49% > MARR. Therefore, alternative A is justified thereby
rejecting DN.
We now compare Location B to Location and this gives an IRR% of 17.28% and ˃ MARR;
therefore Location B is accepted while Location B is rejected. Finally, Location D is compared
with Location B and the IRR% is 8.55% and < MARR. So Location D is rejected while the
accepted and selected location is Location B. It should be note that the rejection means that the
increase in investment is not justified while acceptance shows that the increase in investment
is justified.
Alternative B remains and is selected.

3.5 Comparison of Alternatives by Benefit Cost Analysis (BCA)

The motive behind pubic project is benefits.

Corporate profit
Benefits
Societal benefit – evaluate.

Public project is the project executed by government e.g.

a) Construction of highways, primary health centres.
b) Building of dams.
c) Stadia.
35
In analysis public project, we evaluate the following.

i. Cost (i.e. initial investment + annual OXM cost)

ii. Corporate profit
iii. Societal benefit

Disbenefits – consequences to the public resulting from the implementation of a public project.

You can also use any of the discounting methods as the case may be i.e. AW, FW etc.
How to take care of disbenefits? Net benefit

It could be accounted for as cost i.e.

The following are the procedures involved in a benefit – cost incremental analysis:

a) Calculate the total cost and total benefit of each alternative. Calculate the individual
B/C<1.0. Select alternatives with B/C<1.0.
b) Rank all selected alternatives in ascending order of initial investment (first cost).
c) Subtract the cost of the lower- investment alternative from those of the larger-cost
alternative.
d) Subtract the benefits of the lower – cost alternative from the benefit of the larger-cost
alternative, paying attention to algebraic signs.
e) Carry out incremental analysis. If ∆B/∆C>1, select the larger- investment alternative.
f) Otherwise select the lower-cost alternative.
Example 3.10: Two mutually exclusive alternative public works are under consideration.
Their respective costs and benefits are included below. If the interest rate is 5% which of these
project should be selected?
Project I Project II
Capital Investment 750’000 625’000
Annual o α m cost 120’000 110’000
Annual benefit 245’000 230’000
Project Life (years) 15 10

36
Solution:
AW (cost I) = 750000 (A/P, 5%, 15) + 120000
= 750000 (0.09634) + 120000
= ₦ 192’262.50
AW (II) = 625000 (A/P, 5%, 10) + 110000
= 625000 (0.1295) + 110000 = ₦190’937.50
- Arrange in order of increasing investment
- Carry out incremental analysis
First, compare project II with do nothing,

Decision: project I is selected.

Note that when two or more independent projects are evaluated using B/C analysis and there
is no budget limitation, no incremental comparison is necessary. The only comparison is
between each project separately with the do-nothing alternative. The project B/C values are
calculated and those with B/C ≥ 1.0 are accepted.

3.5 CAPITALIZED COST EVALUATION

Sometimes there are considerations, such as some public works projects, which are considered
to last indefinitely and thereby providing perpetual service. Permanent endowments for
charitable organizations and universities also have perpetual lives. The economic worth of
these types of projects or endowments is evaluated using the present worth of the cash flows.
Capitalized Cost (CC) is the present worth of a project that has a long life say more than 50
years and/or when the planning horizon is indefinite. From uniform series present worth
amount given below

( )

As n approaches infinity; the uniform series present worth factor becomes ⁄ . Therefore the
present worth value which is the capitalized cost (CC) becomes

37
The cash flows for a capitalized cost evaluation are usually of two types: periodic, and non-
periodic. The procedure for carrying out the capitalized costs evaluation for a perpetual cash
flow is given below:
a) Draw a cash flow diagram showing all non-periodic cash flows and about two cycles of all
periodic cash flows.
b) Find the present worth of all non-periodic amounts. This is their CC value.
c) Find the A value through one life cycle of all periodic amounts. (This is the same value in
all succeeding life cycles). Add this to all other annuities (A) occurring in years 1 through
infinity. The result is the total equivalent annuities (AW).
d) Divide the AW obtained in step 3 by the interest rate i to obtain a CC value.
e) Add the CC values obtained in steps 2 and 4.

Example 3.11: How much money should we ask the taxpayers to give us if we need to
repair a dam for the next million years, and the yearly repair cost will be #120’000 a year and
assuming that the money gleaned from the taxpayers will be invested at 10% per year?
Solution:

= ₦ 1’200’000.00
Example 3.12: If we need #10’000 for repairs each month? At 6% nominal interest rate
compounded monthly, how much do we need to extract from the taxpayers?
Solution:

Example 3.13: Two sites are currently under consideration for a bridge to cross a river in
Ibogun Akinsinde:
a) The north site, which connects a major state highway with an interstate loop around the
city, would alleviate much of the local through traffic. The disadvantages of this site are
that the bridge would do little to ease local traffic congestion during rush hours, and the
bridge would have to stretch from one hill to another to span the widest part of the river,
railroad tracks, and local highways below. This bridge would therefore be a suspension
bridge.

38
b) The south site would require a much shorter span, allowing for construction of a truss
bridge, but it would require new road construction.
The suspension bridge will cost $50 million with annual inspection and maintenance - costs of
$35,000. In addition, the concrete deck would have to be resurfaced every 10 years at a cost of
$100,000.
The truss bridge and, ‘approach roads' are expected to cost $25 million and have annual
maintenance costs of $20,000. The bridge would have to be painted every 3 years at a cost of
$40,000. In addition, the bridge would have to be sandblasted every 10 years at a cost of
$190,000. The cost of purchasing right-of-way is expected to be $2 million for the suspension
bridge and $15 million for the truss bridge.
Compare the alternatives on the basis of their capitalized cost if the interest rate is 6% per year.
Solution:
Suspension Bridge

@ Time, t = 0
CC1 = -50,000,000 – 2,000,000
= -$52million
A1 = -$35,000
A2 = -100000(A/F,6%,10)
= -$7,587
CC2 =
= -$709,783
Total CC for the Suspension bridge = -52million – 709,783 = -$52,709,783.00

39
Truss Bridge

@ Time, t = 0
CC1 = -25million – 15million
= -$40,000,000
A1 = -$20,000
A2 = annual cost of painting (every 3 years)
= -40000(A/F,6%,3)
= -$12,564
A3 = annual cost of sandblasting (every 10 years)
= -190000(A/F,6%,10)
= -$14,421
CC2 = =
= -$783,083
Total CC for the Truss bridge = -40million – 783,083
= -$40,783,083
Decision: Select the Truss bridge.

Exercises
1. Nissan’s all-electric car, the Leaf, has a base price of $32,780 in the United States, but it is
eligible for a $7500 federal tax credit. A consulting engineering company wants to evaluate
the purchase or lease of one of the vehicles for use by its employees traveling to job sites in the
local area. The cost for leasing the vehicle will be $4200 per year (payable at the end of each
year) after an initialization charge of $2500 paid now. If the company purchases the vehicle,
it will also purchase a home charging station for $2200 that will be partially offset by a 50%
tax credit. If the company expects to be able to sell the car and charging station for 40% of the
base price of the car alone at the end of 3 years, should the company purchase or lease the
car? Use an interest rate of 10% per year and annual worth analysis.
2. The Nigerian Army received two proposals for a turnkey design-build project for barracks for
infantry unit soldiers in training. Proposal A involves an off-the-shelf “bare-bones” design and
standard grade construction of walls, windows, doors, and other features. With this option,
heating and cooling costs will be greater, maintenance costs will be higher, and replacement
will be sooner than for proposal B. The initial cost for A will be $750,000. Heating and cooling
costs will average $72,000 per year, with maintenance costs averaging $24,000 per year.
Minor remodelling will be required in years 5, 10, and 15 at a cost of $150,000 each time in
order to render the units usable for 20 years. They will have no salvage value. Proposal B will
include tailored design and construction costs of $1.1 million initially, with estimated heating
40
 and cooling costs of $36,000 per year and maintenance costs of $12,000 per year. There will
be no salvage value at the end of the 20-year life. Which proposal should be accepted on the
basis of an annual life-cycle cost analysis, if the interest rate is 6% per year?
3. Yomakie investment has been told that they may win their bid to house the Haastrup Library
if they can guarantee that they can fund the upkeep and repairs in perpetuity. The library is
expected to cost ₦20000 every year for light bulbs, plus ₦100,000 every two years for minor
repairs plus an additional ₦5,000,000 every 5years for a complete refurnishing of the facility.
How much must be deposited today to guarantee the funding of these expenses? Assume a
nominal interest rate of 6% compounded monthly.
4. Michelle Foods, Inc. has determined that any one of five machines can be used in one phase of
its chilli canning operation. The costs of the machines are estimated below, and all machines
are estimated to have a 4-year useful life. If the minimum attractive rate of return is 20% per
year, determine which machine should be selected on the basis of a rate of return analysis.

Machine First Cost, $ Annual Operating Cost, $ per Year

1 31000 16000
2 29000 19300
3 34000 17000
4 49000 12200
5 41000 15500

5. Oil spills in the Gulf of Nigeria have been known to cause extensive damage to both public and
private oyster grounds along the Lagos and Delta shores. One way to protect shellfish along
the shoreline is to release large volumes of freshwater from the River Niger to flush oil out to
sea. This procedure inevitably results in death to some of the saltwater shellfish while
preventing more widespread destruction to public reefs. Oil containment booms and other
temporary structures can also be used to intercept floating oil before it damages sensitive
fishing grounds. If the Fish and Wildlife Service spent $110 million in year 0 and $50 million in
years 1 and 2 to minimize environmental damage from one particular oil spill, what is the
benefit-to-cost ratio provided the efforts resulted in saving 3000 jobs valued at a total of $175
million per year? Assume disbenefits associated with oyster deaths amounted to $30 million in
year 0. Use a 5-year study period and an interest rate of 8% per year.

41
 CHAPTER FOUR
4.1 DEPRECIATION TERMINOLOGY
a) Depreciation is the decline in the value of an asset. Depreciation model use government
approved rules, rates and formulas to represent the current value on the company books.
Annual depreciation charges are tax deductible.
b) Books value represents the remaining undepreciated investments on the books after the
total amount of depreciation charges to date have been subtracted from the basis.
c) Market value is the estimated amount realizable if an asset were sold in the open market.
d) Depreciation rate is the fraction of the first cost removed by depreciation each year.
e) Salvage value is the estimated trade in or market value at the end of the asset’s useful life.
f) Personal property is (one of the two type of property for which depreciation is allowed)
the income - producing, tangible possessions of a company used to conduct business e.g.
vehicles, manufacturing equipment, computers, telephones, office furniture etc.
g) Real property include real estate and any similar types of property e.g. office buildings,
manufacturing structures, warehouses, apartment etc.

4.2 DEPRECIATION MODELS

4.2.1 Straight line depreciation method
Book value decreases linearly with time because the depreciation rate is the same each year
over the recovery period.
BV

Where n= 1, 2….N (year)

Time
DC (n) = depreciation change in year n
BV (n) = book value in year n
D = depreciation rate
S = salvage value
P = first cost

42
4.2.2 Declining Balance Depreciation.
DB is an accelerated write-off model. Deprecation charge is determined by multiplying the BV
at the beginning of each year by a depreciation rate, d. The maximum DR permitted is double
the SL depreciation rate. When this rate is used, the method is known as DDB.

BV

DC (n) = (d) BVn-1

If the BVn-1 is not known the DC (n) may be

calculated as
Time
DC (n) = (d) P (1-d)n-1

BV (n) = P (1-d)n

= BVn-1 –DC (n)

Here, the BV never goes to zero. There is an implied salvage value after n years given as

Implied S = BVn = P (1-d) n

Also, it is possible to determine an implied DR by using estimated salvage value amount i.e.

⁄
Implied d = ( ) , If S > 0.

The allowed range on d is 0 < d < ⁄ .

Example 4.1: The Haastrup Mining Company has purchased 9 computer – controlled
ore – grading unit for N80, 000. The unit has an anticipated life of 10years and a salvage value
of N10, 000. Use the DB method to develop a schedule of depreciation and book values for each
year.

Solution:

Since S > 0, an implied DR is determined i.e.

⁄ ⁄
d= ( ) ( )

= 0.1877.

43
This fall within the range of d for DB.
Year, n DC (n) BV(n)
0 - N 80’000
1 N 15’016 64984
2 12197 52787
3 9980 42879
4 8048 34831
5 6538 28293
6 5311 22982
7 4314 18668
8 3504 15164
9 2846 12318
10 2318 10’000
In year n = 3

DC (3) = d (BV3-1) = d*BV2

= 0.1877 x 52787 = N 9908.
BV (3) = BV2 – DC (3)
= 52787 – 9908 = N 42’879.
Other methods of computing depreciation are:

Other methods of computing depreciation are:

1. Declining balance with conversion to straight line

2. Accelerated cost Recovery System
3. Sum – of – years digits.

4.2.3 Half Year Convention

Another way to calculate depreciation is with ‘’ half – year convention’’. When using half – year
convention, the depreciation is assumed to start mid –way through the year, so only half of the
annual depreciation is taken during the first tax year and half of the annual depreciation is
taken during the n+1 tax year.

Example 4.2: An asset costs N2500 with an estimated salvage value of N1’100 at the end
of 3 years. Find the book value at the end of each year using half – year convention.

Solution:
DC =

BV1 = 2500 - ½(466.67) = N 2’266. 67

BV2 = 2666.67 - 466.67 = N 1’799. 99
BV3 = 1799.99 - 466.67 = N 1’333.33
BV4 = 1333.33 – ½(466.67) = N 1’100.00

44
Note that using half – year convention, depreciation is taken in n+1 tax years. Note in the
diagram below that, although diagram spans 4 tax years, the total length is only 3 years.

½DC DC DC ½DC
0 1 2 3 4
Tax Years

4.2.4 Modified Accelerated Cost Recovery System (MACRS)

This depreciation system was instituted during the mid – 1980’s in the US. Its purpose
was to allow a biz to depreciate an asset more rapidly during the first few years of its life. This
helped small biz get started by giving them some tax relief in the early staged of their
development.

This system differs from the straight line method is several important ways:

a) The depreciation rates are found in a table.

b) The asset is depreciated down to zero, rather than estimating its salvage value
c) The asset is classified by depreciation periods either 3, 5, 7, 10, 15 and 20 years
d) It has half –year convention built into the table value.

Example 4.3: An asset has a first cost of N 80’000 and has a 5 – year classification under
MACRS rules. Find the depreciation for each year.

Solution:
Tax Year MACRS Dep. Beginning of EOY BV
Dep. Rate Year BV
1 0.2 16’000 80’000 64’000
2 0.32 25600 64000 38400
3 0.192 15630 38400 22770
4 0.1152 9216 22770 13554
5 0.1152 9216 13554 4338
6 0.0576 4608 4338 0

Notice that the depreciation occurs over a 6 – year tax period indicating built – in half year
convention. Also notice that the entire first cost is depreciated or recovered.

45
Exercises
1. An asset that is book-depreciated over a 5-year period by the straight line method has BV3 =
$62,000 with a depreciation charge of $26,000 per year. Determine (a) the first cost of the
asset and (b) the assumed salvage value.
2. Equipment for immersion cooling of electronic components has an installed value of $182,000
with an estimated trade-in value of $40,000 after 15 years. For years 2 and 10, use DDB book
depreciation to determine (a) the depreciation charge and (b) the book value.
3. A 120-metric-ton telescoping crane that cost $320,000 is owned by Upper State Power.
Salvage is estimated at $75,000. (a) Compare book values for MACRS and standard SL
depreciation over a 7-year recovery period. (b) Explain how the estimated salvage is treated
using MACRS.
4. A plant manager for a large cable company knows that the remaining invested value of
certain types of manufacturing equipment is more closely approximated when the equipment
is depreciated linearly by the SL method compared to a rapid write-off method such as
MACRS. Therefore, he keeps two sets of books, one for tax purposes (MACRS) and one for
equipment management purposes (SL). For an asset that has a first cost of $80,000, a
depreciable life of 5 years, and a salvage value equal to 25% of the first cost, determines the
difference in the book values shown in the two sets of books at the end of year 4.

46
 CHAPTER FIVE

e) RETIREMENT AND REPLACEMENT ANALYSIS

5.1 REASONS FOR REPLACEMENT
A replacement study is an application of the AW method of comparing unequal-life alternatives.
The need for a replacement study can arise from several situations namely:

a) Reduced performance: Because of physical deterioration, the ability to perform at an

expected level of reliability (being available and performing correctly when needed) or
productivity (performing at a given level of quality and quantity i.e. effectiveness and
efficiency) is not present. This usually results in increased costs of operation, higher scrap
and rework costs, lost sales, reduced quality, diminished safety, and larger maintenance
expenses.
b) Altered requirements: When new requirements of accuracy, speed, or other
specifications cannot be met by the existing equipment or system. Often the choice is
between complete replacement or enhancement through retrofitting or augmentation.
c) Obsolescence: International competition and rapidly changing technology make
currently used systems and assets perform acceptably but less productively than
equipment from technological innovation. The ever-decreasing development cycle time to
bring new products to market is sometimes the reason for premature replacement studies,
that is, studies performed before the estimated useful or economic life is reached.

5.2 ECONOMIC SERVICE LIFE

Economic service life for an investment that is primarily cost is the life that minimises the net
annual cost and for an investment that has both income and cost is the life that maximises the
net annual worth. This section looks at how one can decide the economic service life for a
particular investment i.e. retirement; and what would be the best time for a replacement.

The opportunity cost for the defender is the money that you give up by not disposing off the
defender. The opportunity cost is the current market value for the defender, less costs
necessary for its disposal, less taxes on the capital gain. The investment in the defender is the
opportunity cost plus any real costs that must be expended at time zero necessary to keep the
defender. The investment in the challenger is just cost of purchasing the challenger. The
Defender and challenger are the names of the two mutually exclusive alternative projects
encountered in a replacement study. Market value is the current value of the installed asset if
it were sold or traded on the open market. It is also called trade-in value.

47
It should be noted that you don’t use any defender characteristics to compute the challenger
investment and/or cost or salvage and vice versa. The economic life minimises the NAC of
operation (or maximises the NAW when benefits are considered); in cases where the operating
cost of the defender is increasing, the economic service life of the defender is often one year. To
simplify computation, compute the NAC for one year. If the defender wins on the basis of one
year, keep it for one more year. Do the analysis again next year. When lives of the defender or
the challenger are different (the usual case), use NAW or NAC to make the decision.

Example 5.1: Current machine is 1 year old, i = 20%

Rescale value = N 12’500 today
 N 8’000 in 1 year
 N 5’000 in 2 years
 N 2’200 in 3 years
Annual expenses = N 8’900 in year 1
 N 10’500 in year 2
 N 12’500 in year 3
Determine the economic life of the machine @ i = 20%

Solution:
If we keep the machine for 1 year, cost =

- N 12’500 (A/P, 20%, 1)

= 12500 (1.2) = N 15’000
- - N 8’000 (A/F, 20%, 1)
= - 8000 (1) = - N 8’000
(Year 1 Salvage Value)

- N 8’900 (already in year 1) = N 8900

Total annual cost = N 15’900
If we keep for 2 years, cost =>

- N 12’500 (A/P, 20%, 2)

= 12500 (0.6545) = 8181.25
- - N 5000 (A/F, 20%, 2)
= - 5000 (0.4545) = - 2272.50
(Year 2 Salvage Value)

48
 - N 8’900 (P/F, 20%, 1) (A/P, 20%, 2)
= 8900 (0.8333) (0.6545) = 4854.01
- N 10’500 (A/F, 20%, 2)
= 10500 (0.4545) = 4772.25
Total annual cost = N 15’535.01
If we keep for 3 years, cost =>

- N 12’500 (A/P, 20%, 3) = 5933.75

= - 2200 (A/F, 20%, 3) = - 604.34
- N 8900 (P/F, 20%, 1) (A/P, 20%, 3) = 3520.55
- 10’500 (P/F, 20%, 2) (A/P, 20%, 3) = 3461.13
- N 12500 (A/F, 20%, 3) = 3433.75
Total annual cost = N 15’744.84
From the above analysis, the economic life of the machine is 2 years.

Total
Cost
AC Maintenance
Cost

Capital Recovery

Life time

5.3 REPLACEMENT STUDY ANALYSIS

A replacement study determines when a challenger replaces the defender. The complete study
is finished if the challenger (C) is selected to replace the defender (D) now. However, if the
defender is retained now, the study may extend over a number of years equal to the life of the
defender nD, after which a challenger replaces the defender. The replacement study procedures
are:

49
a) New replacement study:
On the basis of the better AWC or AWD value, select the challenger C or defender D. When
the challenger is selected, replace the defender now, and expect to keep the challenger for
nC years. This replacement study is complete. If the defender is selected, plan to retain it
for up to nD more years. (This is the leftmost branch of the Figure below). Next year,
perform the following steps.
b) One-year-later analysis:
Determine if all estimates are still current for both alternatives, especially first cost,
market value, and annual operating cost (AOC). If not, proceed to step 3 (see Figure
below). If yes and this is year nD, replace the defender. If this is not year nD, retain the
defender for another year and repeat this same step. This step may be repeated several
times.
c) Whenever the estimates have changed, update them and determine new AWC and AWD
values. Initiate a new replacement study (step 1).

Figure: An overview of replacement study analysis

Example 5.2: A Company currently owns several moving vans which are deteriorating
faster than expected. The vans were all purchased 2years ago for N 60’000 each. The company
currently plans to keep the vans for 10 more years. Fair MV for a 2-year-old van is N 42’000,
and for a 12-year-old van is N 8’000. AOC is N 12’000.

50
The replacement option is to lease on a yearly basis. The annual lease cost is N9’000 (beginning
– of – year payment) with AOC of N14’000. Should the company lease its vans if the MARR is
20%?
Solution:
Defender Challenger
P = N42’000 Lease Cost = N9’000
AOC = N12’000 AOC = N14’000
S = N8’000 No Salvage
n = 10yrs n = 10yrs
AWD = - 42000 (A/P, 20%, 10) + 8000 (A/F, 20%, 10) – 12’000
= - 42’000 (0.2385) + 8000 (0.03852) – 12000
= - 10017 +308.16 – 12000
= - N 21708.84
AWc = - 9000 (A/P, 20%, 1) – 14000
= - 9000 (1.2) – 14000
= - N 24’800
The company should retain the vans since AWD > AWC.

Example 5.3: Haastrup Investment usually keeps its company fleet of cars for 5years
before replacement. Since discounted autos purchase 2years ago have deteriorated much more
rapidly than expected, management wonders what is more economical: replace the cars this
year with new autos, retain the cars 1 more year and replace them; or keep for 3 more years
until the end of their estimated lives. Perform a replacement analysis at i = 20% using this
estimate costs below.

Defender Challenger
Value at Beginning of Year AOC

Next year (3) N 3800 N 4500 First Cost N 8700

Next year (4) 2800 5000 AOC N 3900/yr
Next year (5) 500 5500 Life 5 years
Remaining life 3 SV N 1800
Salvage after
3 more years N 500
Solution:
AWC = - 8700 (A/P, 20%, 5) + 1800 (A/F, 20%, 5) – 3900
= - N 6,567.
Calculate the defenders next year (n = 1) cost
51
 AWD (1) = - 3800 (A/P, 20%, 1) + 2800 (A/F, 20%, 1) – 4500
= - N 6,260.
Since AWD (1) cost is less than AWC, retain the current cars for the next year.

After the next year i.e. year 3 is over, to determine if the autos should be kept yet another year
i.e. year 2 Defender:

AWD (2) = - 2800 (A/P, 20%, 1) + 500 (A/F, 20%, 1) – 5000

= - N 7,860.
Now AWD (2) costs more than AWc, so we must compute the AWD value for the remaining 2
years of the defenders life i.e.

AWD = - 2800 (A/P, 20%, 1) + 500 (A/F, 20%, 1) – 5000(P/F, 20%, 1)

(A/P, 20%, 2) – 5500 (A/F, 20%, 2)
= - 2800 (0.6545) + 500 (0.4545) – 5000(0.8333)(0.6545) –
5500(0.4545)
= - N 6,833

Since the challenger is also cheaper for the remaining 2 years, select it and replace the current
cars (offenders) after one additional year of service i.e. year 3.

Exercises
1. To improve package tracking at a UPS transfer facility, conveyor equipment was upgraded
with RFID sensors at a cost of $345,000. The operating cost is expected to be $148,000 per
year for the first 3 years and $210,000 for the next 3 years. The salvage value of the
equipment is expected to be $140,000 for the first 3 years, but due to obsolescence, it won’t
have a significant value after that. At an interest rate of 10% per year, determine
a. The economic service life of the equipment and associated annual worth
b. The percentage increase in the AW of cost if the equipment is retained 2 years longer
than the ESL
2. A large, standby electricity generator in a hospital operating room has a first cost of $70,000
and may be used for a maximum of 6 years. Its salvage value, which decreases by 15% per
year, is described by the equation S = 70,000(1 – 0.15)n, where n is the number of years after
purchase. The operating cost of the generator will be constant at $75,000 per year. At an
interest rate of 12% per year, what are the economic service life and the associated AW
value?
3. In planning a plant expansion, Haastrup Investment Company has an economic decision to
make—upgrade the existing controlled-environment rooms or purchase new ones. The
presently owned ones were purchased 4 years ago for $250,000. They have a current “quick
sale” value of $20,000, but for an investment of $100,000 now, they would be adequate for
another 4 years, after which they would be sold for $40,000. Alternatively, new controlled-
environment rooms could be purchased at a cost of $270,000. They are expected to have a 10-
year life with a $50,000 salvage value at that time. Determine whether the company should
upgrade or replace. Use a MARR of 20% per year.

52
4. A recent environmental engineering graduate is trying to decide whether he should keep his
presently owned car or purchase a more environmentally friendly hybrid. A new car will cost
$26,000 and have annual operation and maintenance costs of $1200 per year with an $8000
salvage value in 5 years (which is its estimated economic service life). The presently owned
car has a resale value now of $5000; one year from now it will be $3000, two years from now
$2500, and 3 years from now $2200. Its operating cost is expected to be $1900 this year, with
costs increasing by $200 per year. The presently owned car will definitely not be kept longer
than 3 more years. Assuming used cars like the one presently owned will always be available,
should the presently owned car be sold now, 1 year from now, 2 years from now, or 3 years
from now? Use annual worth calculations at i = 10% per year and show your work.
5. An industrial engineer at a fiber-optic manufacturing company is considering two robots to
reduce costs in a production line. Robot X will have a first cost of $82,000, an annual
maintenance and operation (M&O) cost of $30,000, and salvage values of $50,000, $42,000,
and $35,000 after 1, 2, and 3 years, respectively. Robot Y will have a first cost of $97,000, an
annual M&O cost of $27,000, and salvage values of $60,000, $51,000, and $42,000 after 1, 2,
and 3 years, respectively. Which robot should be selected if a 2-year study period is specified
at an interest rate of 15% per year and replacement after 1 year is not an option?

53
 CHAPTER SIX
f) BREAKEVEN ANALYSIS
6.1 BREAKEVEN POINT
Breakeven analysis is performed to determine the value of a variable that makes two elements
or projects, or alternatives, equal. The breakeven point q* is determined from mathematical
relationships, e.g., product revenues and costs or other parameters that involve the variable; q.
Breakeven analysis is fundamental to evaluations such as make or buy decisions.

6.2 EVALUATION OF A SINGLE PROJECT USING BREAKEVEN ANALYSIS

When one of the engineering economics parameters namely P, F, A, i, or n is not known or not
estimated, a breakeven variable can be determined by setting an equivalence relation for
engineering economics parameters equal to zero. This type of breakeven analysis has been
used severally. For instance, we have had the situation for the rate of return i*, determination
of the replacement value for a defender, and determination of the value of P, F, A or S at which a
series of cash flow estimates return a specific MARR.

The unit of the variable of interest may vary widely: units per year, cost per kilogram, hours per
month, percentage of full plant capacity, etc. Figure 6a presents different trends of revenue
relationship identified as revenue, R. A linear revenue relationship is commonly assumed, but a
nonlinear relationship is often obtainable in practice. It can model the variable increasing per
unit revenue with larger volumes (curve 1 in Figure 6.1) or the variable decreasing per unit
revenue that usually prevails at higher quantities (curve 2).

q, units per year

Figure 6.1: Revenue relationships namely; (a) Linear revenue, and (b) Nonlinear revenue
namely: (1) increasing and (2) decreasing revenue per unit

Costs can also be linear or nonlinear and this includes two components namely; fixed and
variable costs; as indicated in Figure 6.2.

54
 q, units per year q, units per year
(a) (b)

Figure 6.2: Cost relationships namely: (a) Linear and (b) Non-linear
a) Fixed costs (FC): These include costs such as buildings, insurance, fixed overhead, level
of labour, equipment capital recovery, and information systems. The fixed-cost
component is always the same for all values of the variable and so it does not change for a
wide range of operating parameters, such as production level or workforce size. Even if
no units are produced, fixed costs are incurred at some minimum level.
b) Variable costs (VC): These include costs such as direct labour, materials, indirect costs,
contractors, marketing, advertisement, and warranty. Variable costs vary with
production level, workforce size, and other parameters. It is always the case to decrease
variable costs through better product design, manufacturing efficiency, improved quality
and safety, and higher sales volume.

When FC and VC are summed up, they become the total cost relationship TC. Figure 6.2a
represents the TC relationship for linear fixed and variable costs. Figure 6.2b shows the TC
curve for a nonlinear VC in which case the unit variable costs decrease as the quantity level
rises.

At a specific but unknown value of the decision variable q; the revenue R and total cost TC
relationship intersect to identify the breakeven point q* (Figure 6.3). If q ˃ q*, we have a profit
situation; but otherwise, there is a loss.

55
 q* q, units per year
Figure 6.3: Effect on the breakeven point when the variable cost per unit is reduced

The condition for the breakeven point of a single project is when revenue, R and total cost, TC
are equal to each other, indicating a profit of zero i.e.
……………………………………………………………………….6.1

where r = revenue per unit

v = variable cost per unit
Solving for the breakeven quantity q=q* for linear R and TC functions; we have:

The breakeven graph is an important management tool because it is easy to understand and
can be used in decision making in many ways. For instance, if the variable cost per unit is
reduced, the slope of the TC line becomes smaller (Figure 6.3) and the breakeven point
decreases. This is an advantage because the smaller the value of q*, the greater the profit for a
given amount of revenue. If nonlinear R or TC relationship is used, there is more than one
breakeven point. Figure 6.4 represents this situation for two breakeven points. The maximum
profit occurs at between the two breakeven points where the distance between R and TC
relationships is greatest.

56
 q* 𝑞𝑃 q* q, units
per year
Figure 6.4: Breakeven points and maximum profit point for a nonlinear analysis

Example 6.1: Indira Industries is a major producer of diverter dampers used in the gas
turbine power industry to divert gas exhausts from the turbine to a side stack, thus reducing
the noise to acceptable levels for human environments. Normal production level is 60 diverter
systems per month, but due to significantly improved economic conditions in Asia, production
is at 72 per month. The following information is available.
Fixed costs FC = $2.4 million per month
Variable cost per unit v = $35,000
Revenue per unit r = $75,000
a) How does the increased production level of 72 units per month compare with the current
breakeven point?
b) What is the current profit level per month for the facility?
c) What is the difference between the revenue and variable cost per damper that is necessary
to break even at a significantly reduced monthly production level of 45 units, if fixed costs
remain constant?
Solution:

a) Use Equation 6.3 to determine the breakeven number of units. All dollar amounts are in
$1000 units.

57
Figure 6.5 shows the plot of R and TC lines. The breakeven value is 60 damper units. The
increased production level of 72 units is above the breakeven value.

q, units per year

Figure 6.5: Breakeven graph for Example 6.1

b) To estimate profit (in $1000 units) at q = 72 units per month, we use Equation [6.1].

There is a profit of $480,000 per month currently.

(c) To determine the required difference between r and v i.e. r - v, we use Equation [6.3] by
setting profit = 0, q = 45, and FC = $2.4 million. In $1000 units, we have:

The difference between r and v must be $53,330. If v is says $35,000, the revenue per damper
must increase from $75,000 to $88,330 (i.e., 35,000 + 53,330) for the firm to break even at a
production level of q = 45 units per month.

58
Example 6.2: Haastrup Investment Company is trying to determine at what level they
must operate their plant just to break even. Their fixed costs are N75’000/month and their
variable costs are N30 per unit. Revenue is expected to be N 100/unit.

Solution:
Fixed Cost, FC = N75’000
Variable Cost, VC = N30/unit
Let = numbers of unit to manufacture
Total Cost, TC = FC + VC
= 75’000 +
R = 100/unit =
@ Breakeven point,

6.3 BREAKEVEN ANALYSIS FOR ALTERNATIVE PROJECTS

As stated earlier, breakeven analysis determines the value of a common variable between two
alternatives. Whenever we equate PW or AW relationships; breakeven point can be determine.
For example, you might have two pumps available for purchase, each costing different amount
for initial cost and yearly cost, wherein one is cheaper if you only need to pump small amount
and the other is cheaper if you have to pump large quantities. Then you could find a breakeven
point by varying the amount to be pumped until the cost of the two pumps was equal. The
selection between alternatives is based on the following guidelines:
a) If the required level of the common variable is below the breakeven value, select the
alternative with the higher variable cost (higher slope).
b) If the level is above the breakeven point, select the alternative with the lower variable
cost (lower slope).

A second use of break-even analysis is to determine at what level a manufacturing plant must
operate in order to break-even, considering it’s fixed and variable costs, and profit.

59
Example 6.3: A construction company need to remove water from excavation. It
considers pump A which initially cost N1, 800; cost N1.10 per hour to operate, requires
N360/yr in maintenance and will have a salvage value of N600 at the end of its 4year life.
Alternatively, pump B, has an initial cost of N550, cost N2.35 per hour to operate, require no
maintenance and has no salvage value at the end of 4years. Use an interest rate of 5%.
Solution:
Variable yearly costs:
Pump A : N1.10 / hr * hour / year
Pump B : N2.35 / hr * hour / year

Then, the annual equivalent fixed cost will be:

- Initial Cost:
Pump A: N1800 (A/P, 5%, 4) = 1800(0.2820)
= N507.60
Pump B: N500 (0.2820) = N155.10
- Salvage Value :
Pump A: 600 (A/F, 5 %, 4) = 600(0.2320)
= N139.20
Pump B: N0
- Maintenance Cost :
Pump A: N360/yr
Pump B: N#0
Then setting the cost of the two alternatives equal to each other we can solve for the
number of hours of pumping the divides when each pump should be selected:

Pump A annual equivalent cost = Pump B AEC

507.6 ± 139.2 +1.10 = 155.1 + 2.35
728.4 + 1.1 = 155.1 + 2.35
2.35 - 1.10 = 728.4 – 155.1
1.25 = 573.3
= 458.6 hours/year

If requirement for the excavation job is less than 458.6 hours, Pump B (with higher VC) would
be better selection. However, if the pump will operate more than 458.6 hours/yr, Pump A (with
lower VC) would be better.

Example 6.4: A choice must be made between two devices. Given the following data,
what should be paid for device B to make the two devices economically equivalent? (MARR =
20%)

60
 Device A Device B
Initial Cost N 15’000 N
Annual Cost N 4’500 N 7’500
Salvage N 7’400 N 12’000
Useful life 6 years 6 years
Solution:

@ Breakeven point; Net PW = Benefits – Costs

7400 (P/F, 20%, 6) - 4500 (P/A, 20%, 6) – 15000 = 12’000 (P/F, 20%, 6) - 7500
(P/A, 20%, 6) –

7400(0.3349) - 4500(3.3255) – 15000 = 12000(0.3349) - 7500(3.3255) –

2478.26 - 14964.75 – 15000 = 4018.8 - 24941.25 –

2478.26 – 29964.75 = -20922.45 –

= 27486.49 – 20922.45

= N 6,564.04

Exercises
1. A design-to-cost approach to product pricing involves determining the selling price of the
product and then figuring out if it can be made at a cost lower than that. Banner
Engineering’s QT50R radar-based sensor features frequency-modulated technology to
accurately monitor or detect objects up to 15 miles away while resisting rain, wind, humidity,
and extreme temperatures. It has a list price of $589, and the variable cost of manufacturing
the unit is $340. (a) What could the company’s fixed cost per year be in order for Banner to
break even with sales of 9000 units per year? (b) If Banner’s fixed cost is actually $750,000
per year, what is the profit at a sales level of 7000 units per year?
2. A metallurgical engineer has estimated that the capital investment cost for recovering
valuable metals (nickel, silver, platinum, gold, etc.) from the copper refinery’s wastewater
stream will be $12 million. The equipment will have a useful life of 15 years with no salvage
value. Its operating cost is represented by the relation ($2,600,000)E1.9, where E is the
efficiency of the metal recovery operation (in decimal form). The amount of metal currently
discharged is 2880 pounds per year prior to recovery operations, and the efficiency of
recovery is estimated at 71%. What must the average selling price per pound be for the
precious metals that are recovered and sold in order for the company to break even at its
MARR of 15% per year?
3. An irrigation canal contractor wants to determine whether he should purchase a used
Caterpillar mini excavator or a Toro powered rotary tiller for servicing irrigation ditches in
an agricultural area of California. The initial cost of the excavator is $26,500 with a $9000
salvage value after 10 years. Fixed costs for insurance, license, etc. are expected to be $18,000
per year. The excavator will require one operator at $15 per hour and maintenance at $1 per
hour. In 1 hour, 0.15 mile of ditch can be prepared. Alternatively, the contractor can purchase
61
 a tiller and hire 2 workers at $11 per hour each. The tiller costs $1200 and has a useful life of
5 years with no salvage value. Its operating cost is expected to be $1.20 per hour, and with the
tiller, the two workers can prepare 0.04 mile of ditch in 1 hour. The contractor’s MARR is 10%
per year. Determine the number of miles of ditch per year the contractor would have to
service for the two options to break even.
4. Providing restrooms at parks, zoos, and other city owned recreation facilities is a
considerable expense for municipal governments. City councils usually opt for permanent
restrooms in larger parks and portable restrooms in smaller ones. The cost of renting and
servicing a portable restroom is $7500 per year. In one northeastern municipality, the parks
director informed the city council that the cost of constructing a permanent restroom is
$218,000 and the annual cost of maintaining it is $12,000. He remarked that the rather high
cost is due to the necessity to use expensive materials and construction techniques that are
tailored to minimize damage from vandalism that often occurs in unattended public facilities.
If the useful life of a permanent restroom is assumed to be 20 years, how many portable
restrooms could the city afford to rent each year and break even with the cost of one
permanent facility? Let the interest rate be 6% per year.

62
 CHAPTER SEVEN

7. INVESTMENT UNDER INFLATION, UNCERTAINTY AND RISK

7.1 EFFECT OF INFLATION ON EQUITY – FINANCE PROJECTS AND DEBT-FINANCE
PROJECTS
Inflation is the increase in the cost of goods and services over a time period. Causes include the
following:
a) Tight job market
b) Decrease in productivity
c) Increase in money supply
d) Pressure for wage increase by labour unions
e) Demand for goods [shortages]
Inflation hurts retired persons on fixed incomes as items and services increase in cost. Inflation
also hurts lenders because loan gets paid off with cheaper naira.

How inflation is measured:

a) Consumer price index [CPI]
b) Producer price index [PPI]
The consumer price index is determined by the data supplied to the CBN by responsible
departments who check prices monthly on thousands of items from merchants across the
country.

To calculate inflation for an item, we can use the same equation as we did for finding the future
value, F, given the present value, P where by f is
substituted. For ί i.e. 1975 2008
Loaf of $0.40 $1.69
bread

√ –

√ –

Considering the effect of inflation on equity-finance project and debt-finance project; there are
three different rates under consideration namely:

63
 a) Real or Inflation – free interest rate: This is the rate at which interest is earned
when the effects of changes in the value of currency have been removed.
b) Market interest rate: interest in the market place and is the combination of real
interest rate and inflation rate.
c) Inflation rate: this is the measure of the rate of change in the value of the currency.
It should be noted that in analysis with inflation, amounts expressed using the values of naira of
today are called constant naira (or year-0 naira). Also amounts expressed using the values of
the naira in n years from today are called actual or current naira (year – n naira).

So, cash flow at a time is given in constant (year – 0) naira. The general inflation rate is f.
Expressed in actual (year – n) naira, the cash flow will be: C (F/P, f, n) where C = constant naira.

Also cash flow at time n is given in actual [year – n] naira, D. Expressed in constant (year – 0)
naira, the cash flow will be: D (P/F, f, n).

Generally, if f represents the inflation rate period and n is the number of periods,
therefore we have:

The MARR considering inflation should be:

Where = Real interest rate,

f = Inflation rate, and
= Inflated interest rate.

Example 7.1: What is the actual present value (to you) of a bond which pays
6000/year at the end of each year for 10 years, if the purchase price of 20’000 would be paid
back at the end of the 10th year? Assume inflation rate will average 4% during this period and
MARR = 6%.

Solution:
Using the market value of interest rate, we have:

= 0.06 + 0.04 + (0.06 0.04)

= 0.1024
= 10.24%
64
 * + [ ]

Comparing the answer with real interest rate we have:

= ₦ 55’328.60

The effect of inflation has been clearly shown. The value has been decreased.

Example 7.2: A bank lends you ₦ 100’000 today, to be repaid in a lump sum at the end
of 10years at a market interest rate of 10% compounded annually. If the rate of inflation is 8%,
what is the bank’s true rate of return and how much money will they really make in 10years?

Solution:

From

= 1.85%
So, the Bank’s real rate of return will be 1.85%.

How much money they actually made can be found by:

= ₦ 120’118.60
So the bank will really make an additional = ₦ 120’118.60

Note: Bonds are bad investments in times of inflation but loans are good investments in times of
inflation. So is also a mortgage.

65
7.2 EFFECT OF UNCERTAINTY AND RISK ON EQUITY AND DEBT FINANCE PROJECTS
The engineering economist must deal with uncertain future monetary and life values.
Uncertainty and risk analysis involves the use of probability and the computation of expected
value of economic alternatives. The expected value can be interpreted as a long run average
outcome if the project were repeated many times.

The expected value E[X] may be computed using the expression below:

∑ n = 1, 2, 3…

Where = specific variable value and = Probability that a specific value will occur.

Example 7.3: The Haastrup Investment Company has had experience with automatic
reaming equipment. A certain piece of equipment will cost ₦5’000 and have a life of three years.
Suspected actual cash flow and probability of each are listed below; depending on a receding,
stable and expanding economy. Determine if the equipment should be purchased at 15% rate of
return.
Year Receding Stable Expanding
Pro6 = 0.2 Pro6 = 0.6 Pro6 = 0.2
0 - ₦ 5’000 - ₦ 5000 - ₦ 5’000
1 +2500 +2000 +2000
2 +2000 +2000 +3000
3 +1000 +2000 +3500

Solution: First, we find the PW under each anticipated economy.

PWR = - 5000 + 2500 (P/F, 15%, 1) + 2000(P/F, 15%, 2) + 1000(P/F, 15%, 3)

= - ₦ 656
Similarly, PWS = ₦ 1,309
∑ = ∑
= - 656(0. 2) – 434(0.6) + 1309(0.2)
= - ₦ 310.00

Since E (PW) < 0, the project is not expected to be a paying proposition @ a 15% required rate
of return.

Example 7.4: Three alternatives are being evaluated for the protection of electrical
circuits, with the following required investments and probabilities of failure:

Alternative Capital Investment Prob. of loss in any year

A - $ 90’000 0.40
B - 100’000 0.10
C - 160’000 0.01
66
If a loss does occur, it will cost $80’000 with a probability of 0.65 and $120’000 with a
probability of 0.35. The probability of loss in any year is independent of the probability
associated with the resultant cost of a loss if one does occur. Each alternative has a useful life of
8years with no market value at the time. The MARR is 12% per year and annual maintenance
cost is expected to be 10% of the capital investment. It is desired to determine which
alternative is best based on expected total annual cost.

Solution:

The expected cost of loss, if it occurs can be calculated as follows:

- 80’000 (0.65) – 120’000(0.35) = - 94’000.

Alt. CR = I (A/P,12%,B) Annual Expected Annual Total Expected

Maintenance Cost of Failure Equivalent
annual cost
A - 90’000(0.2013) - 9000 - 94’000(0.4) - 64’717
B - 100’000(0.2013) - 10000 - 94’000(0.1) - 39530
C - 160000(0.2013) - 16000 - 94’000(0.01) - 49148
Thus, Alternative B is the best based in total expected equivalent annual cost which is a long-
run cost.

Exercises
1. Assume the inflation rate is 4% per year and the market interest rate is 5% above the
inflation rate. Determine (a) the number of constant-value dollars 5 years in the future that is
equivalent to $30,000 now and (b) the number of future dollars that will be equivalent to
$30,000 now.
2. Ford Motor Company announced that the price of its F-150 pickup trucks is going to increase
by only the inflation rate for the next 3 years. If the current price of a well-equipped truck is
$28,000 and the inflation rate averages 2.1% per year, what is the expected price of a
comparably equipped truck next year? 3 years from now?
3. An environmental testing company needs to purchase equipment 2 years from now and
expects to pay $50,000 at that time. At a real interest rate of 10% per year and inflation rate
of 4% per year, what is the present worth of the cost of the equipment?
4. How much can the manufacturer of superconducting magnetic energy storage systems afford
to spend now on new equipment in lieu of spending $75,000 four years from now? The
company’s real MARR is 12% per year, and the inflation rate is 3% per year.
5. The costs associated with a small X-ray inspection system are $40,000 now and $24,000 per
year, with a $6000 salvage value after 3 years. Determine the equivalent cost of the system if
the real interest rate is 10% per year and the inflation rate is 4% per year.

67
 CHAPTER EIGHT

8. SENSITIVITY ANALYSIS
Sensitivity refers to the relationship between the relative change in forecast of some elements
(factors) of an economic study and the measure of attractiveness of an alternative. If one
particular element (factor) can be varied over a wide range of values without affecting the
recommended decision, the decision in question is insensitive to uncertainties about the
element. On the other hand, if a small change in the estimate of some elements alters the
recommended decision, the decision is said to be sensitive to uncertainties about the factor.
Sensitivity analysis involves the following procedures:
a) Determine which factors (elements) are most likely to vary from the estimated value.
b) Select the probable range and increment of variation for each element.
c) Select an evaluation method that will be used to evaluate each element’s sensitivity.
d) Compute and, if necessary, plot the result from the evaluation method selected.
Note: The results of sensitivity analysis will show those elements that should be carefully
estimated by collecting more information when possible.

Example 8.1: Haastrup Rice, Inc. expects to purchase a new asset for automated rice
handling. Most likely estimates are a first cost of $80,000, zero salvage value, and a cash flow
before taxes (CFBT) per year t that follows the relation $27,000 − 2000t. The MARR for the
company varies over a wide range from 10% to 25% per year for different types of
investments. The economic life of similar machinery varies from 8 to 12 years. Evaluate the
sensitivity of PW by varying (a) MARR, while assuming a constant n value of 10 years, and (b) n,
while MARR is constant at 15% per year. Perform the sensitivity analysis.
Solution:

a) Follow the procedure above to understand the sensitivity of PW to MARR variation.

i. MARR is the parameter of interest.
ii. Select 5% increments to evaluate sensitivity to MARR; the range is 10% to 25%.
iii. The measure of worth is PW.
iv. Set up the PW relation for 10 years. When MARR = 10%,

68
The PW for all MARR values at 5% intervals is as follows:
MARR, % PW, $
10 27,830
15 11,512
20 -962
25 -10,711
v. A plot of MARR versus PW is shown in Figure 8.1. The steep negative slope indicates
that the decision to accept the proposal based on PW is quite sensitive to variations
in the MARR. If the MARR is established at the upper end of the range, the
investment is not attractive.
b) Follow the procedure above to understand the sensitivity of PW to n variation.
i. Asset life n is the parameter.
ii. Select 2-year increments to evaluate PW sensitivity over the range 8 to 12 years.
iii. The measure of worth is PW.
iv. Set up the same PW relation as in part (a) at i = 15%. The PW results are

n, years PW, $
8 27,830
10 11,512
12 -962
v. Figure 8.1 shows the plot of PW versus n. Since the PW measure is positive for all
values of n, the decision to invest is not materially affected by the estimated life. So,
asset life is insensitive to changes in cash flow.

Figure 8.1: Plot of PW versus MARR and n for sensitivity analysis, Example 8.1.
69
Exercises
1. Yomakie Instruments is considering an investment of $500,000 in a new product line. The
company will make the investment only if it will result in a rate of return of 15% per year or
higher. If the revenue is expected to be between $135,000 and $165,000 per year for 5 years,
determine if the decision to invest is sensitive to the projected range of income using a present
worth analysis.
2. A company that manufactures clear PVC pipe is investigating the production options of batch
and continuous processes. Estimated cash flows are as follows:
Batch Continuous
First cost, $ -80,000 -130,000
Annual cost, $ per tear -55,000 -30,000
Salvage value for any 10,000 40,000
year, $
Life, years 3 - 10 5
The chief operating officer (COO) has asked you to determine if the batch option would ever
have a lower annual worth than the continuous flow system, using interest rates over a range
of 5% to 15% for the batch option but only 15% for the continuous flow system. (Note: The
continuous flow process was previously determined to have its lowest cost over a 5-year life
cycle; the batch process can be used from 3 to 10 years.)
3. Saint Joel Technologies purchases several parts for the instruments it makes via a fixed-price
contract of $190,000 per year from a local supplier. The company is considering making the
parts in-house through the purchase of equipment that will have a first cost of $240,000 with
an estimated salvage value of $30,000 after 5 years. The operating cost is difficult to estimate,
but company engineers have made optimistic, most likely, and pessimistic estimates of
$60,000, $85,000, and $120,000 per year, respectively. Determine if the company should
purchase the equipment under any of the operating cost scenarios. The MARR is 20% per
year.
4. When the country’s economy is expanding, Michelle Investment Company is optimistic and
expects a MARR of 15% for new investments. However, in a receding economy the expected
return is 8%. Normally a 10% return is required. An expanding economy causes the estimates
of asset life to go down about 20%, and a receding economy makes the n values increase
about 10%. Calculate and observe or plot the sensitivity of PW values versus (a) the MARR
and (b) the life values for the two plans detailed below, using the most likely estimates for the
other factors. (c) Considering all the analyses, under which scenario, if any, should plan M or
Q be rejected?
Plan M Plan Q
Initial investment, $ -100,000 -110,000
Cash flow, $ per year +15,000 +19,000
Life, years 20 20

70
 CHAPTER NINE
9. AFTER – TAX ANALYSIS
9.1 BASIC TECHNOLOGY AND TAX RELATIONS

a) Gross income is the total of all income from revenue – producing source i.e.
Gross Income (GI) = revenue + other income.
b) Operating Expenses, E include all company costs incurred in the transaction of business.
c) Taxable income (T.I) is the naira amount upon which taxes are calculated i.e.
T.I = Cash Flow before Tax (CFBT) – interest on loan – depreciation
d) Tax rate is a percentage or decimal equivalent of taxable income owed in taxes.
Taxes = T.I. x tax rate
Cash Flow before Tax (CFBT) = GI – E
Cash Flow After tax (CFAT) = CFBT – taxes – interest on loan – principal
repayment
Example 9.1: A company is thinking of investing in a new production process. It needs
to expend N 600’000 on new machines with estimated lives of 5years. They are expected to
have no appreciable salvage values at the end of the project. The accountant and the industrial
engineer are at loggerhead as to which funding option is the more beneficial. The accountant
wants the company to commit only N 450’000 of company funds, while the balance is source at
20% from finance houses. The IE on the other hand wants no company funds committed – i.e.
all required funds should be borrowed. If project is expected to bring in net revenue of N
230’000 per annual, and loan obligations are to be met in equal instalments (with the principal
repayment at end of project life) and assuming the current corporate tax rate is 35%, which
option is better?
Solution:

Accountant Plan
Project life = 5 years
Investment = N 600’000
Company fund = N 450’000
Loan = N 150’000
N 600’000
Assume Straight line Depreciation Method
Salvage Value (SV) = 0
Depreciation Charge (DC) = 600/5 = N 150’000

71
 Interest on loan = x 150’000

= N 30’000.
CFBT = N 230’000
Taxable Income = CFBT – Dep – Int. in loan
= 230’ – 120’ – 30’
= N 80’000
CFAT = CFBT – Int. on Loan – loan repayment – Taxes
(Assume loan repayment is paid @ the end of the project life.)
Taxes = T.I x Tax rate
= 80’000 x 0.35 = N 28’000
CFAT = 230’000 – 30’000 – 28’000 = N 172’000.
Industrial Engineer Plan
DC = N 120’000
Interest on loan = x 600’

= N 120’000.
T.I = 230’ – 120’ – 120’
= - N 10’000.
Taxes = - 10’ x 0.35
= - N 3’500
(A negative taxable income or negative tax represents a tax credit).
CFAT = 230’000 – 120’000
= N 110’000 (Assume neglecting tax credit).

72
Accountant Plan

Yr CFBT Dep Interest Principal T.I Tax CFAT Factor P/W

0 - 600’ - - + 150’ - - - 450’ 1 - 450
1 230’ 120’ 30’ - 80’ 28’ 172’ 0.8333 143’327
2 230’ 120’ 30’ - 80’ 28’ 172’ 0.6944 119’436.8
3 230’ 120’ 30’ - 80’ 28’ 172’ 0.5787 99’536.4
4 230’ 120’ 30’ - 80’ 28’ 172’ 0.4823 82’955.6
5 230’ 120’ 30’ - 80’ 28’ 172’ 0.4019 69126.8
5 - 150’ - - - 150’ 0.4019 - 60285
N 124’668.20

Industrial Engineer Plan

Yr CFBT Dep Interest Principal T.I Tax CFAT Factor P/W

0 - - - + 600’ - - + 600’ 1 - 600
1 230’ 120’ 30’ - - 10’ 0 110’ 0.8333 91663
2 230’ 120’ 30’ - - 10’ 0 110’ 0.6944 76384
3 230’ 120’ 30’ - - 10’ 0 110’ 0.5787 63657
4 230’ 120’ 30’ - - 10’ 0 110’ 0.4823 53053
5 230’ 120’ 30’ - - 10’ 0 110’ 0.4019 44209
5 - - - - 600’ - 600’ 0.4019 - 24140
N 687’826

From the above analysis, the Industrial Engineer’s plan is selected.

Exercises
1. Four years ago a division of Harcourt-Banks purchased an asset that was depreciated by
the MACRS method using a 3-year recovery period. The total revenue for year 2 was $48
million, depreciation was $8.2 million, and operating expenses were $28 million. Use a
federal tax rate of 35% and a state tax rate of 6.5% to determine (a) CFAT, (b) percentage
of total revenue expended on taxes, and (c) net profit after taxes for the year.
2. Use an effective tax rate of 32% to determine the CFAT and NOPAT associated with the
asset shown below under two different scenarios: (a) with depreciation at $6000 per year
and (b) with depreciation at $6000, $9600, $5760, and $3456 in years 1 through 4,
respectively.
3. Choose between alternatives A and B below if the after-tax MARR is 8% per year, MACRS
depreciation is used, and Te = 40%. The GI - OE estimate is made for only 3 years; it is zero
when each asset is sold in year 4.

73
 Alternative A Alternative B
First cost, $ -8,000 -13,000
Actual salvage value, $ 0 0
Gross income – expenses, $ 3,500 5,000
Recovery period, years 3 3

4. The defender in a catalytic oxidizer manufacturing plant has a market value of $130,000
and expected annual operating costs of $70,000 with no salvage value after its remaining
life of 3 years. The depreciation charges for the next 3 years will be $69,960, $49,960, and
$35,720. Using an effective tax rate of 35%, determine the CFAT for remaining life that
should be used in a present worth equation to compare this defender against a challenger
that also has a 3-year life. Assume the company’s after-tax MARR is 12%.

74
 CHAPTER TEN
10. FUNDAMENTAL OF COST ACCOUNTING
10.1 ACCOUNTING RATIOS
6. Ratios measuring company’s liquidity and indebtedness
a) Current ratio = current assets/curent labilites
The higher the ratio the better. Reserve strength is the difference between current assets
and current liabilities. Current ratio relates to working capital.
b) Liquidity ratio (or Acid-Test ratio)

c) Debt Ratios – It appraise the coy ability to meet its short-term and long term obligations.

i. , Total Debts = Total current liabilities + long term LAD

(LAD – Loan Advances)

ii.

iii.

7. Ratios appraising funds management [Turnover Relationships]

a) Account receivables – results expressed in days which indicate the company effectiveness
towards collection of the account.

i. , obtain the average daily sales.

ii. Obtain day’s sales represented by receivables.

b) Account Payable – similar to account receivables.
c) Inventories

i. Frequency of turnover through operations.

ii.

d) Fixed assets
8. Ratios measuring company’s Profitability
a) Profitability as related to investment

i.

ii.

iii.

b) Profitability as related to Sales. – appraise the efficiency of operations.

75
 i.

ii.

c) Return in Investment, ROI

ROI = Turnover x Operating Profit as % of Sales

10.2 BALANCE SHEET AND INCOME STATEMENT

Balance sheet shows the statement of condition of a company at a given point in time. This is
also an equation of state of the firm. The state equation is given below:
Assets = Liabilities [Debt] + Equity.
Where Assets – a summary of all resources owned by you to the firm. Two classes of
assets are distinguishable viz, Current assets – represent the short term, working capital
of the company [cash, account receivables, etc.], which can be converted to cash in
approximately one year. Long term assets which are referred to as fixed assets [land,
equipment etc.)
Liabilities – a summary of financial obligation of the company.
Equity – a summary of the worth of ownership including outstanding stock issues and
earning retained for expansion (Represent the balance sheet of a company as an
example).
Income Statement summarises the flow of revenues and costs for a specified time interval.
The major categories of any income statement are given below:
a) Expenditures: includes labour, materials, interest and taxes etc.
b) Revenues: includes all sales, interest, revenue etc.
The income statement use the equation stated below:
Revenue – Expenditures = Profit + Depreciation

76
10.3 FINANCING TECHNOLOGY
10.3.1 Sources of funds
Sources of funds should be sought whenever any investment appears to be economically
attractive. Sources of fund include the following:
1. Internal Sources of Funds
Funds available from internal sources are profits of taxes, and dividends plus depreciate,
depletion and amortization
The cost of using internal fund can be estimated from the point of view of the company
stockholder. Retain earnings for investment instead of paying them out in the form of dividends
has an opportunity cost to the stockholders.
New equity is another source of internal funds. This involves the sales of new common
stocks or shares or new preference shares. Before the sales of these stocks, the company must
get approval of the stockholders and the Securities and Exchange Commission. Others are
freeing of capital through decrease in asset in liabilities or net worth.
2. External source of funds
Funds available from external source are borrowing, bonds and leasing.
i. Borrowing (Debt):- The economist tells us that company should borrow money to
finance project until the marginal cost of borrowing equals the marginal rate of
return. Source of borrowing includes banks, and insurance company. Examples of
banks are NIDB, Nigeria economic reconstruction fund NERFUND, CBN, ADB and
commercial banks.
ii. Leasing: This is a popular method of acquiring capital equipment. This involves
company (lessees) acquiring capital equipment from a leasing coy for their
investment purposes.
iii. Bonds: Major projects, particularly for local government may be financed by the sales
of bonds. Corporate bonds are usually sold at interest rates in the neighbourhood of
9% e.g. Cadbury Nig. Plc. in 2001, sold bond at an interest of 4%.
10.3.2 Uses of Funds
This is the application of company fund for immediate obligate. These are as follows:
a) Reduction of Liabilities
b) Claims against the Firm
c) Payment of cash dividends to stockholders
d) Commitments of capital to increase assets
Each application of funds must be offset by one or more sources of funds.

77
10.3.3 The concept of funds flow
The flow of funds is view as a circular movement. The movement is the use of funds for
the purchase of goods or materials. Sources of funds could be capital by the owners, reduction
of cash or investment owned or created from suppliers of materials or goods. At the same time,
funds are committed to the costs or expenses of production or operation and finished goods are
produced. The next step is sales if goods, funds will flow back in the cash accounts.
Funds flows help to appraise the impact of management decision made in the business. The
balance sheet of a coy shows all the flow of funds because it covers all net sources and uses of
funds.

78
BIBLOGRAPHY
Leland Blank T and Anthony Tarquin J. (2012). Engineering Economy. 7th Ed. McGraw-Hill Inc.

Oluleye Ayodeji E (2000). Lecture note on TIE212: Engineering Economics. Department of

Industrial and Production Engineering, Faculty of Technology, University of Ibadan, Ibadan.

Abdelaziz Berrado. (2018a). Engineering Economics- Annual Worth Analysis. Al Akhawayn

University.

Abdelaziz Berrado. (2018b). Engineering Economics- Present Worth Analysis. Al Akhawayn

University.

79
APPENDIX A: Discrete Compound Interest Tables

5% TABLE A1 Discrete Compound Interest Factors 5%

Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Gradient

Amount Worth Fund Amount Recovery Worth Present Worth Uniform Series
n F/P P/F A/F F/A A/P P/A P/G A/G
1 1.0500 0.9524 1.00000 1.0000 1.05000 0.9524
2 1.1025 0.9070 0.48780 2.0500 0.53780 1.8594 0.9070 0.4878
3 1.1576 0.8638 0.31721 3.1525 0.36721 2.7232 2.6347 0.9675
4 1.2155 0.8227 0.23201 4.3101 0.28201 3.5460 5.1028 1.4391
5 1.2763 0.7835 0.18097 5.5256 0.23097 4.3295 8.2369 1.9025
6 1.3401 0.7462 0.14702 6.8019 0.19702 5.0757 11.9680 2.3579
7 1.4071 0.7107 0.12282 8.1420 0.17282 5.7864 16.2321 2.8052
8 1.4775 0.6768 0.10472 9.5491 0.15472 6.4632 20.9700 3.2445
9 1.5513 0.6446 0.09069 11.0266 0.14069 7.1078 26.1268 3.6758
10 1.6289 0.6139 0.07950 12.5779 0.12950 7.7217 31.6520 4.0991
11 1.7103 0.5847 0.07039 14.2068 0.12039 8.3064 37.4988 4.5144
12 1.7959 0.5568 0.06283 15.9171 0.11283 8.8633 43.6241 4.9219
13 1.8856 0.5303 0.05646 17.7130 0.10646 9.3936 49.9879 5.3215
14 1.9799 0.5051 0.05102 19.5986 0.10102 9.8986 56.5538 5.7133
15 2.0789 0.4810 0.04634 21.5786 0.09634 10.3797 63.2880 6.0973
16 2.1829 0.4581 0.04227 23.6575 0.09227 10.8378 70.1597 6.4736
17 2.2920 0.4363 0.03870 25.8404 0.08870 11.2741 77.1405 6.8423
18 2.4066 0.4155 0.03555 28.1324 0.08555 11.6896 84.2043 7.2034
19 2.5270 0.3957 0.03275 30.5390 0.08275 12.0853 91.3275 7.5569
20 2.6533 0.3769 0.03024 33.0660 0.08024 12.4622 98.4884 7.9030
21 2.7860 0.3589 0.02800 35.7193 0.07800 12.8212 105.6673 8.2416
22 2.9253 0.3418 0.02597 38.5052 0.07597 13.1630 112.8461 8.5730
23 3.0715 0.3256 0.02414 41.4305 0.07414 13.4886 120.0087 8.8971
24 3.2251 0.3101 0.02247 44.5020 0.07247 13.7986 127.1402 9.2140
25 3.3864 0.2953 0.02095 47.7271 0.07095 14.0939 134.2275 9.5238
26 3.5557 0.2812 0.01956 51.1135 0.06956 14.3752 141.2585 9.8266
27 3.7335 0.2678 0.01829 54.6691 0.06829 14.6430 148.2226 10.1224
28 3.9201 0.2551 0.01712 58.4026 0.06712 14.8981 155.1101 10.4114
29 4.1161 0.2429 0.01605 62.3227 0.06605 15.1411 161.9126 10.6936
30 4.3219 0.2314 0.01505 66.4388 0.06505 15.3725 168.6226 10.9691
31 4.5380 0.2204 0.01413 70.7608 0.06413 15.5928 175.2333 11.2381
32 4.7649 0.2099 0.01328 75.2988 0.06328 15.8027 181.7392 11.5005
33 5.0032 0.1999 0.01249 80.0638 0.06249 16.0025 188.1351 11.7566
34 5.2533 0.1904 0.01176 85.0670 0.06176 16.1929 194.4168 12.0063
35 5.5160 0.1813 0.01107 90.3203 0.06107 16.3742 200.5807 12.2498
40 7.0400 0.1420 0.00828 120.7998 0.05828 17.1591 229.5452 13.3775
45 8.9850 0.1113 0.00626 159.7002 0.05626 17.7741 255.3145 14.3644
50 11.4674 0.0872 0.00478 209.3480 0.05478 18.2559 277.9148 15.2233
55 14.6356 0.0683 0.00367 272.7126 0.05367 18.6335 297.5104 15.9664
60 18.6792 0.0535 0.00283 353.5837 0.05283 18.9293 314.3432 16.6062
65 23.8399 0.0419 0.00219 456.7980 0.05219 19.1611 328.6910 17.1541
70 30.4264 0.0329 0.00170 588.5285 0.05170 19.3427 340.8409 17.6212
75 38.8327 0.0258 0.00132 756.6537 0.05132 19.4850 351.0721 18.0176
80 49.5614 0.0202 0.00103 971.2288 0.05103 19.5965 359.6460 18.3526
85 63.2544 0.0158 0.00080 1245.09 0.05080 19.6838 366.8007 18.6346
90 80.7304 0.0124 0.00063 1594.61 0.05063 19.7523 372.7488 18.8712
95 103.0347 0.0097 0.00049 2040.69 0.05049 19.8059 377.6774 19.0689
96 108.1864 0.0092 0.00047 2143.73 0.05047 19.8151 378.5555 19.1044
98 119.2755 0.0084 0.00042 2365.51 0.05042 19.8323 380.2139 19.1714
100 131.5013 0.0076 0.00038 2610.03 0.05038 19.8479 381.7492 19.2337

80
10% TABLE A2 Discrete Compound Interest Factors 10%
Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Gradient

Amount Worth Fund Amount Recovery Worth Present Worth Uniform Series
n F/P P/F A/F F/A A/P P/A P/G A/G
1 1.1000 0.9091 1.00000 1.0000 1.10000 0.9091
2 1.2100 0.8264 0.47619 2.1000 0.57619 1.7355 0.8264 0.4762
3 1.3310 0.7513 0.30211 3.3100 0.40211 2.4869 2.3291 0.9366
4 1.4641 0.6830 0.21547 4.6410 0.31547 3.1699 4.3781 1.3812
5 1.6105 0.6209 0.16380 6.1051 0.26380 3.7908 6.8618 1.8101
6 1.7716 0.5645 0.12961 7.7156 0.22961 4.3553 9.6842 2.2236
7 1.9487 0.5132 0.10541 9.4872 0.20541 4.8684 12.7631 2.6216
8 2.1436 0.4665 0.08744 11.4359 0.18744 5.3349 16.0287 3.0045
9 2.3579 0.4241 0.07364 13.5795 0.17364 5.7590 19.4215 3.3724
10 2.5937 0.3855 0.06275 15.9374 0.16275 6.1446 22.8913 3.7255
11 2.8531 0.3505 0.05396 18.5312 0.15396 6.4951 26.3963 4.0641
12 3.1384 0.3186 0.04676 21.3843 0.14676 6.8137 29.9012 4.3884
13 3.4523 0.2897 0.04078 24.5227 0.14078 7.1034 33.3772 4.6988
14 3.7975 0.2633 0.03575 27.9750 0.13575 7.3667 36.8005 4.9955
15 4.1772 0.2394 0.03147 31.7725 0.13147 7.6061 40.1520 5.2789
16 4.5950 0.2176 0.02782 35.9497 0.12782 7.8237 43.4164 5.5493
17 5.0545 0.1978 0.02466 40.5447 0.12466 8.0216 46.5819 5.8071
18 5.5599 0.1799 0.02193 45.5992 0.12193 8.2014 49.6395 6.0526
19 6.1159 0.1635 0.01955 51.1591 0.11955 8.3649 52.5827 6.2861
20 6.7275 0.1486 0.01746 57.2750 0.11746 8.5136 55.4069 6.5081
21 7.4002 0.1351 0.01562 64.0025 0.11562 8.6487 58.1095 6.7189
22 8.1403 0.1228 0.01401 71.4027 0.11401 8.7715 60.6893 6.9189
23 8.9543 0.1117 0.01257 79.5430 0.11257 8.8832 63.1462 7.1085
24 9.8497 0.1015 0.01130 88.4973 0.11130 8.9847 65.4813 7.2881
25 10.8347 0.0923 0.01017 98.3471 0.11017 9.0770 67.6964 7.4580
26 11.9182 0.0839 0.00916 109.1818 0.10916 9.1609 69.7940 7.6186
27 13.1100 0.0763 0.00826 121.0999 0.10826 9.2372 71.7773 7.7704
28 14.4210 0.0693 0.00745 134.2099 0.10745 9.3066 73.6495 7.9137
29 15.8631 0.0630 0.00673 148.6309 0.10673 9.3696 75.4146 8.0489
30 17.4494 0.0573 0.00608 164.4940 0.10608 9.4269 77.0766 8.1762
31 19.1943 0.0521 0.00550 181.9434 0.10550 9.4790 78.6395 8.2962
32 21.1138 0.0474 0.00497 201.1378 0.10497 9.5264 80.1078 8.4091
33 23.2252 0.0431 0.00450 222.2515 0.10450 9.5694 81.4856 8.5152
34 25.5477 0.0391 0.00407 245.4767 0.10407 9.6086 82.7773 8.6149
35 28.1024 0.0356 0.00369 271.0244 0.10369 9.6442 83.9872 8.7086
40 45.2593 0.0221 0.00226 442.5926 0.10226 9.7791 88.9525 9.0962
45 72.8905 0.0137 0.00139 718.9048 0.10139 9.8628 92.4544 9.3740
50 117.3909 0.0085 0.00086 1163.91 0.10086 9.9148 94.8889 9.5704
55 189.0591 0.0053 0.00053 1880.59 0.10053 9.9471 96.5619 9.7075
60 304.4816 0.0033 0.00033 3034.82 0.10033 9.9672 97.7010 9.8023
65 490.3707 0.0020 0.00020 4893.71 0.10020 9.9796 98.4705 9.8672
70 789.7470 0.0013 0.00013 7887.47 0.10013 9.9873 98.9870 9.9113
75 1271.90 0.0008 0.00008 12709 0.10008 9.9921 99.3317 9.9410
80 2048.40 0.0005 0.00005 20474 0.10005 9.9951 99.5606 9.9609
85 3298.97 0.0003 0.00003 32980 0.10003 9.9970 99.7120 9.9742
90 5313.02 0.0002 0.00002 53120 0.10002 9.9981 99.8118 9.9831
95 8556.68 0.0001 0.00001 85557 0.10001 9.9988 99.8773 9.9889
96 9412.34 0.0001 0.00001 94113 0.10001 9.9989 99.8874 9.9898
98 11389 0.0001 0.00001 0.10001 9.9991 99.9052 9.9914
100 13781 0.0001 0.00001 0.10001 9.9993 99.9202 9.9927

81
15% TABLE A3 Discrete Compound Interest Factors 15%
Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Gradient

Amount Worth Fund Amount Recovery Worth Present Worth Uniform Series
n F/P P/F A/F F/A A/P P/A P/G A/G
1 1.1500 0.8696 1.00000 1.0000 1.15000 0.8696
2 1.3225 0.7561 0.46512 2.1500 0.61512 1.6257 0.7561 0.4651
3 1.5209 0.6575 0.28798 3.4725 0.43798 2.2832 2.0712 0.9071
4 1.7490 0.5718 0.20027 4.9934 0.35027 2.8550 3.7864 1.3263
5 2.0114 0.4972 0.14832 6.7424 0.29832 3.3522 5.7751 1.7228
6 2.3131 0.4323 0.11424 8.7537 0.26424 3.7845 7.9368 2.0972
7 2.6600 0.3759 0.09036 11.0668 0.24036 4.1604 10.1924 2.4498
8 3.0590 0.3269 0.07285 13.7268 0.22285 4.4873 12.4807 2.7813
9 3.5179 0.2843 0.05957 16.7858 0.20957 4.7716 14.7548 3.0922
10 4.0456 0.2472 0.04925 20.3037 0.19925 5.0188 16.9795 3.3832
11 4.6524 0.2149 0.04107 24.3493 0.19107 5.2337 19.1289 3.6549
12 5.3503 0.1869 0.03448 29.0017 0.18448 5.4206 21.1849 3.9082
13 6.1528 0.1625 0.02911 34.3519 0.17911 5.5831 23.1352 4.1438
14 7.0757 0.1413 0.02469 40.5047 0.17469 5.7245 24.9725 4.3624
15 8.1371 0.1229 0.02102 47.5804 0.17102 5.8474 26.6930 4.5650
16 9.3576 0.1069 0.01795 55.7175 0.16795 5.9542 28.2960 4.7522
17 10.7613 0.0929 0.01537 65.0751 0.16537 6.0472 29.7828 4.9251
18 12.3755 0.0808 0.01319 75.8364 0.16319 6.1280 31.1565 5.0843
19 14.2318 0.0703 0.01134 88.2118 0.16134 6.1982 32.4213 5.2307
20 16.3665 0.0611 0.00976 102.4436 0.15976 6.2593 33.5822 5.3651
21 18.8215 0.0531 0.00842 118.8101 0.15842 6.3125 34.6448 5.4883
22 21.6447 0.0462 0.00727 137.6316 0.15727 6.3587 35.6150 5.6010
23 24.8915 0.0402 0.00628 159.2764 0.15628 6.3988 36.4988 5.7040
24 28.6252 0.0349 0.00543 184.1678 0.15543 6.4338 37.3023 5.7979
25 32.9190 0.0304 0.00470 212.7930 0.15470 6.4641 38.0314 5.8834
26 37.8568 0.0264 0.00407 245.7120 0.15407 6.4906 38.6918 5.9612
27 43.5353 0.0230 0.00353 283.5688 0.15353 6.5135 39.2890 6.0319
28 50.0656 0.0200 0.00306 327.1041 0.15306 6.5335 39.8283 6.0960
29 57.5755 0.0174 0.00265 377.1697 0.15265 6.5509 40.3146 6.1541
30 66.2118 0.0151 0.00230 434.7451 0.15230 6.5660 40.7526 6.2066
31 76.1435 0.0131 0.00200 500.9569 0.15200 6.5791 41.1466 6.2541
32 87.5651 0.0114 0.00173 577.1005 0.15173 6.5905 41.5006 6.2970
33 100.6998 0.0099 0.00150 664.6655 0.15150 6.6005 41.8184 6.3357
34 115.8048 0.0086 0.00131 765.3654 0.15131 6.6091 42.1033 6.3705
35 133.1755 0.0075 0.00113 881.1702 0.15113 6.6166 42.3586 6.4019
40 267.8635 0.0037 0.00056 1779.09 0.15056 6.6418 43.2830 6.5168
45 538.7693 0.0019 0.00028 3585.13 0.15028 6.6543 43.8051 6.5830
50 1083.66 0.0009 0.00014 7217.72 0.15014 6.6605 44.0958 6.6205
55 2179.62 0.0005 0.00007 14524 0.15007 6.6636 44.2558 6.6414
60 4384.00 0.0002 0.00003 29220 0.15003 6.6651 44.3431 6.6530
65 8817.79 0.0001 0.00002 58779 0.15002 6.6659 44.3903 6.6593
70 17736 0.0001 0.00001 0.15001 6.6663 44.4156 6.6627
75 35673 0.15000 6.6665 44.4292 6.6646
80 71751 0.15000 6.6666 44.4364 6.6656
85 0.15000 6.6666 44.4402 6.6661

82
20% TABLE A4 Discrete Compound Interest Factors 20%
Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Gradient

Amount Worth Fund Amount Recovery Worth Present Worth Uniform Series
n F/P P/F A/F F/A A/P P/A P/G A/G
1 1.2000 0.8333 1.00000 1.0000 1.20000 0.8333
2 1.4400 0.6944 0.45455 2.2000 0.65455 1.5278 0.6944 0.4545
3 1.7280 0.5787 0.27473 3.6400 0.47473 2.1065 1.8519 0.8791
4 2.0736 0.4823 0.18629 5.3680 0.38629 2.5887 3.2986 1.2742
5 2.4883 0.4019 0.13438 7.4416 0.33438 2.9906 4.9061 1.6405
6 2.9860 0.3349 0.10071 9.9299 0.30071 3.3255 6.5806 1.9788
7 3.5832 0.2791 0.07742 12.9159 0.27742 3.6046 8.2551 2.2902
8 4.2998 0.2326 0.06061 16.4991 0.26061 3.8372 9.8831 2.5756
9 5.1598 0.1938 0.04808 20.7989 0.24808 4.0310 11.4335 2.8364
10 6.1917 0.1615 0.03852 25.9587 0.23852 4.1925 12.8871 3.0739
11 7.4301 0.1346 0.03110 32.1504 0.23110 4.3271 14.2330 3.2893
12 8.9161 0.1122 0.02526 39.5805 0.22526 4.4392 15.4667 3.4841
13 10.6993 0.0935 0.02062 48.4966 0.22062 4.5327 16.5883 3.6597
14 12.8392 0.0779 0.01689 59.1959 0.21689 4.6106 17.6008 3.8175
15 15.4070 0.0649 0.01388 72.0351 0.21388 4.6755 18.5095 3.9588
16 18.4884 0.0541 0.01144 87.4421 0.21144 4.7296 19.3208 4.0851
17 22.1861 0.0451 0.00944 105.9306 0.20944 4.7746 20.0419 4.1976
18 26.6233 0.0376 0.00781 128.1167 0.20781 4.8122 20.6805 4.2975
19 31.9480 0.0313 0.00646 154.7400 0.20646 4.8435 21.2439 4.3861
20 38.3376 0.0261 0.00536 186.6880 0.20536 4.8696 21.7395 4.4643
22 55.2061 0.0181 0.00369 271.0307 0.20369 4.9094 22.5546 4.5941
24 79.4968 0.0126 0.00255 392.4842 0.20255 4.9371 23.1760 4.6943
26 114.4755 0.0087 0.00176 567.3773 0.20176 4.9563 23.6460 4.7709
28 164.8447 0.0061 0.00122 819.2233 0.20122 4.9697 23.9991 4.8291
30 237.3763 0.0042 0.00085 1181.88 0.20085 4.9789 24.2628 4.8731
32 341.8219 0.0029 0.00059 1704.11 0.20059 4.9854 24.4588 4.9061
34 492.2235 0.0020 0.00041 2456.12 0.20041 4.9898 24.6038 4.9308
35 590.6682 0.0017 0.00034 2948.34 0.20034 4.9915 24.6614 4.9406
36 708.8019 0.0014 0.00028 3539.01 0.20028 4.9929 24.7108 4.9491
38 1020.67 0.0010 0.00020 5098.37 0.20020 4.9951 24.7894 4.9627
40 1469.77 0.0007 0.00014 7343.86 0.20014 4.9966 24.8469 4.9728
45 3657.26 0.0003 0.00005 18281 0.20005 4.9986 24.9316 4.9877
50 9100.44 0.0001 0.00002 45497 0.20002 4.9995 24.9698 4.9945
55 22645 0.00001 0.20001 4.9998 24.9868 4.9976

83
25% TABLE A5 Discrete Compound Interest Factors 25%
Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Gradient

Amount Worth Fund Amount Recovery Worth Present Worth Uniform Series
n F/P P/F A/F F/A A/P P/A P/G A/G
1 1.2500 0.8000 1.00000 1.0000 1.25000 0.8000
2 1.5625 0.6400 0.44444 2.2500 0.69444 1.4400 0.6400 0.4444
3 1.9531 0.5120 0.26230 3.8125 0.51230 1.9520 1.6640 0.8525
4 2.4414 0.4096 0.17344 5.7656 0.42344 2.3616 2.8928 1.2249
5 3.0518 0.3277 0.12185 8.2070 0.37185 2.6893 4.2035 1.5631
6 3.8147 0.2621 0.08882 11.2588 0.33882 2.9514 5.5142 1.8683
7 4.7684 0.2097 0.06634 15.0735 0.31634 3.1611 6.7725 2.1424
8 5.9605 0.1678 0.05040 19.8419 0.30040 3.3289 7.9469 2.3872
9 7.4506 0.1342 0.03876 25.8023 0.28876 3.4631 9.0207 2.6048
10 9.3132 0.1074 0.03007 33.2529 0.28007 3.5705 9.9870 2.7971
11 11.6415 0.0859 0.02349 42.5661 0.27349 3.6564 10.8460 2.9663
12 14.5519 0.0687 0.01845 54.2077 0.26845 3.7251 11.6020 3.1145
13 18.1899 0.0550 0.01454 68.7596 0.26454 3.7801 12.2617 3.2437
14 22.7374 0.0440 0.01150 86.9495 0.26150 3.8241 12.8334 3.3559
15 28.4217 0.0352 0.00912 109.6868 0.25912 3.8593 13.3260 3.4530
16 35.5271 0.0281 0.00724 138.1085 0.25724 3.8874 13.7482 3.5366
17 44.4089 0.0225 0.00576 173.6357 0.25576 3.9099 14.1085 3.6084
18 55.5112 0.0180 0.00459 218.0446 0.25459 3.9279 14.4147 3.6698
19 69.3889 0.0144 0.00366 273.5558 0.25366 3.9424 14.6741 3.7222
20 86.7362 0.0115 0.00292 342.9447 0.25292 3.9539 14.8932 3.7667
22 135.5253 0.0074 0.00186 538.1011 0.25186 3.9705 15.2326 3.8365
24 211.7582 0.0047 0.00119 843.0329 0.25119 3.9811 15.4711 3.8861
26 330.8722 0.0030 0.00076 1319.49 0.25076 3.9879 15.6373 3.9212
28 516.9879 0.0019 0.00048 2063.95 0.25048 3.9923 15.7524 3.9457
30 807.7936 0.0012 0.00031 3227.17 0.25031 3.9950 15.8316 3.9628
32 1262.18 0.0008 0.00020 5044.71 0.25020 3.9968 15.8859 3.9746
34 1972.15 0.0005 0.00013 7884.61 0.25013 3.9980 15.9229 3.9828
35 2465.19 0.0004 0.00010 9856.76 .025010 3.9984 15.9367 3.9858
36 3081.49 0.0003 0.00008 12322 0.25008 3.9987 15.9481 3.9883
38 4814.82 0.0002 0.00005 19255 0.25005 3.9992 15.9651 3.9921
40 7523.16 0.0001 0.00003 30089 0.25003 3.9995 15.9766 3.9947
45 22959 0.00001 91831 0.25001 3.9998 15.9915 3.9980
50 70065 0.25000 3.9999 15.9969 3.9993
55 0.25000 4.0000 15.9989 3.9997

84