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monthly payment of $500 , and each successive payment will increase by a constant dollar amountx. The dealer offers to
finance 90% of the car's price for 48 months at a nominal interest rate of 6% per year, compounded monthly.
(a) How much is the constant amount x?
(b) How much is the 48th payment?
Contributed by Hamed Kashani, Saeid Sadri, and Baabak Ashm"i, Georgia Institute of Technology 4-·69 The following
cash flows are equivalent in value if the interest rate is i. Which one is more valuable if the interest rate is 2.i?
A.
t t t t
0- -1- -2- -3- -4
B. 0-
I
1-
t
2- 1- 4
4-70 The following cash flows are equivalent in value if the interest rate is i. Which one is more valuable if the interest
rate is 2i?
t t t l
A. 0- - 1- -2- -3- -4
~
B. 0- - 1- -2 - -3- -4
t I I
4-71
Using a 10% interest rate, for what value of B does the present value equal O?
400
300
0-
+Tr
1
1- 2- 3- 4
11 1
3B
4B
4-72 Consider the following cash flow:
Year Casb Flow
0 -$100
1 50
2 60
3 70
1 of 49 1/25/2020, 10:48 AM
Year Cash Flow

4 80
5 140
If the present value is zero, which one of the following is cmTect?
A 100 = 50 + lO(NG, i, 5) + 50(P /F, i, 5)
B. l = 50(P/A i 5) + lO(P/G.i. 5) + 50(P/ F i 5
100
C. lOO(NP, i., 5) = 50 + lO(NG, i, 5)
D. None of the equations are correct.
4~ 73 Consider the folJowing cash flow:
Year Cash Flow
1 $1000
2 $850
3 $700
4 $550
5 $400
6 $400
7 $400
8 $400
Which of the equations below is correct to compute the present va]ue of the cash flows at 8% interest?
A. P = lOOO(PIA, i, 8) - lSO(Pl G, i, 8) + 150(P /G, i, 4)(PIF , i, 4)
B. P = 400(PlA, i, 8) + 600(PlA, i, 5) - 150(P /G, i, 4)
C. P = lSO(Pl G, i, 4) + BSO(PIA, i, 4) + 400(P /A, i, 4)(P/F, i, 4)
Geon1etric Gradients
4- The market fo r a prodlict is expected to increas.e at an annual rate of 6%. First-year sales are estimated at $45,000, the horizon is
•
74 12 years, and the interest rate is 8%. What is the present value?
4- Precl is evaluating whether a more efficient motor with a life of 5 years sholild be installed on an assembly Une. [£ the interest rate
75 is 10%, what is the present value of the energy savings?
CD (a) Ene.rgy savings are estimated at $4000 for the first year, then increasing by 7% annuaJJy.
(b) What if the energy savings are increasing by 12% annually?
4- A set of cash fJows begins at $20,000 the first year, with an i.ncreas.e ea.ch year until 11 = 10 years. If the interest rate is 8%, what is
76 the pl'es.ent vaJue when
I (a) the annual increase is $2000?
(b) th.e annual increase is 10%?
4- A set of cash flows begins at $80,000 the first year, with an increas.e each year until 11 = 10 years. If the inte.rest rate is 5%, what is
77 the pres.ent vaJue when
(a) the annual increase is $10,000?
(b) the annual increase is 15%?
4- A set of cash flows begins at $1 ,000 the first year, with an increas.e each year until 11 = 12 years. If the inte.rest rate is 8%, what is
I (a) the annual increase is $1000?
(b) the annual increase is 8%?
4- A set of cash flows begins at $20,000 the first year~ with a decrease each year until n = 10 years. If the interest rate is 7%, what is
(a) the annual dec-rease is $2000?
( b) the annual decrease is 10%?
4- Suzanne is a recent chemical engineering graduate who has been offered a S~year conn.ict at a remote location. She has been
2 of 49 1/25/2020, 10:48 AM
80 offered two chokes. The fi rst is a fixed saJary of $80 000 per year. The secon d has a starting salary of $70,000 with annual rajses
O of 8% starting in Year 2. (For simplicity, assume that her sala.ry is paid at the end of the year, just before her annual vacation.) lf
her interest rate is 10%, whi.ch shouJd she take?
4- The foo tball coach at a midwestem university was given a 5-year employment contract that paid $800,000 the first year, and
81 increased at an 8% unifonn rate in each subsequent year. At the end of the first year's football season, the al umni demanded tha t
the coach be fired. The alumni agreed to buy his remajning years on the contract by paying him the equiva)ent present sum,
computed using a 6% interest rate. How much will the coach receive?
4- A contractor estimates maintenance costs for a new backhoe to be $500 fo r the first month with a monthJy increase of 0.75%. The
8.2 conn"actor can buy a 4-year maintenance contract for $20,000 at any point. If the contract is purchased at th e same time as the
backhoe is purchased, tile dealer has offered a 10% d.isco unt. Use i = 1% per m onth . What should the contractor do? Contributed
by Harned Kashani, Saeid Sadri, and BaabakAshuri, Georgia Institute of Technology
4- Eddie is a production engineer for a major supplier of component parts for cars. He has determined that a robot can be instaUed on
R3 the production line to replace one employee. The employee earns $20 per hour and benefits worth $3 per hour for a total annual
cost of $ 8 240 this year. Eddie estimates this cost will increase 6% each year. The robot will. cost $16,500 to operate for the first
year with costs increasing by $1500 each year. The firm uses an interest rate of 15% and a 10-year planning horizon. Tbe robot
costs 75,000 instaJled and will have a salvage value of $5000 after 10 years. Should Eddie recommend that purchase of the
robot?
Contributed by Paul R. McCright, University of South Florida
4- An engineer wiU deposi t 10% of her salary each year in to a 11etiremem fond. If her cuirrent annual sala.ry is $95,000 and she
34 expects that it wiJJ increase by 6% each yea1~ what will be the present worth of the fund after 30 years if it eams 6% per year?
Contributed by Hamed Kashani, Saeid Sadri, and Baabaf< Ashuri, Georgia Institute of Technology
4- Mark Johnson invests a fixed percentage of his salary at the end of each year. This year he invested $1500. For the next 5 years, he
R5 expects his salary to increase 8% annually, and he plans to increase his savings at the same rate. How much will the investments
be worth at the end of 6 years if the average increase in the stock market is
(a) 8%?
(b) 5%?
(c) 3%?
4- Zachary has opened a retirement account tbat ,,,m
pay 4% interest each year. He pfans to deposi t 8% of his amrnaJ salary into the
86 account for 35 years before he retires. His first year's sala.ry js $75,000, and he expects the salary to grow 6% each year. How
much will be in his accmmt after he makes the last deposit? What uniform amount can he withdraw from the account for 30 years
beginning one year after his last deposit?
4- A 25-yea:r-old engineer is opening an individ uaJ retirement account (IRA) at a bank. Her goal is to a.c cumulate $1 miJJion in the
87 account by the time she 11etires from work in 40 years. Th,e bank manager estimates she may expect to receive 6% nominal annual
interest, compounded quarterly, throughout the 40 years. The engineer believes her income wiU jncrease at a 5% annual rate
during her career. She wishes to start her IRA with as low a deposi t as possible and increase it at a 5% rate each year. Assuming
end-of-year deposits, how much sho uld she deposit the fi rst year?
Nmninal and Effective Interest Rates

4- Pete borrows $15,000 t.o purchase a used car. He must repay the Joan in 36 equal end-of-period monthJy payments. Interest is
88 caJculated at l l/4l½ per month. Determine the following:
I (a) The amount of the month.ly payment
(b) The nom inaJ annuaJ interest rate
(c) The effective annual interest rate
4- Picabo bonuws $1000. To repay the amount, she makes 12 equal monthly payments of $93.12. Determine the following:
S9 (a) The monthly interest rate
(b) The nom inaJ annuaJ interest rate
(c) The effective annual interest rate
4- In the 1500s King Henry VlII borrowed m oney from his bankers on the condition that he pay 5% of the loan at each fair (there
90 were four fairs per year) unti.l he had made 40 payments. At that time the loan would be considered repaid. What effective annual
0 interest did King Henry pay?
4- Quentin has been using his credit card boo much. ms plan is to use only cash until the balance of $8 74 is paJd off. The credit card
91 company charges 18% interest, compo unded monthly. What is the effective i11terest rate? How much inte11es t will he owe in the
first mo nth's payment? If he makes month]y payments of $225, how long unti.l it is paid off?
Contributed by Paul R. McCrigh t, University of South Florida
3 of 49 1/25/2020, 10:48 AM
4- One of the largest car dealers in the city advertises a 3-year-old car for !.ale as follows:
9.2 c.ash pri.c e $24 ,000, or a down payment of $2400 with 48 monthly payments of $634.50.
0 Susan DeVau.x bought the ca.r and made a down payment of $4000. The dealer charged her the !.ame interest rate used in his
G advertised offer.
(a) What is the monthly interest rate? How much will Susan pay each month for 48 months? What effective interest rate is being
charged?
(b) Find the Ethics Guide of the ational Automobile Autodealers Association ( ADA). If you were selling an auto on-line
would you practice these guidelines?
4- Yo u are taking a $5000 loan. You will pay it back in four eq ua] amounts, pa.id every 6 months starting 5 years fro m now. The
93 interest rate is 12% compounded semiannuaUy. CalcuJate:
( a) The effective interest rate
(b) The amount of each semiannual payment
(c) The total interest paid
4- The Bourbon Street Journal costs $625, payable now, for a 3-year subscription. The newspa per is published 252 days per year (5
94 days per week, except holidays}. ]fan 8.5% nominal annual interest rate, compounded every two months,. is used:
(a) What is the effective annuaJ interest rate in this problem?
(b) Compute the equivalent interest rate per 1/ 252 of a year.

(c) What is a subscriber s cost per copy of the newspaper, taking interest into account?
4- A bank is offering a loan of $10,000 with a nomina.l interest rate of 6% compounded monthly, payable in 72 months. There is a
9.5 loan origination fee of 3% that fa taken out from the loan amount.
(a) What is the monthly payment?
(b) What is the effective interest rate?
4- A loca.l car dealer offers a customer a 3-year car loan of $15,000 using "add-on" interest.
96
Money to pay for car $15,000
Two years' intere.st at 8%: 3 x 0.08 x 15,000 3,600
$18,600
18,600
36 monthly payments = - - = $516.67
36
The first payment must be made in 30 days. What are the nomina.l and •effective· annual inteiiest rates?
4- A loca.l lending institution advertises the "51-50 O ub." A person may borrow $2000 and repay $51 for the next 50 months,
97 beginning 30 days after receiving the money. Compute the nominal annual interest rate for th.is loan. What is th,e effective interes t
rate?
4- The Rule of 78s is a commonJy used method of computing the amount of .interest when the balance of a 1-year loan is repaid in
98 advance. Adding the numbers from month 1 to month 12 equals 78.
Now the first month's interest is 12/78 of the year's interest. The second month's interest is 11/78 of the year's interest. Thus
after 11 months the total inte.rest charged would be 77n8 of the total year's interest.
Helen bmrnwed $10,000 at 15% annual interest, compounded monthly. The loan was to be repaid in 12 equal end-of-period
payments. After making the firs t two payments she decided to pay off the baJance aJong with the third payment. Calculate the
amount of this additional sum
(a) based on the rule of 78s.
(b) based on exact eco nomic analysis methods.
(c) How dose is the approximation?
Q Spreadsheets for Loans

4- Develop a complete amortization table for a loan of $20,000, to be paid back in 18 uniform monthly instaJJments, based on an
99 interest rate of 6% . The amortization table should include the following col umn headings:
Payment Number, Principal Owed, Interest Owed, Principal Paid, and Balance Due Monthly Payment
You must a.lso show the equations used to calculate each col umn of the table.
4- Ten annual payments at an interest rate of 7% are made to repay a loan of $9000. Build the table that shows the balance due,
100 principal payment, and interest payment for each payment. What is the annual payment? What interest is paid in the fas t year?
0
4 of 49 1/25/2020, 10:48 AM
4- Using the loan and payment pJan developed in Problem 4-99, determine the month that the final payment fa due, and tlh.e amount
101 of the final paymen t, if $1500 is paid for Payment 5 and $2500 is pajd for Payment 10.
4- A newly graduated engineer bo ught furniture for $4500 from a loca.1 store. Monthly payments for 1 yea.r will be made. Interest is
102 computed at a nominal rate of 9%. Build the table that shows the baJance due, principal payment, and interest payment for each
I payment What is the monthly payment? What interest is paid in the last month?
4- CaJculate and prinl out the balance due, principal payment, and interest payment for each period of a used-car loan. The nomjnal
103 interest js 6% per year~ compounded monthly. Payments are made monthly for 3 years. The original loan is for $18,000.
4- CaJculate and print oul the ha.lance due, principal. payment, and interest payment for ,each period of a new car l.oan. The no minal
104 interest js 8% per year~ compounded monthly. Payments are made monthly for 5 years . The originaJ loan is for $27,000.
4- For the used car loan of Problem 4-103 graph the monthly payment
105 (a) As a fu nction of the interes t rate (5-15%).
(b) As a fu nction of the number of payments (24-48).
4- For the new car loan of Problem 4-104, graph the monthly paymen t.
106 (a) As a fu nction of the interes t rate (4-14%).
(b) As a fu nctio n of the number of payments (36-84).
4- Develop a general -purpose spreadsheet to ca.lculate the balance due, principal payment, and interest payment for each period of a
107 loan. The user inputs to the spreadsheet will be the loan amount,. the number of payments per year, the number of years payments
are made, and the nominal interest rate. Submit printouts of your analysis of a loan in the a.mount of $15,000 at 8.9% nominal rate
for 36 months and for 60 months of payments.
4- Use the spreadsheet developed for Problem 4-107 to analyze 180-month and 360-month house Joan payments for a $100,000
108 mortgage loan at a nom inaJ interest rate of 4.5%. Submit a graph of the interest and principal pa.id over time . What is the total
interest pa id for each number of payments?
Q Spreadsheets for Gradients

4- What is the present w01th of cash flows that begin at $10,000 and increase at 5% per year for 10 years? The interest rate is 12%.
109
4- What is the present wmth of cash flows that begin at $15,000 and increase at 8% per year for 10 years? The interest rate fa 6%.
110
I
4- What is th,e present w01th of cash flows that begin at $30,000 and dec11ease at 10% per year for 5 years? The interest rate is 15%.
111
4- What is the present w01th of cash flows that begin at $25,000 and dec11ease at 11% per year for 10 years? The interest rate is 7%.
112
I
4- et revenues at an older manufacturing plant wiIJ be $2 mimon for th.is year. The net reven ue wm decrease 15% per year for
113 years, when the assembly plant will be dosed (at the end of Year 6). If the finn 's interest rate i:s 10%, caJculate tlh.e PW of the
revenue stream.
4- Yo ur beginning salary is $70,000. You deposit 12% at the end of each year in a savings acco unt that earns 3% interest. Your
114 sa.lary increases by 2% per y,ea.r. What value does your savings book show after 40 years?
4- The market volume for widgets is increas1ng by 15% per year from current profits of $300,000. lnvesting in a design change wiU
115 allow the profi t per widget to stay steady; otherwise profits win drop 3% per year. What is the present w01th of the design chan ge
over tlh.e next 5 years? Ten years? The i11terest rate is 9%.
4- In an effort to be more envimnmentally conscious, a homeowne.r may upgrade a furnace that runs on fuel oil to a natural. gas unit.
116 The investment win be $2500 installed. The cost of the natura] gas will average $60 per month over the year~ instead of the $145
(9 per month that the fuel oil costs . Assume energy costs increase 3% per year. If the interest rate is 9% per year~ how long will it
take to recover the initiaJ investment?
Co1npounding and Payn1ent Periods Differ

4- Upon tile birth of his first child, Dick Jones decided to establish a savings account to partly pay for his son' s education. He plans
117 to deposit $200 per month in the account, beginning when the boy is 13 months old. The savings and loan association has a
current interest policy of 3% per annum, compounded month]y, paid quarterly. Assuming no change fo the interest rate, how
5 of 49 1/25/2020, 10:48 AM
much will be in the saVJngs account when Dick's son becomes 16 years old?
4- Ann deposits $500 at the end of each month. into her bank savings account. The bank paid 8% nominal interest, compounded and
118 paid quarterly. No interest was paid on money not in the account for the fuU 3-month period. How much was in Ann's account at
I the end of 4 years?
4- What is the present worth of a series of equal quarterly payments of $5000 that extends over a period of 8 years if the interest rate
119 is 12% comp ounded monthJy?
4- What single amount on ApriJ 1, 2019, is equivalent to a series of equal, semfannual cash flows of $1500 that s1a1ts with a cash
120 flow 0 11 Jan uary l, 2017, and ,ends with a cash flow on January 1 2027? The inte11est rate is 14% and compoundin g is quarterly.
4- A conn-actor wis hes to set up a spedal fund by making uniform sem iannual end-of-period deposits for 20 years. The fund is to
121 provide $10,000 at the end of each of the fas t 5 years of the 20~year period. H interest is 8%, compounded semfann ually, what is
the required semfannual deposit?
4- The State University is considering funding options for a new engineering buj]ding 011 campus. The m oney has been raised for the
122 construction costs and now the focus is raising funds for the annual upkeep and main tenance (U&M) expenses. For this bu1Jding,
conu.ictors will be hired with a series of 3-year agreements over the 30 years. Under each contract the university wm pay
$125,000 at the beginning of each 3-year agreement to cover all U&M buHdi.ng expenses over that 3-yea:r period. The first 3-year
agreement begins when the buildin g opens.
A weaJthy alumnus has agreed to donate enough at the build ing's opening to cover the & M expenses over the 30-year te1m . If
money invested by the school's engi.11ee1i ng fo undation earns 6% interest compounded qua.rterly, how much must be donated?
4- A series of monthly cash flows is deposited into an account that earns 12% nominal interest c-ompounded monthly. Each monthly
123 deposit is equal to $2100. The first month]y deposit occurred on June 1,. 201 2 and the last monthly deposit will be on January 1,
2019. The account (the series of monthly deposits, 12% nominal interest, and mo nthly compounding) aJso has equivaJem
quanerly withdrnwaJs from k The first quarterly withdrawal is equal to $5000 and occurred on October 1, 2012. The last $5000
withdrnwal will occur 0 11 Jan uary 1, 2019. How m uch remains in the account afterthe last withdrawal?
4- Jing, a recent engineering graduate, never took engineerin g econom ics. When slle gJ.iduated, she was hi.red by a prominent
124 engineering firm. T he eam in gs from this job alJowed her to deposi t $1000 each quarter into a savings account. T here were t:v.•o
banks that offered savings accounts in her town (a small town!). The firs t bank was offering 5.0% interest compounded
continuousJy. The second bank offered 5.125% comp ounded monthly. Jin g decided to deposit in the first ban k because it offered
continuous compounding. Did she make the r ight decision?
Mini.cases
4- Assume that you plan to retire 40 years from now and that you expect to need $2 to support the lifestyle that you want
125 (a) 1f the in terest rate is 10%, is tile followin g statement approximately true? "Wa.iting 5 years to start saving doub]es what you
must deposit each year."
(b) If the in terest rate is 12%, is the requked multiplier higher or lower than for the 10% rate in (a)?
(c) At what interest rate is the following statement exactly true? "Wajting 5 years to start saving doubles what you must deposit
each year."
4- For winners of the California SuperLotto Plus, the choice is betv,reen a lump sum and annua] payments that in crease from 2.5%
126 for the flrst year to 2. 7% for the second year and then increase by 0.1% per year to 5.1% for the 26th payment. The lump sum is
equal to the net proceeds of bonds purchased to fund the 26 payments. This is estimated at 45% to 55% of th,e lump sum am ount.
At what interest rate is the present worth of the t:v.10 payment plans equivaJen t if the lump sum is 45%? If it is 55%?
CASES
The foUowing case from Cases in Engineering Economy (www.oup.com/us/newnan), is suggested as H1atcl1ed with
this chapter.
CASE 27 Can Crusher
Basic time value of money, costs, and breakeven analysis .
1 A sinking fund is a separate fund into which one rnakes a un iform series of money depo&ils (A) to accumulate a des.i red future sum (F) by the encl of
per iod n.
2We thank David El.izanclr-o and Jessica Matson of Tennessee Tech for developing, testing, and describing th.is approach (The Engineering Economist,
2007, Vol. 52, o. 2, "Toking a Momen t to Teach Engineering Economy," pp. 97-116).
3 onnallv the inter-est period is one year. but it could be sorne other period (e.~, c:iuarter-,. month. half-year).
6 of 49 1/25/2020, 10:48 AM
CHAPTER S
PRESENT WORTH ANALYSIS
Tbe Present Value of 30 Years of Henefits
The Columbia River, from its headwaters west of Banff in the Canadian Rockies (Columbia Lake, elevation 820 m)
flows 2000 km through British Columbia and the state of Washington before entering the Pacific Ocean at Astoria.
Oregon. Measmed by the volume of its flow, the Columbia is the largest river flowing into the Pacific from orth
America. easured by elevation drop (0.41 mlkm compared to the Mississippi's 0.12 m/km), the Columbia alone
possesses one-third of the hydroelectric potential of the U.S. Because of the steep mountain trenches and high snowfall in
its catchment area, the Columbia's water levels used to fluctuate wildly, and vulnerable areas along its banks were subject
to seasonal flooding.
Anxious to exploit that hydroelectric power and control flooding, the U.S. and Canadian governments negotiated d1e
Columbia River Treaty. It was signed in 1961 and ratified by the U.S. in 1961 and by Canada in 1964.
The Treaty requires Canada to store 15.5 Million Acre Feet [the volume of water that would cover an acre of .land one foot deep], for
Oood control in perpetuity. This storage was accomplJshed with the c-onstruction of the Duncan, Hugh Keenleyside, and Mica Dams in
Canada. In return for consnucting the dams and regulating the water levels, the Province of British Columbia is entitled to half of the
e.lecn'ical downstream power benefits that the water generates on the dams located in the U.S. Canada was also entitled to half of the
estimated value of the future flood contro l benefits in the U.S. in a one-time payment of $69.9 million. (Virtual Museum of Canada)
It to ok Canada several years to ratify the treaty because British Columbia in the 1950s was sparsely populated and not
very indust1ialized, and the prospects of turning a large patt of the interior of the province into a reservoir to provide
benefits that the residents could not use was not appealing to the premier, W. A. C. Bennett. The impasse was reso]ved
when the U.S. agreed to pay in cash to British Columbia the discounted present value of the first 30 years of the
province's benefit entitlement. The treaty said:
The purchase price of the entitlement shall be $254,400,000, in United States funds as of October 1, 1964, subject to adjustment, in the
event of an earlier payment of all or part thereof, to the then p.resent worth, at a discount rate of 4.5% per annum.
The 30 years was up in 1994, and British Columbia then started receiving annual benefits. Today, Canada's 50% share
in the downstream benefits is wmth annually about $250 to 350 million, which is paid to the government of British
Columbia. ■ ■
Contributed by John Whittaker, University of Albetta
7 of 49 1/25/2020, 10:48 AM
QUESTIONS TO CONSIDER
1. Canadian Premier Bennett used the 254 million to finance the Pmtage ountain Dam (later renamed the W. A.
C. Bennett Dam) and an associated 2730-megawatt power station in northern British Columhia. Was this a good
use for the money from the ·Canadian perspective?
2. Negotiating downstream rights can be a curious Hingle. The people at the bottom of the hill can argue that the
water is going to flow there anyway and they are free to use it as they want. The people upstream can argue that
while the water is on their land, they should be free to use or divert it as they please. Who is right- and wrong-
minded in this situation? What are the ethical considerations from hoth perspectives?
3. Was 4.5%, the discount rate used in 1964, a reasonahle one for the governments to choose? Explain and justify
your conclusion.
After Completing This Chapter ...

The student should be able co:
• Define and apply the present worth criteria.
• Compare two competing alternative choices using present wort h (PW).
• Apply the PW model in cases with equal, unequal, and infinite project Hves.
• Compare multiple alternatives using the PW criteria.
• Develop and use spreadsheets to make present worth calculations.
• Compute hond prices and yields.
Key Words
analysis period
capitalized cost
coup on interest rate
economic efficiency
financing
investment
least common multiple
minimum attractive rate of return (MARR)
net present wmth ctiterion
par (face) value
planning horizon
present worth analysis
project Ufe
X PV
In Chapters 3 and 4 we accomplished two important tasks. First, we presented the concept of equivalence. We can
compare cash flows only if we can resolve them into equivalent vafoes. Second., we derived a series of compound interest
factors to find those equivalent values.
ASSUMPTIONS IN SOLVING ECONOMIC ANALYSIS PROBLEMS

One of the difficulties of prohlem solving is that most prohlems tend to be very complicated. It becomes apparent that
some simplifying assumpti ons are needed to make complex prohlems manageable. The trick, of course, is to solve the
simpUfied prohlem and stiU be satisfied that the solution is apphcable to the real problem! In the suhsections that follow,
8 of 49 1/25/2020, 10:48 AM
we will consider six different items and explain the customary assumptions that are made. These assumptions apply to al1
problems and examples, unless other assumptions are given.
End-of-Year Convention
As we indicated in Chapter 4, economic analysis textbooks and praaice follow the end-of-period convention. This makes
"A" a series of end-of-period receipts or disbursements.
A cash flow diagram of P, A, and F for the end-of-period convention is as follows:
Yea!f0 EndofY:ear J End ofY:ear2
Jan I Dec 31 Jan I Dec 31
j
p
i
A
fA
·Ft
If one were to adopt a middle-of-petiod convention it would only apply to the annual cash flows, and the diagram
would be:
Middl or Middl of
Yea!f0 Year I Year 2 End ofY:ear2
Jan I Jun 30 Dec 3 l Jan I Jun 30 Dec 31
I
j
p
i-
A
l
A
l
F
As the diagrams illustrate, only A shifts; P remains at the beginning of the period and F at the end of the period,
regardless of the convention. The compound interest tables in Appendix C are based on the end-of-period convention.
Viewpoint of Econonuc Analysis Studies

When we make economic analysis calculations, we must proceed from a point of reference. Generally, we wil1 want to
take the point of view of a total film when doing industrial economic analyses. Example 1-1 vividly illustrated the
problem : a firm's shipping department decided it could save money by outsourcing its printing work rather than by using
the in-house printing depattment. An analysis from the viewpoint of the shipping department suppotted this, as it cou]d
get for $688 the same printing it was paying $793 for in-house . Fmther analysis showed, however, that its p1inting
depattment costs would decline less than using the commercial printer would save. From the viewpoint of the firm, the
net result would be an increase in total cost.
From Example 1- 1 we see it is important that the viewpoint of the study be carefully considered. Selecting a narrow
viewpoint, like that of the shipping department. may result in a suboptimal decision from the film's viewpoint. It is the
total firm's viewpoint that is used in industrial economic analyses. For public-sector problems, the combined viewpoint of
the government and the citizenry is chosen, since for many public projects the benefits of faster commuting, newer
schools, and so on are received by individuals and the costs are paid by the government.
Sunk Costs
We know that it is the differences between alternatives that are relevant in economic analysis. Events that have occuITed
in the past really have no bearing on what we should do In the future. When the judge says, "$200 fine or 3 days in jail,"
the events that led to these unhappy alternatives really are unimportant. H is the current and future differences between the
alternatives that are important. Past costs, like past events, have no bearing on deciding between alternatives unless the
past costs somehow affect the present or future costs. In general, past costs do not affect the present or the future, so we
refer to them as sunk costs and disregard them.
Borrowed Money Viewpoint

In most economic analyses, the proposed alternatives inevitably require money to be spent, and so it is natural to ask the
source of that money. Thus, each problem has two monetary aspects: one is the financi.ng-:the obtaining of money; the
other is the investment-the spending of money. Expe1i ence has shown that these two concems should be distinguished.
When separated, the problems of obtaining money and of spending it are both logical and straightforward. Failure to
separate financing and investment sometimes produces confusing results and poor decision making.
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The conventional assumption in economic analysis is that the money required to finance altematives is considered to
be obtained from the bank or the firm at interest rare i.
Effect of Inflation and UeOation

For the present we will assume that prices are stable or stated in constant-value dollars. This means that a machine that
costs $5000 today can be expected to cost the same amount several years hence. Inflation and deflation may need to be
considered for after-tax analysis and for cost and revenues whose inflation rates differ from the economy's inflation rates
(see Chapter 14), hut we assume stahle or constant dollar pnces for now.
Incon1e Taxes
Income taxes, like inflation and deflation, must be considered to find the real payoff of a project However, taxes will
often affect alternatives simUarly, allowing us to compare choices without considering income taxes . We will introduce
income taxes into economic analyses in Chapter 12..
ECONOMIC CRITERIA
We have shown how to manipulate cash flows in a variety of ways, and we can now solve many kinds of compound
interest problems. But engineering economic analysis is more than simply solving interest prohlems. The decision process
(see Figure 1-1) requires that the outcomes of feasible alternatives be arranged so that they may be judged for economic
efficiency in terms of the selection crited on. The economic criteria were previously stated in general terms, and they are
restated in Table 5-1.
We , .,,mnow examine ways to resolve engineering problems, so that criteria for economic efficiency can be applied.
Equivalence provides the logic by which we may adjust the cash flow for a given alternative into some equivalent sum
or series. We must still choose which comparable units to use. In this chapter we will learn how analysis can resolve
alternatives into equivalent present consequences, referred to simply as present worth analysis. Chapter 6 wilJ show how
alternatives are converted into an equivalent uniform annual cash flow, and Chapter 7 soives for the interest rate at wh.ich
favorable consequences-that is, benefits--a.re equivalent to unfavorable consequences-or costs.
As a general rule, any economic analysis problem may be solved by any of these three methods. This is true because
presenr worth, annual cash flow, and rate of return are exact methods that will always yield the same recommendation for
selecting the best alternative from among a set of mutually exclusive alternatives. Remember that "mutuaUy exclusive"
means that selecting one alternative precludes selecting any other alternative. For example, constructing a gas station and
constructing a drive-in restaurant on a patticu]ar piece of vacant land are mutually exclusive alternatives.
Tuli>ll" 5-1 Present Worth Analysis

Input/Output Situation Criterion
either input nor Maximize (present worth of benefits minus present worth of costs),
TypicaJ, general case
output is fixed that is, maximize net present worth
Amount of money or other input
Fixed input Maximize present worth of benefi ts or other outputs
resources a11e fixed
The11e is a fixed task, benefit, or other
Fixed output Mfoim.ize present worth of costs or othe.r inputs
output to be accomplished
Some problems, however, may be more easily solved by one method. Present worth analysis is most frequently used to
determine the present value of future money receipts and disbursements. It would help us, for example, to detennine the
present wotth of an income-producing property, like an oil well or an apa11mem house. lf the future income and costs are
known, then we can use a suitable interest rate to calculate the property's present worth. This should provide a good
estimate of the price at which the property could be bought or sold. Another application is valuing stocks or bonds based
on the anticipated future benefits of ownership.
TIME PERIOD FO,R ANALYSIS

In present wm1h analysis, careful consideration must be given to the time period covered by the analysis. Usually the task
to be accomplished has a time period associated with it. The consequences of each alternative must be considered for this
nPrin ril nf timP whirh k 11 4-11,1l lv r;il lPil t hP ;i,m , lv,;ii,; n Prinil . nbnn in u hori7,nn . n r nmiPrf lif,P.
10 of 49 1/25/2020, 10:48 AM
period at time, which is usually called the analysis period, planning horizon, or project lite.
The analysis period for an economy study should be dete1mined from the situation. In some industries with rapidly
changing techno]ogies, a rather short analysis period or planning horizon might be in order. lndusu·ies with more stable
technologies (like steel making) might use a longer period (say, 10-20 years), while government agencies frequently use
analysis periods extending to 50 years or more.
Three different ana]ysis-period situations are encountered in economic analysis problems with multiple alternatives:
1. The useful life of each altemative equals the analysis period.
2.. The alternatives have useful lives different from the analysis period.
3. There is an infinite analysis petiod, n =
Useful Lives Equal the Analysis Period

Since different lives and an infinite analysis period present some complications, we will begin with four examples in
which the useful life of each alternative equals the analysis petiod.
EXAMPLE 5-1
A firm will install one of two mechanical devices to reduce costs. Both devices have useful lives of 5 years and no
salvage value. Device A costs $10,000 and can be expected to resuh in $3000 savings annually. Device B costs $13,500
and will provide cost savings of $3000 the first year, but savings will increase $500 annuaUy, making the second-year
savings $3500, the third-year savings $4000, and so f01th. With interest at 7%, which device should the finn purchase?
SOLUTION
The analysis period can conveniently be seleaed as the useful life of the devices, or 5 years. The appmpriate decision
criterion is to choose the a]temative that maximizes the net present worth of benefits minus costs.
1
A = 3000
t r t t
0- -1- -2- -3- -4- -5
T fret TT
3
0-----1- -2- -3- -4- -5
!
P = 10;000
n = -)'ears !
P = 13, -00
n = 5 )'ears
PWA = - 10,000 + 3000(P/ A, 7%, 5)= - 10,000 3000 4.100 2300

PWB = - 13,500 + 3000(PJA, 7%, 5) + 500(P/ G, 1°"- , 5)
= - 13,500 + 3000(4.100 ,+ 500(7.647) = $2624
Device B has the larger present worth and is the preferred alternative.
EXAMPLE5-2
Wayne County will build an aqueduct to bring water in from the upper part of the state . It can be built at a reduced size
now for $300 mil]ion and be enJarged in 25 years for an additional $350 million. An alternative is to construct the full-
sized aqueduct now for $400 million.
Both alternatives wou]d provide the needed capacity for the SO-year analysis period. Maintenance costs are small
and may be ignored. At 6% interest, which altemative should be selected?
TABLE SOLUTION
This problem illustrates staged construction. The aqueduct may be built in a single stage, or in a smaller first stage
followed many years later by a second stage to provide the additional capacity when needed.
For the Tho-Stage Construction
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PW of cost = $300 million 350 million P/ F, 6%, 25)

= $300 million+ 81 .6 million
= $381.6 million
For the Single•Stage Construction
PW of cost = $400 million
The two-stage construction has a smaller present worth of cost and is the preferred constmction plan.
5-BUTl'ON SOLUTION
A B C D E F G ff
1 Problem i n PMT PV FV Solve for Answer
2 Two-Stage 6% 25 0 -350 l?V $81.55
3 yearO $300.00
4 total $38l.5S
This is less than the $400M for the one-stage construction, so the two-stage is preferred.
EXAMPLES-3
A firm is trying to decide which of two weighing scales it should install to check a package-filling operation in the
plant. The idea] scale would allow better control of the fiJling operation, hence less overfilling. If both scales have lives
equal to the 6-year analysis pe1iod, which one should be selected? Assume an 8% interest rate.
Alternatives Cost Uniform Annual Benefit End-o(-Useful-Life Sa]vage Value
All.as scal.e $2000 $450 $200
Tom Thumb scale 3000 600 700
TABLE SOLUTION
Atlas Scale
PW of benefits - PW of cost = 450 P/ A 8%. 6 + 200 P/ F &%, 6 , - 2000
= 450 4.623) + 200(0.6302) - 2000
= 2080 + 126 - 2000 = $206
Tom Thumb Scale
PW ofbenefi - PW of cost = 600 P/A 8%,6) 700 P/ F, &% 6 , - 3000
= 600 4.623) + 700(0.6302) - 3000
= 2774 +441 - 3000 = $21 5
The salvage value of each scale, it should be noted, is simply treated as another positive cash flow. Because the PWs
for the two alternatives are nearly identical, it is likely that there are other tangible or intangible differences that should
determine the decision. If there are no such differences, buy the Tbm Thumb equipment.
5-BUTl'ON SOLUTION
A B C D E F G ff
1 Alternative i n PMT PV FV Solve for Answer
2 Atlas 8% 6 450 200 PV -$2,206
3 -2000 total= -H2+E3 $206
4
r 'T"'- .- TL~~-'L 00./ ,. ,.,,.,, 7n.n I n~ 1 .d'"l! ""l1 r
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1-$3,215 I
In Examples 5-1 and 5-3, we compared two alternatives and selected the one in which present wmth of benefits minus
present worth of cost was a maximum. The criterion is called the net present worth criterion and written simply as
NPW:
et present worth = Pre ent wmth of benefit - Pre ent worth of cost (5-1)
PW = PW of benefits - PW of c-0 t
The field of engineering economy and this text often use present wmth (PW), present value (PV), net present worth
(NPW), and net present value ( PV) as synonyms. Sometimes, as in the foregoing definition, net is included to
emphasize that both costs and benefits have been considered.
Useful Lives Different from the Analysis Period

In present worth analysis, there always must be an identified analysis period. It follows, then, that each alternative must
be considered for the entire period. In Examples 5-1 to 5- 3, the useful life of each alternative was equal to the analysis
period. While often this is tme, in many situations at least one alternative will have a useful life different from the analysis
period. This section describes one way to evaluate alternatives with lives different from the study pe1iod.
For present wmth calculations, It is impmtant that we select an analysis period and judge the consequences of each of
the alternatives over that period. As such, in Example 5-4 it is not a fair comparison to compare the PW of Pump A over
its 12-year Ufe against the NPW of Pump B over its 6-year life.
The film, its economic environment, and the specific situation are important in selecting an analysis period. If Pump A
(Example 5-4) has a useful life of 12 years, and Pump B will fast 6 years, one method is to select an analysis period that is
the least common multiple of their useful lives. Thus we would compare the 12-year life of Pump A against an initial
purchase of Pump B plus its replacement with new Pump Bin 6 years. The result is to judge the alternatives on the basis
of a 12-year requirement
EXAMPLE5-4
Two pumps are being considered for purchase. If interest is 7%, which pump should be bought? Their maintenance
costs are the same.
Pump A PumpB
Initial cost $7000 $5000
End-of-useful-life salvage value 1200 1000
Useful Hfe, in yea.rs 12 6
TABLE SOLUTION
Since the maintenance costs are the same, they can be omitted from the comparison. The present wmth of Pump A over
12 years is
PWA = - 7000 + 1200(PJF, 7 %. 12

=- 7000 + 1200(0.4440)
= - $6467
For a common analysis period of 12 years, we need m replace Pump B at the end of its 6-year useful life. If we
assume that another pump B' can be obtained, having the same $5000 initial cost, $1000 salvage value, and 6-year life,
the cash flow will be as follows:
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1000 1000
t
O- -l- -2- -3- -4- -5- -6- -7- -8- -9- - IO- -JJ - - J2
t
,l Pmnp B
6 years
1 Repl=mrn<Pu..,B'
6 years ~ I
For the 12-year analysis period, the present worth for Pump Bis
PW8 = - 5000 + 1000(PJF , 7% 6) - 5000(PJF, 7% 6)

+ 1000 PJF , 7% 12)
= - 5000 + 1000 - 5000)(0.6663 ,+ 1000(0.4440)
= - $7221
By assuming that the shmter-Jife equipment is replaced by equipment with identical economic consequences, we
have avoided a lot of calculations. Select Pump A.
5-BUTI'ON SOLUTION
A B C En F G ff I
1 Exp. 5-4 i n PMT PV FV Solve for Answer Formula
2 Pump A 7% 12 0 1200 PV -$533 =PV(B2,C2,D2, F2)
3 $533 change sign
4 -$7,000 Injtial cost
5 -$6,467 PW
6 Pump B yr6 7% 6 0 -4000 PV $2,665 =PV(B6,C6,06, F6)
7 yr 12 7% 12 0 1000 PV -$444 =PV(B7,C7,D7,F7}
8 -7000 -$2,221 sum & change sign
9 yr 0 -$5,000 Injtial cost
10 -$7,221 PW
We have seen that setting the analysis period equal to the least common multiple of the lives of the two alternatives
seems reasonable in .Example 5-4. However, what if the alternatives had useful lives of 7 and 13 years? Here the least
common multiple of lives is 91 years. An analysis period of 91 years hardly seems realistic. Instead, a suitable analysis
period should be based on how long the equipment is likely to be needed. This may require that terminal values be
estimated for the a1ternatives at some point prior to the end of theh" useful lives.
As Figure 5- 1 shows, it is not necessary for the analysis period to equal the useful life of an alternative or some
multiple of the useful life. To properly reflect the situation at the end of the analysis period, an estimate is required of the
market value of the equipment at that time. The calculations might be easier if everything came out even, but this is not
essential.
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AJternat iH! 1
Salvage Terrni a.al Value at
Value End of 1011, Year
t t
_J
0----1- -2- -3- -4- -5- -6- -7- -S- -9- -IO- -l l- - 12- - 13- -14
jInitial
Co.st
Replacement!
Cost · I
I
i
i - - - - - - 7-year Life - - - - - -- -- - - - - - 7-year Lii
I
AJte-rnath·e 2
Te rrni nal Value at
End of IOtt, Year
0----1- -2- -3- -4- -5- -6- -7- -&- -9- -IO- -ll- - 12- - l.3
t
jInitial
Cost
!
I
I
.
13-year Life i
I:i - - - - - - - - 10-yearAnalysis Peiri od - - - - - - - -
FIG RE 5-1 Superimposing a 10-year analysis period on 7- and 13-year alternatives.
EXAMPLE5-5
A diesel manufacturer is considering the two alternative production machines graphically depicted in Figure 5- 1.
Specific data are as follows:
Alt. 1 Alt. 2
Initial cost $50,000 $75,000
Estimated salvage value at end of usefuJ lif,e $10,000 $12,000
Useful life of equipment, in years 7 13
The manufacturer uses an interest rate of 8% and wants to use the PW method to compare these a]ternaHves over an
analysis period of 10 years. To do so, the market values at year 10 must be estimated. Alt. 1 wiU be 3 years into its
"second" life and Alt. 2 will be nearing the end of its "first" Jife.
Alt.1 Alt. 2
Estimated market value, end of 10-year analysis period $20,000 $15,000
SOLUTION
In this case, the decision maker is setting the analysis period at 10 years rather than accepting a common multiple of
the lives of the alternatives, or assuming that the pe1iod of needed service is infinite (to be discussed in the next
section). This is a Jegitimate approach- perhaps the diesel manufacturer will be phasing out this model at the end of
the 10-year period. In any event, we need to compare the alternatives over 10 years.
As illustrated in Figure 5-1, we may assume that Alternative 1 will be replaced by an identical machine after its 7-
year useful life. Al.ternative 2 has a 13-year useful life. The d1esel manufacturer has provided an estimated market
value of the equipment at the time of the analysis period. We can compare the two choices over 10 years as foUows :
PW (Alt. 1 = - 50,000 + (10,000 - 50,000)(P / F, 8% 7) + 20,000(P JF, 8 • 10

=- 50,000 - 40 000(0.5835 , + 20,000(0.4632
= - $64,076
PW (Alt. 2 = - 75,000 + 15,000(P / F , 8%, 10)

= - 15,000 + 15,000(0.4632,
= - $68,052
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To minimize PW of costs the diesel manufacturer should select Ah. 1.
Infinite Analysis Period: Capitalized Cost

Some present wotth analyses use an infinite analysis period (n = . In governmental analyses, a service or condition
sometimes must be maintained for an infinite period. The need for roads, dams, pipeJines, and so on, is sometimes
considered to he permanent. In these situations a present wmth of cost analysis would have an infinite analysis petiod. We
call this particular analysis capitalized cost
Infinite Uves are rare in the private sector, but a similar assumption of "indefinitely long" horizons is sometimes made.
This assumes that the facility will need elecuic motors, mechanical HVAC equipment, and forklifts as long as it operates
and that the facility wilJ last far longer than any individual unit of equipment. So the equipment can be analyzed as though
the problem horizon is infinite or indefinitely long.
Capitalized cost is the present sum of money that would need to be set aside now, at some interest rate, to yield a
uniform cash flow indefinitely. To accomplish this, the money set aside for future expenditures must not decline. The
interest received on the money set aside can be spent. but not the principal. When one stops to think about an infinite
analysis period, we see that an unchanged principal sum is essential.
In Chapter 3 we saw that
P1incipal um+ Interest for the period = Amount at end of period, or
p
+ iP P+iP
If we spend iP, then in the next interest pe1iod the principal sum P will again increase to P + iP. Thus, we can again
spend iP.
Th.is concept may be illustrated by a numerical example. Suppose you deposited $200 in a bank that paid 4% interest
annual1y. How much money could be withdrawn each year without reducing the balance in the account below the initial
$200? At the end of the first year, the $200 would have eamed 4%($2.00) = $8 interest. lf this interest were withdrawn, the
$200 would remain in the account. At the end of the second year, the $200 balance would again earn 4%($200) = $8. This
$8 could also be withdrawn and the account would still have $200. This procedure could be continued indefinitely and the
bank account would always contain $200. If more or less than $8 is withdrawn each year, over time the account will either
increase to or decrease to 0.
The year-by-year situation would be depicted like this:
Year I.: 200 initial P ➔ 200 + 8 = 208

Withdrawal iP =- 8
Year 2.: $200 ➔ 200 + 8 = 208

Withdrawal iP = - 8
200
and so on
Thus, for any i.nitial present sum P, there can be an end-of-period withdrawal of A equal to iP each period, and these
withdrawals can continue forever without diminishing the initial sum P. This gives us the basic relationship:
For n = , A = iP
This relationship is the key to capitalized cost calculations. Earlier we defined capitalized cost as the present sum of
money that would need to be set aside at some interest rate to yield the funds to provide the desired task or service
forever. Capitalized cost is therefore the P in the equation A = iP. It follows that:
A (5-2)
apitalized co t P =~
l
If we can resolve the desired task or service into an equivalent A. the capitalized cost can be computed. The following
examples illustrate such computations.
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EXAMPLE5-6
How much should one set aside to pay $5000 per year for maintenance on a small park if interest is assumed to be 4%?
For perpetual maintenance, the p1incipa] sum must remain undiminished after the annual disbursement is made.
SOLUTION
Annual disbut ement A
Capitali.zed cost P = - - - - - - - -
lntere t rate i
5000
P= - = $125000
0,04 '
One should set aside $125,000.
EXAMPLES-7
A city plans a pipeline to transport water from a distant watershed area to the city. The pipeline will cost 8 million and
will have an expected life of 70 years. The city expects to keep the water line in service indefinitely. Compute the
capitalized cost, assuming 7% interest.
SOLUTION
The capitalized cost equation
P= ~
l
is simple to apply when there are end-of-period disbursements A. Here we have renewals of the pipeline every 70
r---J4•r
years. To compute the capitalized cost, it is necessary to first compute an end-of-pe1iod disbursement A that is
equivalent to $8 million every 70 years .
1-=r ,. - - - - -n=oo
Capi tal ized Cost 8 mill ion $8 rnillio11 $8 million $8 million

p
The $8 million disbursement at the end of each 70-year period may be resolved into an equivalent A
O
-r immm~immuu
=
n=70
$8 million
A = FA / F i, n · = $8 million(A/ F , 7% 70)
= $8 million(0.00062)
= $4960
Each 70-year petiod is identical to this one, and the infinite series is shown in Figure 5-2.
. li· z ed c o st P = 8 m1·1~10
Cap1ta 1• A = 8· 1111·11·10n + 4960
11 + T 0 _07
= $8,071 000
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i- triiii-ni-imwnnimun-nni-iu . . nin~i+nii1
Capitaliied
=
A = 4960
00
Cost 8, millio11
FIGURE 5-2 Using the sinking fund factor to compute an infinite series.
ALTERNATE SOLUTION 1
Instead of solving for an equivalent end-of-period payment A based on a furure $8 million disbursement. we could find
A, given a present $8 million disbursement .
A = PA / P,i n) = 8 million(A/ P 7%. 70)

= 8 million(0.0706) = 56.S 000
On this basis, the infinite series is shown in Figure 5-3. Carefully nore the difference between this and Figure 5-2.
Now:
4= ~~~
Capitalized cost P= 5 = $8,071 .000
1-=i-ininnnnnnnnnnnnnn . . ninnnnn
P A = 565,000
FIGURE 5-3 Using the capital recovery factor to compute an infinite series.
ALTERNATE SOLUTION 2
Another way of solving the problem is to assume the interest period is 70 years long and compute an equivalent
interest rate for the 70-year pe1i od. Then the capitalized cost may be computed by using Equation 3-8 form = 70
h oyr = 1 + ir yr)70 - 1 = (1 + 0.07 70 - 1 = 112.989
. r1zed cost
C ap1ta = 8 m1'Ir10 n + 8112
million
_989 = 8 070
• •,803,
MULTIPLE ALTERNATIVES
So far rhe discussion has been based on examples with only rwo alternatives. But multiple-alternative problems may be
solved by exactly the same methods. (The only reason for avoiding multiple alternatives was to simphfy the examples.)
Examples 5-8 and 5-9 have multiple alternatives.
EXAMPLE5-8
A contractor has been awarded the contracr to constmct a 6-mile-long tunnel in the mountains. Dming the 5-year
construction period, the contractor will need water from a nearby stream. She will construct a pipeline to can)' the
water to the main construction yard. An analysis of costs for various pipe sizes is as follows:
Pipe Sizes (in.)
2 3 4 6
Installed cost of pipeline and pump $22,000 $23,000 $25,000 $30,000
Cost per hour for pumpin g $1.20 $0.65 $0.50 $0.40
At the end of 5 years, the pipe and pump will have a salvage va]ue equal to the cost of removing them. The pump
wil1 operate 2.000 hours per year. The lowest interest rate at wMch the contractor is willing to invest money is 7%. (The
minimum required interest rate for invested money is called the minimum attractive rate of return, or MARR.)
Select the alternative wid1 the least present wmth of cost.
18 of 49 1/25/2020, 10:48 AM
SOLUTION
We can compute the present worth of cost for each alternative. For each pipe size, the present worth of cost is equal to
the installed cost of the pipeline and pump plus the present wmt h of 5 years of pumping costs .
Pipe Size (in.)
2 3 4 6
lnstaUed cost of pipeline and pump $22,000 $23,000 $25,000 $30,000
1.20 x 2000 hr x (P/A, 7%, 5) 9,840
0.65 X 2000 tu )( 4.100 5,330
0.50 x 2000 hr x 4.100 4,100
0.40 X 2000 tu )( 4.100 3,280
Present worth of cost $31,840 $28,330 $29,100 $33,280
Select the 3-in. pipe, since rhe lowest present wonh of cost.
EXAMPLE5-9
An investor paid $8000 to a consuhing firm to analyze possible uses for a small parcel of land on the edge of town that
can be bought for $30,000. In their repmt, the consultants suggested four alternatives:
Alternatives Total Investlllent lnduding Land* Uniform Net Annual Benefit Terminal Value at End of 20 yr
A Do nothing $0 $0 $0
B Vegetable market 50,000 5,100 30,000
C Gas station 95,000 10,500 30,000
D Small motel 350,000 36,000 150,000
* Includes the land and structures but does not include the $0000 fee to the consultin~ firm.
Assuming 10% is the minimum attractive rate of return, what should the investor do?
SOLUTION
Alternative A is the "do-nothing" alternative. GeneraUy, one feasible alternative is to remain in the present status and
do nothing. The investor could decide that the most attractive alternative is not to purchase the pmpeny at al].
Note that if the investor does nothing, then the total venture would appear to be an unsatisfactory one because of the
$8000 spent on professional advice. However, because the $8000 is a past cost, it is a sunk cost. The only relevant
costs in an economic analysis are present and furure costs. Sunk costs are gone and should not be allowed to affect
future planning. (Past costs may be relevant in computing depreciation charges and income taxes, but nowhere else.)
The past should not deter the investor from making the best decision now.
This problem is one of neither fixed input nor fixed output, so our criterion will be to maximize the present worth of
benefits minus the present wmth of cost; that is, to maximize net present worth.
Alternative A, Do Nothing
NPW = O
Alternative B, Vegetable Market
NPW =- 50,000 + 5100 PJA, 10%, 20) + 30,000(PJF, 10%,20)
= - 50,:000 + 5100(8.514 + 30,000(0.14&6)
=- 50,000 + 43,420 4460

= - $2120
Alternative C, Gas Station
NPW = - 95,000 + 10,500 PJA, 10%, 20) + 30,000 PJF, 10%,20 ,

= - Q.5J100 + SQ.400 + 4460 = - . 1140
19 of 49 1/25/2020, 10:48 AM
=- 9),UUU + 1SY,4UU + 44t>U = - ·1 t4U
Alternative D, SmaJl Motel

NP\V = - .350,000 + 6 OOO(P/ A, 10%, 20 + I 50,000(P / F, 10%, 20)
= - 350 000 + 306 500 + 22,290 = - $21 ,210
The ni.terion is to maximize net present wmt h. In this situation, one alternative has NPW equal to zero, and three
alternatives have negative values for NPW. We will select the best of the four alternatives, namely, the do-nothing Alt.
A , with NPWequal to zero.
5-BUITON SOLUTION
A B C D E F G H
1 AHemati.ve i n PMT PV FV Sol.ve for Answer
2 Vegetable market 10% 20 5100 30,000 PV -$47,878
3 50,000 total =-H2+E3 -$2, 122
4
5 Gas station 10% 20 10,500 30,000 PV -$93,852
6 -95,000 total = -H5+E6 -$1, 148
7
8 Small otel 10% 20 36,000 150,000 PV -$328,785
9 -350,000 total =-H8+E9 -$21,215
Since the total present wmth of each action alternative is negative, the best choice is to do nothing. Note that In this
case the PV of the positive annual revenue and positive salvage value is negative. To compute the present worth of
each alternative, we must suhtract the PV values in H2, H5, and HB.
APPLICATIONS AND COMPLICATIONS
EXAMPLE 5-10
Two pieces of constmction equipment are being analyzed.
Year Alt. A Alt. B
0 -$15, 000 -$12, 000
1 5, 000 3, 500
2 4, 500 3, 500
3 4, 000 3, 500
4 4, 000 3, 600
5 4, 000 3, 700
At an 8% interest rate, which alternative should be selected?
SPREADSHEET SOLUTION
In this case the cash flows are so irregular that it is easier and dearer to treat them as individual data block entries.
Time can be saved by dragging or double-dicking on the cell corners to copy the cash flows and gradients.
20 of 49 1/25/2020, 10:48 AM
A B C
I S% l.nte rest rate
- Ye,ar Alt.A
-$15,000
AltB
-$ l2,000
3 0
4 I 5,COO 3,500
5 2 4,500 3,500
6 3 4,000 3 500
7 4 4,000 3,600
g 5 4,000 3,700
9 / $2,325 $2,184
/
''
IO
II =B3+NPV($A$ I,B4:B8)
12 =C3+NPV($ASl,C4:C8)
TABLE SOLUTION
Ahernative A
r~-T-~r- r-r
0- -1- -2- -3- -4- -5
l
15,000
PW of benefit = 4000(PJA 8%, 5) + (5000 - 4000 PJA, 8%, 3) - 500 PJG, 8~ 3)

= 4000(3.993 · + 1000(2.577 · - 500(2.445 = 17,326
PW of cost = 15, 000
Net present worth = 17. 326 - 15 000 = $2326
Alternafr,·e B
, r_}r _T.Jr==~r
0- -1- -2- -3- -4- -5
j
12,00'.l
PW of benefits = 3500 P/ A,8% 5) + 100 P/ G,8%, 3 PJF,8% 2 ·

= 3500 3.993) + 100(2.445 0.8573) = 14,185
PW of cost = 12 000
Net pre ent woith = 14 185 - 12,000 = $2185
To maximize PW, choose Alt. A
21 of 49 1/25/2020, 10:48 AM
EXAMPLE 5-ll
A p:i.ece of land may be purchased for $610,000 to be strip-mined for the underlying coal. Annual net income will be
$200,000 for 10 years. At the end of the 10 years, the surface of the land will be restored as required by a federal law
on strip-mining. The reclamation will cost .$.1.5 million more than the resale value of the land after it is restored. Using
a 10% interest rate, detetmine whether the project is desirable.
SOLUTION
The investment opportunity may be described by the following cash flow:
Year Cash Fh1w (thousands)

0 -$610
1-10 + 200 (per year)
10 -1500
NPW = - 610+200(P/A 10%, JO - 1500(P/ F, 10%, 10)

= - 610 + 200(6.145) - 1500(0.3855
= - 610 + 1229 - 578
= + $41
Since PW is positive, the project seems desirable. However, at interest rates below 4.07% or above 18.29%, the NPW
is negative, indicating an undesirable project. This indicates that the project is undesirable at 4% and desirable at 10%.
This does not make sense. The results warn us that PW may not always be a proper criterion for judging whether or
not an investment should be undertaken. In this example the disbursements ($610,000 + $1,500,000) exceed the
benefits (10 x $200,000), which ce1tainly does not portray a desirable investment. Thus Example 5-11 shows that
NPW calculations in certain infrequent conditions can lead to unreliable results. Very large environmental cleanup
costs can cause this, as in this example. Appendix 7A addresses this in more detail.
Spreadsheets make it easy to build more accurate models with shmter time pe1iocls. When one is using factors, it is
common to assume that costs and revenues are uniform for n years. With spreadsheets it is easy to use 120 months instead
of 10 years, and the cash flows can be estimated for each month. For example, energy costs for air conditioning peak in
the summer, and in many areas there is little constmction during the winter.
Example 4-14 illustrated how spreadsheets can be used for aiithmetic and geometric gradients. The latter are
Important, because cash flows that depend on population often Increase at x% per year, such as for electric power and
transportation costs. Example 5-12 is another Hlustration of how spreadsheets support models that more closely match
reality.
EXAMPLE 5-12
Regina Industries has a new product whose sales are expected to be 1.2, 3.5, 7, 5, and 3 million units per year over the
next 5 years. Production, distribution. and overhead costs decline 10% per year from $140 per unit in the first year. The
price wilJ be $200 per unit for the first 2 years and then $180, $160, and $140 for the next 3 years. The remaining R&D
and production costs are , 300 million. If i is 15%, what is the present wmth of the new product?
SOLUTION
All of the variable values are entered in the spreadsheet's data block, except for the yearly volume. Since each year is
different, these values are simply entered into column B. Note that the gradient for revenue per unit first makes a
difference in Year 3.
22 of 49 1/25/2020, 10:48 AM
A B C D E F G
I $300 Fiist oo:st ($M}I
2 Sl40 Lnitial unit co.~t
3 -10% Geometric gradie nt for co.,;t
4 S200 Initial unit reve nue
5 -S20 Arithmetic c h.an ge in unit revenue for vears 3 to 5
6 15% Interest rate
Re enue Co..~t Net reve nue
7
Y ear Volume(M) unit un it unit Ca.~h tlow
g 0 -5300.0 .,.-SASI
9 I 1.2 s200 S140 %0 72.0
10 2 3. 5 200 126 74 2 59 .0 - BIO"EI0
II 3 7.0 l&O 113 67 466..2
12 4 5.0 160 102 58 289.7
s _ 140
13
14
3 .0
__.......,,.. .,.,v ....- 92 48 14 4 .4
IS / D12°(1+SAS.3) PW (SM) sso2

16 Cl 2+SAS 5 F8+NPV(SA$6,.f9 '.FI 3)
With a present wmt h of over $500M, thfa is a desirable proj ect.
Examp]e 5-13 uses the XNPV spreadsheet function, which finds the present wmt h of a series of cash flows that occur
on specific dares. The NPV function assumes that time 0 is one period before the first cash flow, so time 0 must not be
included in the function's range. X PV is different Time 0 must be specified just like every other date--even if there is
no cash fl ow at time 0. The time 0 date specifies the when for the net present value or present worth. The interest rate for
the XNPV function is an effective annual rate, and XNPV is using calendar dates, so leap year has an extra day and the
daily interest rate is slightly smaJler in leap years.
EXAMPLE 5-13
A construction firm has just won a contract for $2.25 million. If work fa completed on schedule, it will receive a series
of progress payments. The first $100,000 will be received 15 days after the contract is signed. Fmther payments of
$450,000 each will be received at 45 and 180 days. The remaining $1.25 mi.llion will be received 390 days after the
contract is signed. If the firm's interest rate is 9.5%, what is the present worth of the progress payments on the contract
signing date of September 23, 2019?
SOLUTION
Notice that the X PV function specifies the range of cash flows and then the range of dates.
A B C
1 9.50% I nterest rate
2
3 Days Dates Ca:s h tlows
4 0 9/23/201§ 0
5 15 10/08/201§ $ 100,000
6 45 11/07/2019 450,000
7 180 3/21/202( 450,000
8 390 10/17/202( 1,250,000
9 I
IO - Sll$4+A8
II $2,109,403 =XNPV(A 1,C4:C8, B4:B8 l
The two key differences between the 'PV and XNPV functions can be seen in Examp]e 5-13. X PV includes:
• The time 0 cash flow, as in ceU C4.
• A fina] anmment of the ramie of dates for the cash flows. as in cells B4 to B8.
23 of 49 1/25/2020, 10:48 AM
• A nna1 argumem oI me range or aares ror me casn nows, as m ceus .tl"+- rn tlO.
Bond Pricing
The calculation in Example 5-14 is done routinely when hands are hought and sold during their life. Bonds are issued at a
face or par value (usually $1000), which is received when the bonds mature. There is a coupon interest rate, which is
set when the bond is originally issued or sold. The term coupon interest dates from the time when bonds were paper rather
than electronic, and a paper coupon was detached from the hand to be redeemed in cash. This rate is a nominal interest
rate. Most bonds pay interest semi-annually which is calculated as (face value) x (coupon rate)/2. Some bonds have other
compounding periods. A cash flow diagram for the remaining interest payments and the final face value is used with a
current interest rate to calculate a present wmth. This is the bond's price.
Bond pricing calculations are impo1tant because selling bonds is the principal source of new external funds for existing
firms. Bonds are also how govemments fund many projects for bridges, schools, airpm1s, dams, and so on. Bonds are also
considered a safer way for individuals, pension funds, and other entities to invest.
Appendix lOA is about the return and risks of portfolios including bonds and stocks. A hand is a contract to deliver
interest payments when due and the face value of the bond at maturity. The cash flows are on known dates and of known
amounts. When interest rates rise above the coupon rate, those future cash flows are discounted more and the bond sells at
a discount When interest rates fall below the coupon rate, future cash flows are discounted less and the bond sells at a
premium. Bonds of the federal government are safer than bonds of a firm or many cities and nations. The U.S.
government is less likely to default or not pay interest or face value when due. See Appendix 9A for past interest rates on
government bonds.
EXAMPLE 5-14
A 15-year municipal bond was issued 5 years ago. Its coupon interest rate is 4%, interest payments are made
semiannually, and its face value is $1000. If the crnrent market interest rate is 6.09%, what should be the bond's price?
Note: The issuer of the bond (cHy, state, company) makes interest payments to the bondholder (at the coupon rate), as
well as a final value payment.
TABLE SOLUTION
The first 5 years are past, and there are 20 more semiannual payments. The coupon interest rate is the nominal annual
rate or APR Half that, or 2%, of $1000 or $20 is paid at the end of each 6-month period.
The bond's price is the PW of the cash flows that will lbe received if the bond is purchased. The cash flows are $20
at the end of each of the 20 semiannual periods and the face value of $1000 at the end of period 20.
$20 + $1000
520
t t t t t t t
O- -l- -2- - 3 -4- -5- -6VVV\. l7- - 18 - - 19- -20
t t t
Since the $20 in interest is received semiannually, the market or effective annual interest rate (i0 ) must be converted to
a semiannual rate. Using Equarion 3-8, we obtain
(l + t)°2 = 1 + ia = 1.0609
(l i) = 1.03
i = 3% semiannual intere t rate
PW = 20 P/ A,3% 20 + 1000(P/ F, 3% 20
= 20 14,877) + 1000(0.5537 = $851.24
The $851.24 is the discounted p1ice;. that is, the PW at 6.09% of the cash flows from the $1000 bond. The $148.77
discount raises the investment's rate of return from a nominal 4% for the face value to 6.09% on an investment of
$851.24.
24 of 49 1/25/2020, 10:48 AM
5~BUITON SOLUTION
II A G H
A B C u E F G H
1 Problem i n PMT PV FV Solve for Answer
2 Exp. 5-14 3% 20 20 1000 PV -$851.24
This example also illustrates why it is better to separately state cash flows. At the end of period 20, there are two cash
flows, $20 and $1000. The $20 is part of the 2O-period uniform series, and the $1000 is a single cash flow. All of these
numbers come directly from the problem statement. If the two final cash flows are combined into $1020, then the $20
uniform series has only 19 periods~nd it is easy to e1T and forget that change.
SUMMARY
Present worth analysis is suitable for almost any economic analysis problem. But it is patticu]ady desirable when we wish
to know the present wmth of future costs and benefits. We frequently want to know th e value today of such things as
income-producing assets., stocks., and bonds.
For present wmth analysis, the proper economic criteria are:
either input nor aximize (PW of benefits - PW of costs)
output is fixed or, more simply stated:
aximizeNPW
Fixed input aximize the PW of benefits
Fixed output htimize the PW of costs
To make valid comparisons, we need to analyze each alternative in a problem over the same analysis period or
planning horizon. If the alternatives do not have equal lives, some technique must be used to achieve a common analysis
period. One method is to select an analysis period equal to the ]east common multiple of the alternative lives. Another
method is to select an analysis period and estimate end-of-analysis-period salvage values for the ahematives.
Capitaliz.ed cost is the present wmth of cost for an infinite analysis period (n = ). When n = , the
fundamental relationship is A = iP.
The numerous assumptions routinely made in solving economic analysis problems include the following.
1. Present sums (P) are beginning-of-period, and all series receipts or disbursements (A) and future sums (F) occur at
the end of the interest period. The compound interest tables were derived on this hasis.
2. In industrial economic analyses, the point of view for computing the consequences of altematives is that of the total
firm. a1TOwer views can result in suboptimal solutions.
3. Only the differences between the alternatives are relevant. Past costs are sunk costs and generally do not affect
present or future costs. For this reason they are ignored.
4. The investment problem is isolated from the financing problem. We general1y assume that all required money is
bonuwed at interest rate i.
5. For now, stable prices are assumed. The inflation-deflation problem is deferred to Chapter 14. Similarly, our
discussion of income taxes is defe1Ted to Chapter 12.
6. Often unifmm cash flows or arithmetic gradients are reasonable assumptions. However, spreadsheets simplify the
finding of PW in more complicated problems.
STUDENT STUDY GUIDE

These questions are intended for self-study. Click the [solution] box to reveal a detailed solution.
5- A tax refund expected 1 year from now has a present worth of $3000 if i = 6%. What is its present worth if i = 4%?
1
5- Investment in a crane is expected to prod uce pmfit from its rental of $15,000 during the first year of service. The profit is expected
2. tn rlPrT-P~SP hv $7"i00 P~ch V Mr thPl'f'.:lfti>r. At 17% intPl-P.~t. finrl thi> nrP.~i>nt worth o f thi> n mfits.
25 of 49 1/25/2020, 10:48 AM
'l. to decrease by $l 3UU each year thereatter. At 11% interest, find the present worth o t the protits.
Wi1•Gi08i
5- Strickland Storage Inc. leases storage units for $200/morrth. Calculate the present worth of 12 lease payments at 6%.
5- The win ner of a sweepstakes prize is given the choice of a one-ti.me payment of $1,000,.000 or a guaranteed $80,000 per year for
4 20 years. If the value of money is 5%, which option shou]d the winner choose?
WiN•Gi081
5- A local car wash charges $3 per wash, or one can pay $12.98 for washes, payable in advance with the first wash. If yo u normaUy
5 washed your car once a month, and your cost of money is 1 % compounded monthly, would the option be worthwhile?
Wi•ll'•U-ki
5- A project being considered by the XYZ Company wrn have $100,000 in constrnction costs in each of the firs t 3 years of the
G project Income of $100,000 will begin flowing in Year 4 and will continue through Year 10. Fin d the net present worth at 4% of
the proj ect
Wi-1•Gi081
5- The community theater spends $10,.000 annually to produce a musical extravaganza. Immediately before this year's extravaganza,
7 the theater had a balance of $60,000 in an account paying 4% interest. After this year, how many extravaganzas can be sponsored
without raising more money?
Wi•ll'fic•ii
5- The annual income from an apartment house is $20,000. The annual expense is estimated to be $2000. If the apartment house can
8 be sold for$100,000 at the end of 10 years, how much should you be willing to pay for it now, with a 11eqwred return of 10%?
Wi•l•Gi081
5- Your company has been presemed with an opportunity to invest in the following project The facts on the project are:
9
lnvestment required $90,000,000
Salvage value after 10 years 0
Gross income 20,000,000
Annual operating costs:
Labor 2,500,000
Materials, licenses, insurance, etc."' 1,000,000
Fuel and other costs 1,500,000
Ma.i.ntenance costs 500,000
,;,Beginning-of-period cash flow
The project wiU operate for 10 years. If management expects 8% on its investments before taxes, would you recommend this
project?
Wi-!•Gi081
5- Sarah Bishop, having become a very successful engineer, wishes to start an endowment at TM that will provide scholars hips of
10 $10,000 per yea.r to four engineering students beginning in Year 6 and continuing indefinitely. Determjne the amount Sarah must
donate now if the university earns 10% per year on endowment funds .
Wi•ll'dM§i
5- What is the maxjm um amount you should be wiUing to pay for the followin g piece of equipment? First-year income is anticipated
11 to be $18,000 and decrease by $1500 each year thereafter. First-year costs are antici pated to be $5000 and increase by $500 each
year thereafter. The saJvage val ue is estimated to be 8.5% of the firs t cost. Use an interest ra te of 4% and usefuJ life of 5 years .
WidGi081
5- Find the present worth of the following cash flow diagram if i = 8 %.
12
26 of 49 1/25/2020, 10:48 AM
0 1 2 3 4 5 6 7 8 9 10
100 150 150 100

200 200
250 250
300 '
3 ,o 300
5- A couple wants to begin saving money for thei.r daughter's education. $16,000 wiJJ be needed on the child 's 18 th birthday, $18,000
13 on the 19 th birthday,. $20,000 on the 2olh birthday, and $22,000 on the 21st birthday. Assume 5% interest with annual
compounding. T he couple is considering two methods of accumulating the mon ey.
a. How much money would have to be deposited foto the account on the child's first birthday to accumuJate enough money to
rover the education expenses? (Note: A chi]d's "first birthday" is celebrated 1 year after the child is bom.)
b. What uniform annua] amount would the couple have to deposit each year mi the child's first th ro ugh seventeenth birthdays to
accumulate enough money to cover the education expenses?
Wffl•!iihS•
5- Assume that you borrowed $50,000 at an interest rate of 1% per month, to be repaid in uniform monthly payments for 30 years.
14 How much of the 163 rd payment would be interest, and how much would be principal?
Wi•ll'Pi0¥i
5- A town is seeking a new tourist attraction, and the town counciJ has voted to budget $500,000 for the project. A survey shows that
15 an interesting cave can be enlarged and developed for a contract price of $400,000. The proposed attraction is expeded to have an
jn fin ite life. The estimated annual expenses of operation total $50,000. The price per ticket is to be based on an average of 12,000
visitors per year. If money is worth 8%, what should be the price of each ti~et?
Wi•!l!ii 081
5- Two alternatives are being considered for recovering aluminum from garbage. Alternative 1 has a capital cost of $100,000 and a
16 fi rst-year maintenance cost of $12,000, with maintenance increasing by $500 per year fo r each year after the first.
Alternative 2 has a capital cost of $140,000 and a first-year maintenance cost of $4000, with maintenance increasing by $1000 per
year after the first.
Revenues from the sale of aluminum are $20,000 in the first year~ increasing $2000 per year for each year after the first. The Ufe of
both aJtematives is 10 years. There is no salvage value. The before-tax MARR is 4%. Use present worth analysis to determine
which alternative is prefeITed.
Wi■a§ju8•
5- As a temporary measure, a brewing company is deciding between two used fllling machines: the Kram and the Zanni.
17 a. The Kram fiUer has an injtial cost of $85,000; the estimated annual ma.intenance is $8000.
b. The Zanni filler has a purchase prk e of $42,000, with annual. maintenance costs of $8000.
The Kram filler has a higher efficiency than the Zanni, and .it is expected that savings would amount to $4000 per year if the Kram
fiUer were installed. The filling machine wiJI not be needed after 5 years, and at that time, the salvage value for the Kram filler
wouJd be $25,000, whi.le the Zanni would nave littJe or no val ue . Assuming a MARR of 10%, which filling machine should be
purchased?
Wi•'8Gd-81
5- cClain, Edwards, SMver, and Smith ( ESS) LLC is considering the purchase of new automated cleaning equipment. The
18 industrial enginee.r for the company has been asked to caJculate the present worth of the tvrn best alternatives based on the
fonowing data.
Mess Away Quick Dean
First cost $65,000 $78,000
27 of 49 1/25/2020, 10:48 AM
Annual savings 0,000 24,000

Annual operating costs 4,000 2,750
Scheduled ma.intenance $1500 at the end of 3rd year $3000 at the end of 3rd year
Annual insurance>!< 2,000 2,200

Salvage value 10% of first cost 12.5% of first cost
Useful bfe 5 years 5 years
"" Assume beginnjng-of-period payments.
Detennine whkh equipment should be purchased, given an interest rate of 8%.
Wi■!•Gd•Si
5- Helbing Construction has just been awarded a conu.ict that will require the company to either purchase or lease a new track hoe.
19 The equipment will be needed for the ,entire length of the 4-year contract The equipment can be leased for $85,000 per year. All
ope111ting costs must be paid by Helbing. These are estimated to be $56,000 per year. AIJ other expenses wiU be paid by the leasing
company. If the track hoe is purchased, the firs t cost wiJJ be $485,000 and the antici pated salvage value is $365,000 at the end of
the 4 years. The annual operating costs a11e expected to be $75,000 with an additional majntenance costing $5000 occurring at the
end of Year 2. If Helbing's ARR is 5%, shou]d the company lease or purchase the track hoe?
Wffl•Gi081
5- Gullett Glue must replace a machine used to fill gJue tubes. The relevant data concerning the machines under cons.ideration are
20 presented in the table befow. If the MARR for GG is 5%, determine which machine shouJd be purchased.
HU-Rite Best-Fill
First cost $72,000 $68,000
$6,000 the first year increasing
Annual costs $7,800 per year
by $750 ea.c h year thereafter
Overhaul $7,525 at the end of ¥ear 4 $8,000 at the end of Year 4
Salvage value 7.5% of first cost $5,500
Useful life 8 years 8 years
5- Two alternatives are under consideration by XYZ Inc. Alternative A has a NPV of $1,243 and a li fe of 4 years. Alternative B has a
2.1 PV of 2,196 and a life of 8 years. Which alternative should XYZ select if the MARR is 5%?
Wi•1•Gi 081
5- A project has a first cost of $10,000, net annual benefits of $2000, and a salvage value of $3000 at the end of its 10-year useful life.
2.2. The project will be replaced identicaUy at the end of 10 years, and again at th.e end of 20 years. What is the present worth of the
entire 30 years of service, given an interest rate of 10%?
Wi•ll'd 081
5- Using a 10% interest 1.ite, determine which alternative, if any, should be selected.
2.3
Alternative A B
First cost $5300 $10,700
Uniform annual benefit 1800 2,100
Useful ]jfe 4 years 8 years
Wi•ll'd 081
5- The lining of a chemical tank in a certain manufacturing operation is replaced every 5 years at a cost of $5000. A new type of
2.4 lining is now available that would last 10 years but it costs $9000. The manufacturer's tan k needs a new lining now, and the
company intends to Uf>e the tank fo r 40 years, replacing linings when necessary. Compute the present worth of costs of 40 years of
service for the 5-year and 10-year linings if i = 10%.
Wi■!•Gi 081
5- Be~low Mining, Inc., is trying to decide whether it should purchase or lease new earthmoving equipment. If purchased, the
2.5 equjpment wiU cost $175,000 a11d will be used 6 years, at which time it can be sold for $72,000. At Year 3, an overhaul costing
$20,000 must be performed . The equipment ca11 be leased for $30,000 per year. Be-low will not be respons.ible for the midJife
28 of 49 1/25/2020, 10:48 AM
L Printed by: [email protected]. Printing is for personal, private use only. No part of this book
. ... '-' .
overhaul if the equipment is l,eased. If the equipment fa purchased, it win be leased to other mining companies when possible; this
is expected to yield revenues of $15 000 per year. The annual operating cost regardless of the decision will be approximately equal
What would you recommend if the MARR is 6%?
WidGi081
5- Two technologies are currently avaiJable for the manufacture of an important and expensive food and drug additive.
2.6 Laboratory A is willing to release the exclusive right to manufacture the additive in this country for $50,000 payable immediately,
and a $40,000 payment each year for the next 10 years. The production c-osts are $1.23 per unit of product.
Laboratory B is also willing to re.lease similar manufactming rights, with the foHowing sched ule of payments:
on the closing of the contract, $10,000
from Years 1 to 5, at the end of each year, a payment of $25,000 each
from Years 6 to 10, aJso at the end of each year, a payment of $20,000
The production costs are $1.37 per unit of product.
either lab is to receive any money after 10 years for this rnntract. It is anticipa ted there wiU be an annua.1 production of 100,000
items for the next 10 years. On the basis of analyses and trials, the products of A and B are practicaUy identical in quality.
Assuming a MARR of 12%, whic.h fab should be chosen?
Wi•!l'fic•ii
5- An engineering analysis by net present worth (NPW) is to be made for the purchase of two devices, A and B. If an 8% interest rate
2.7 is used, recommend the device to be purchased.
Uniform
Cost Salvage Useful Life
Annual Benefit
Device.A $600 $100 $250 5 years
Device B 700 100 180 10 years
5- An engineer is considering buying a life insurance policy for his family. He cunently owes $50,500, and he would like his family
28 to have an annual ava.iJable income of $55,000 indeflnitely upon receipt of the policy proceeds. H the engineer believes that money
from the polky can be invested in an account paying 4% annuaJ interest, how much life insurance should he buy?
►M•Gi 08•
5- A successfuJ engineer wishes to estab lish a scholars hip at her aJrna mater that wilJ pay twu indusnial engineering students $4000
2.9 per year. The university earns 5% on endowment accounts. Determine the amou nt that must be deposited today if the scholarships
will be awarded 1 year from today.
Wi"5Gi08i
5- A bridge is being considered at a cost of $220M. The annual maintenance costs are estimated to be $150K. A major renovation
30 costing $50M is requked every 25 years. What is the capitalized cost of the b1idge at 5% interest?
Wi•!l'd08i
5- A resident wm give money to his town to purchase a statue honoring the town founders and wilJ pay to maJntain the work at a cost
31 of $500 per year forever. Jf an interest rate of 5% is used , and the resident gives a total of $25,000; how much can be paid for the
statue?
5- A minor league baseball stadium is built at a rnst of $12,0 00,000. The annuaJ maJntenan ce costs are expected to cycJe every 6
32. years with a cost of $18,000 the first year and $2000 each year thereafter until the cost is $28,000 at the en d of Year 6. Tile
maintenance costs cyde wil.l repeat starting with $18,000 in Year 7. Every 6 years an expenditure of $1,500,000 must be made to
renovate and update the stadium. Determine the capitalized cost at 4%.
Wi•!l'dt•81
5- A was n·ansporting tunnel through a mountain range initial.ly cost $1,000,000 and has expected maintenance costs that will occur in
33 a 6-year cycle as shown.
End of Year : 1 2 3 4 5 6
Maintenance: $35,000 $35,000 $35,000 $45,000 $45,000 $60,000
Determine the capitalized cost at 8% interest.
Wi•ll'•U-ii
29 of 49 1/25/2020, 10:48 AM
El"IRZll"O:
5- A new runway at Chester International Airport was recently built at a mst of $16,000,000. aintenanc-e and upkeep costs will be
34 $450,000 per year. The runway lighting will require replacement at a projected cost of $2,000,000 every 4 years. Every 8 years the
runway wilJ require resurfacing at a projected cost of $6,000,000. Detennjne the capitali21ed cost of the runway at an interes t rate of
5%.
Wi•1•Gi081
5- Cheap otors anufacturing must l'epla.c e one of its tow motors. The NPW of Alternative A is -$5,876; for Alternative B it is -
35 $7547, an d for AJternative C, -$3409. Alternatives A and B al'e expected to last for 12 years, and Alternative C is expected to last
for 6 years. IfCheap's MARR is 4%, which alternative should be chosen?
Wi•ll'•U-81
5- A company decides that it must provide repafr service fo r the equipment it sells. Based on the folJowing, which aHernative for
36 providing repair service should be selected?
Alternative NPW
A -$9241
B ~6657
C -8945
5- A farmer must bonow $20,000 to purchase a used n·actor. The bank has offered the following choice of payment plans, each
37 determjned by using an interest rate of 8%. H the farmer's MARR is 15%, which plan shouJd he choose?
Plan A: $5010 per year for 5 years
Plan B: $2956 per year fo r 4 years plus $15,000 at end of 5 years
Plan C: Nothing for 2 years, then $9048 per year for 3 years
Wi•!IGi@i
5- A firm is considering the pul'Chase of a new machine to innease the output of an existing production process. Of all the machines
38 considered, management has narrowed the field to the ma.chines represented by the followi ng cash flows.
Machine Initial Investment Annual Operating Income
1 $50,000 $22,815
2 60,000 25,995
3 75,000 32,116
4 80,000 34,371
3 100,000 42,485
If each of these machines provides the same service for 3 years and the minimum attractive rate of return is 6%, which machine
should be se.lected?
5- Tlle ci ty council wants the municipal engineer to evaluate three alternatives for supplementing the ci ty water supply. The firs t
39 alternative is to continue deep-welJ pumping at an annua.l cost of $10,500. The second allemative is to instaJJ an 18-inch pipeline
from a surface reservoir. Fi.rst cost is $2 ,000 and annual pumping cost is $7000.
The third alternative is to instan a 24-inch pipeline from the res.ervofr at a first cost of $34,000 and annual pumping cost of $..5000.
The life of each alternative is 20 years. For th e second and thi.rd alternatives, salvage value is 10% of firs t cost. With interest at 8%,
which alternative should the engineer recom mend? Use preseat worth analysis.
Wi•l•Gd■8 1
5- The foUowing data are associated with three grape-crushing machines under consideratio n by Rabbit Ridge Wineries LLC.
40
Smart Crus h Super Crush Savage Crush
First cost $52,000 $63,000 $105,000
O&Mcosts 15,000 9,000 12,000
Annual benefits 38,000 31,000 37,000
Salvage value 13,000 19,000 22,000
Useful me 4 years 6 years 12 years
30 of 49 1/25/2020, 10:48 AM
If Rabbit Ridge uses a MARR of 12%, which alternative, if any, shouJd be chosen?
Wffl•Gic•8i
5- A used car dealer states that if you put $2000 down on a particular car, your monthly payments will be $199.08 for 4 years at an
41 interest rate of 9%. What is the cost of the car to you ?
Wi•Wd0S1
5- ary Ann requires approxi.mately 30 pounds of banan as each month, January through June, and 35 pounds of bananas each month,
42 July th.rough December, to ma ke banana cream pies fo r her fii ends. Bananas can be bought at a local market for 40 cents/lb. If
ary Ann's rnst of money is 3%, approxjmately how much should she set aside at the beginning o eac.h year to pay fo r the
bananas?
Widl1d0Si
5- Three purchase plans are avaHable for a new car.
43
Plan A: $5000 cash immediately
Plan B: $1500 down and 36 monthly payments of $97.75
Plan C: $1000 down and 48 monthly payments of $96.50
If a customer exp ects to keep the car for 5 years, and her cost of money is 6%, which payment plan should she choose?
Wii1•!ii 0S1
5- 5-83 Mod
44 A firm has the fol.lowing monthly costs. Find the present worth of the costs if the a.mmal interest rate is 15%.
Wi•l•'d0ii
5- Parker Designs has a profitable project, and the customer has agreed to payments as follows. Use the X PV function to find the
45 present worth of the cash flows as of January 1, 2019 if the interest rate is 8.0%.
Date Income
1/1/20 19 $75,000
5/6/2019 75,000
7/8/2019 75,000
9/212019 75,000
12/2/20 19 100,000
WiQ•••i0Si
5- A retail sunsc11een's manufacturer has inmme for one season as shown. Use X P V to find the present worth as of March 1, 2019 if
46 the ARR is 15%.
Date Income
3/1/20 19 -$15.0 million
4/1/20 19 6.1 million
5/6/20 19 1.3 million
6/3/20 19 3.5 million
7/1/20 19 4.6 million
8/5/20 19 2.5 million
9/2/2019 0.9 million
5- If the cmTent market interest rate on bonds of a certafo typ1:! is 3%, compounded semiannually, what should be the ma.rkcet prke of a
47 5% bond having a $1000 face value? The bond will matu re (pay its face value) 6½ years fro m today, and the next interest payment
to the bondholder will be due in 6 months.
Wffl•!iioS•
5- A bond issued by Golden Key casinos has a face value of $100,000 and a face rate of 3. 75% payable semiannually. If the bond
48 matures 6 yea.rs from the da te of purchase and an investor requires a 5% return, what is the maximum the investor should pay for
the bond?
W4 ■ 11CJP&i
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PROBLEMS
Key to icons: D = d ick to reveal answer; e = Green, which may include environmental ethics; CJ =Ethics other than
green; = autograded prob]ems that are available online in Dashboard; = The icon indicates that a spreadsheet is
recommended.
Present Value of One Alternative

5- A project has a net p11esent worth of -$20,000 as of January 1, 2022. If a 4% interest rate 1s used, what is the project NPW as of
1 December 31, 2017?
5- The a:nnua.l incom e fro m a rented house is $26,400. The an nuaJ expenses are $7200. H the house can be sold fo r $255,000 at the
•
2 end of 12 years, how much could you afford to pay for it now, if you conside11ed 8% to be a suitable interest rate?
5- A machine costs $250,000 to purchase and will provide $60,000 a yea:r in benefits. The company plans to use the mach ine fo r 12
3 years and then will sell the machine fo r scrap, receiving $15,000. T he com pany interest rate is 10%. Should the machine be
puochased?
5- IBP Inc. is consid ering establishing a new machine to automate a meatpackJng process. The machine will save $ 55,000 in labor
4 annually. The machine can be purchased for $22 ,000 today a:nd will be used for 10 years. It has a salvage val ue of $12,500 at the
O end of its useful life. The new machine w:iJJ require an annual maintenance cost o f $11,000. The corporation has a minim um rate
of return of 9%. Do you recommend automating the p rocess?
5- A student has a job that I.eaves her with $300 per month in disposable 1ncome. She decides that she will use the money to buy a
5 car. Before loo king for a car, she arranges a 100% loan whose terms are $300 per m onth for 4B m onths at 9% nominal annual
im erest. What is the maximum car purchase price that she can afford with her loan?
5- The student in Pro blem 5-5 finds a car she likes and the dealer offers to arTange financing. His terms are 6% interest for 72 months
•
6 and no down payment. The car's sticker price is $24,000. How expensive a car can she afford on the dealer's terms?
5- A road build ing contractor has received a major highway construction contract that will require 50,000 m 3 of crushed stone each
7 year for 5 years. The stone can be obtained from a quarry for $7.80/m 3 . As an al ternative, the contractor has decided to try to buy
CD the qu.arry. He believes that if he owned the quaITy, the stone would cost him only $6.30/m 3 • He thin ks he could reseU the q uarry
at the end of 5 years for $200,000.
(a) If the connactor uses a 12% interest rate, how much would he be willing to pay for the quany?
(b) The extraction of needed quarry stone and other aggregates via minin g can pose serious social consequences to various
stakeho]ders. Provid e a list of concerns and m itigating potential actions that the road-building con tractor may want to
consider if he pu.rchases the quany
5- Compute the present value, P, for the followin g cash flows.
•
8
4500
lI
3000
1500
0- -1- -2- -3- -4

t 0
i = 10%
5- You su.pervise an aging production Une that constantly needs maintenance and new parts. Last mon th you spent $25,000 replacing
9 a faUed controller. Sho uld the fo llowing plan be accepted if the interest rate is 15%? The net installed mst of the new line to
replace the old hne is $600,000 with a useful life of six years . ln th.e flrst year its operating cost wm be $100,000, and it wm
gene.rate annual revenues of $30 0,000. Each yea.r th e operating cost wm increase by $5000 and the revenues win fall by $15,000.
After six years the equipment w:ilJ have a val ue of $100,000 in the next re~build ing of the line.
Contributed by Yasser Alhenawi, University of Evansville
5- (a), How much would the owner of a build ing be justified in paying for a sp rin kler system that will save $1300 a year in
10 insurance p11emiums if the system has to be replaced every 20 years and has a salvage value eq uaJ to 8% of its initial cost?
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•
.LU JU:SU!a.HCI:! µ rt!I.LllUl U:S l.l Ul t! :,.y S Lt!I.IJ lli:IS LU UI:!' 11:'!-'ldLl:!U •t!Vl:!·1y LU Jt!i:l[l> i:11.IU I l i:ll> d Sd.l V i:lgt! V d.lUI:! t!l.j UdJ LU 070 Ul n:,. ll U Ll.i:ll UJiSlf
Assume money is worth 6%.
G (b) Research the International Code Council (ICC). Find and read their code of ethics. Why are organizations such as ICC
important from a building safety perspective?
5- A wholesale company has signed a contract with a supplier to purchase goods for $2,000,000 annually. The first purchase wiU be
11 made now to be followed by 10 more. Determjne the contract's present worth at a 7% inte11est rate.
Contributed by Hamed Kashani, Saei d Sadri, and Baabak Ashuri, Georgia Institute of Technology
5- Compute the present value, P, for the following cash flows.
•
12
1000
400
t i t t t
400
0- -1- -2- -3- -4- -5

400
i= 10'¼,
400 400
I
5- By instaJHng some elaborate inspection equipment on its assembly line, the Robot Corp. can a.void hiring an extra worke.r who
13 wouJd have ,earned $36,000 a year in wages and an additional $9500 a year in employee benefits. The inspection equjpment has a
6-year useful Life and no salvage vaJue. Us,e a nomfoal 18% in terest rate in your cakulations. How much can Robot afford to pay
fo r the equipmen t if the wages and worker benefits were to have been paid
(a) At the end of each year
(b) Monthly
Explain why the answer in (b) is larger.
5- On February l, the Mi ro Company needs to pun:hase some office equipment The company is short of cash and expects to be short
•
14 for several months. The treasurer has sa.id that he could pay for the eq uipment as follows:
Date Payment
April 1 $100
June 1 220
Aug.1 340
Oct 1 460
Dec.1 580
A local office supply firm will agree to sell the equipment to Miro now and accept payment according to the treasurer ' s
schedule. If interest will be cha.rged at 2.5% every 2 months, WJ th compo unding once every 2 months, how much office equipment
can the Miro Company buy now? What is the effective interest rate?
5- A stonecutter, assigned to carve the headstone for a weJJ-known engineering economist, began with the following design.
15
SC
4G
+
0- - 1- -2- -3- -4- -5
'f 'f l
p
He started the eq uation

P = G(P/ G,i, 6)
He reaUzed he had made a m istake, but he does not want to disca.rcl the stone and start over. What one compound .interest factor
can be added to make the equation co!Tect?
P = C PJG i. 6 ,i )
5- A young industrial engjneer analyzed some equipment to ~eplace one production worker. The present worth of employing one less
16 production worker j ust equaled the present worth of the equipment costs, assuming a 10-year useful life for the equipment. It was
I dedded not to buy the equipment.
G A short time fatei-, the production workers won a new 3-year union contract that granted them an .immediate 40¢-per-hour wage
increase, plus an additional 25 -per-hour wage increase in years 2 and 3. Assume that in future yea.rs, a 25'¢..per-ho ur wage
i n rrp;i~p will hi> or;intPrl
33 of 49 1/25/2020, 10:48 AM
increase wHI be granted.
(a) By how much does the present worth of replacing one production employee increase? Assume an interest rate of 8%, a single
8-hour shift, and 250 days per yea.r.
(b) What are the ethical issues of replacing workers with advanced technologies from the firm's, the workers', and society's
perspective?
5-- Use a geometric gradient fo rmula to compute the present va]ue, P, for the following cas h flows.
17
266.20
r---r--r/
0- -1- -2- -3 -4
i = 15%
5-- A firm has instaJJed a manufacturing l.ine for packaging materials. The firm plans to produce 45 tons of packing peanuts at $4000
18 per ton annually for 3 years, and then 60 tons of packJng peanuts per year at $5000 per ton for the next 5 years. What is the present
worth of the expected income? The firm's jmerest rate is 15% per year.
Contributed by Hamed Kashani, Saei d Sadri, and Baabak Ashuri, Georgia Institute of Technology
5-- Annual maintenance cos.ts for a particuJar section of highway pavement are $2500. The plac,emen t of a new surface would reduce
19 the annual maintenance cost to $500 per year for the first 3 years and to $1000 per year fo r the next 7 years . After 10 years the
annual mafotenance would again be $2500. If main tenance costs are the only saving, what investment can be j ustified for th e new
surfa0e? Assume interest at 5%.
5-- Luis is responsible for buying some specialized manufacturing eq uipment that has a purchase price of $10,000 and annual
2.0 operating costs of $1000. The vendor is offering a special buyer incentive that provides free maintenance for the first four years.
After that time, the maintenance is $500 per y,ear over the 10-yea.r life, and there is an ove.rhauJ expense .in year 5 of $2000. The
equipment has a saJvage value of $10 00. H the interes t rate is 8% what is the present value? Contributed by Gillian Nicholfs,
Southeast Missouri State University
5-- A new office building was co11Sn11cted 5 years ago by a consulting engineering finn . At that time the film obtained a bank loan for
2.1 $600,000 with a 12% annual interest rate, compounded quarterly. The loan terms call for equal qua1tedy payments for 10 years.
The foan also allows for its prepayment at any time without penalty.
The firm proposes to refinance the loan through an insuranc,e company. The new loan would be for a 20-yea.r term with an jnterest
rate of 8% per year, compounded quarterly. The insuranc,e com pany requires the payment of a 5% loan initiation charge (ofte.n
described as a "5-point loan fee"), whkh will be added to th,e starting balance.
(a) What is the balance due on the original mortgage if 16 payments have been made?
(b) What is the difference between tile old and new quarterly payments?
5-- Argentina is cons idering constructing a bridge. across the Rio de ]a Plata to connect its northern coast to the southern coast of
22 Uruguay. If th.is bridge is constructed, it will reduce the travel time fro m Buenos Aires, Argentina, to Sao Paulo, Brazil, by over 10
hours, and there is the potentia.1 to significantly imp rove the flow of manufactured goods between the two countries. The co.st of
the new bridge, which will be the longest bridge in the world, spanning over 50 miles, will be $700 milUon. The bridge will
require an annual main tenance of $10 miUion for repairs and upgrades and is estimated to last 80 years. It is estimated that
550,000 vehicles wilJ use the bridge during the firs t year of operation and an addjtional 50,000 vehides per year until the tenth
year. The annual traffic fo r the remafoder of the life of the bridge wrn be 1,000,000 vehicles per year. These data are based on a
toU charge of $90 per vehkl e. The Argentine government requires a minimum rate of return of 9% to proceed with the project.
(a) Does th.is project provide sufficient revenues to offset its costs?
(b) What considerations are there besides economic factors in deciding whether to construct the bridge?
5-- Compute the present value, P, for the following cash flows.
23
1200 1200 1200
O- -l - -2- -3-
Tr Tr Tr
4- -5- -6- -7- -&- -9
i = 10~
34 of 49 1/25/2020, 10:48 AM
Lives Match
5- Wa]t WaJJace Con strnction Enterprises may buy a new dump tn.1ck with a 10-year life. Interest is 6%. The cash flows for two
24 likely models are as follows:
I Model First Cost Annual Operating Cost Annual Income Salvage Value
Model First Cost Annual Operating Cost Annual Income Salvage Value
A $65,000 $8,000 $16,000 $25,000
B 59,000 10,000 17,500 19,000
(a) Using present worth analysis, which truck shou]d the firm buy, and why?
,(b) Before the construction company can dose the deal, the dealer se11s out of Model Band cannot get any more. What should
the firm do now, and why?
5- A new tennis court complex is planned. Each of t\'rO alternatives will last 18 years, and the interest rate is 7%. Use present w01th
25 analysis to determine which should be selected.
Contributed by D. P. Loucks, Corne.II University
Construction Cost AnnualO&M
A $500,000 $25,000
B 640,000 10,000
5- Two alternative coUl'Ses of action have the following schedules of disbursements:
•
26 Year A B
0 -$21, 000
1 0 - $2,000
2 0 -3, 500
3 0 -5, 000
4 0 -6, 500
5 0 -8, 000
- $21,000 - $25,000
Based on a 4% interest rate, whkh alternative should be selected?
5- If produced by Method A, a product's initial capital cost will be $100,000, its annual operating cost will be $20,000, and its
27 salvage value after 3 years will be $20,000. With Method B there is a flrst cost o f $150,000, an annuaJ operating rnst of $10,000,
and a $50,000 salvage value after its 3-year life. Based on a present worth anaJysjs at a 15% interest rate, which method sho ul d be
used?
Contributed by Hamed Kashani, Saeid Sadri, and Baabaf< Ashuri, Georgia Institute of Technolo9Y
5- For a new punch p11es.s . Company A charges $250,000 to deliver and mstall it. Company A has estimated that th.e machine will
2.8 have operating and majntenance (0 & ) costs of $4000 a year. You estimate an annual benefit of $89,000. Company B charges
I $205,000 to deliver and instaU th,e device. Company B has estimated O & M of the press at $4300 a yea.r. You estimate an annual
benefit o f $86,000. Both machines will last 5 years and can be sold for $15,000. se an interest rate of 12% . Which machine
shouJd your company buy?
5- Quinton 's refrigera tor has j11St died. He can get a basic refrigerator or a more efficient and e.nvironmentaUy friendly re.frigerator
2'9 with an Energy Star designation. Quinton earns 4% compounded annually on his investments, he wants to consider a 10-yea.r
C9 plannfog horizon, and he will use. present worth analysis to determine the best alternative. What is your rernm mendation?
Contributed by Paul R. McCright, University of South F.lorida
Basic nit Energy Star nit
Jnjtial cost 700 800
Deli very and installation 60 60
Professional servicing (year 5) 100 100
Annual energy costs 120 55
Salvage value (year 10) 150 175
5- A battery man ufacturing plant has been ordered to cease discharging acidic waste liquids containing mercury into the city sewer
30 system. As a result, the firm mu.st now adjust the pH and remove the mercury from its was te liquids. Quotations from three firms
O are included in the following table of costs .
mI Bidder IInstaUed Cost IAnnual Operating Cost IAnnual I ncome frum Mercury Recovery ISalvage Value I
35 of 49 1/25/2020, 10:48 AM
_____ ._
.aJ:.I ..........' - . . . . . . .:, ...Q..S.1.·... - ....,, ... .,, ... .S :a.1111111,1:iu. . . . '-J' t' ...... - ~....& ....._, U' o:11 ... .,_ .......... - .... ..a.••'-·""""".._ .... u-... ., .,_,, ..................... J ............... u .. ....... J ....,....... ..-ue....
Foxhill $70,000 $5000 $6500 $10,000

Instrument
Quicksilver 50,000 5000 2500 0
Almaden 90,000 5000 7800 10,000
If the installation will last 15 years and money is worth 12%, whi.ch equ.ipment shouJd be pu.rchased?
5- TeJefono Mexico is expandjng its facilities to serve a new manufacturing plant. The new plant will require 2000 telephone l.ines
31 this year, and another 2000 lines after expansion in 10 years. The plant wHI operate for 30 years.
Option 1 Provide one cable now with capacity to serve 4000 lines. The cable wiJl rnst $20,000 and annual maintenance costs
will be $1500.
Option 2 Provide a cable with capacity to serve 2000 lines now and a second cable to serve the other 2000 lines in 10 years .
Each cable will cost $15,000 and will have an annuaJ maintenance of $1000.
The telephone cables will last at least 30 years,. and the cost of removing the cables is offset by their salvage va.lue.
(a) Which alternative should be seJected, assuming a 10% interest rate?
(b) Will your answer change if the demand for add.itional lines occurs in 5 years?
5- A consulting engineer has been hked to advise a town how best to proceed with the construction of a 200,000-m3 water supply
3.2 reservoir. Since only 120,000 m3 of storage wilJ be required for the next 25 years, an alternative to building the full capacity now
0 is to build the reservoir in two stages. Injtially, the reservoir could be built with 120,000 m3 of capacity and then, 25 yea.rs hence,
the additional 80,000 m3 of capacity cou.ld be added by increasing the height of the reservoir. If interest js computed at 4%, which
construction plan is prefe1Ted?
Constniction Cast Annual Maintenance Cost
Build in two stages
First stage $14,200,000 $75,000
Second stage 12,600,000 add $25,000
Build full capacity now 22,400,000 100,000
5- In order to improve evacuation routes out of New Orleans in the event of another major djsaster such as Hun-icane Katrin a,. the
33 Louisiana Department of Transportation (L-DoT) is planning to construct an add.itional bridge across the Mississippi River. The
department uses an interest rate of 8% and plans a SO-year life for either blidge. Which design has the beuer present worth?
All Costs in $M Suspension Bridge Cantilever Bridge
Initial constl'uction $585 $470
Land acquisition 120 95
AnnualO&M 2 3
Annual increase 4% 0.3
Major maintenance 185 210
(Year 25)
I Salvage cost 30 27
5- Javier is an m at Lobos Manufacturing. He has been studying process line G to determine if an automated system wouJd be
34 preferred to the existing labor-intensive system. If Lobos wants to earn at least 20% and uses a 15-year planning horizon, which
alternative is preferred? Contributed by Paul R. Mc:Cr.ight, University of South Florida
Labor Intensive Automated
Initial cost $0 $110,000
InstaUation cost 0 18,500
First-year O&M 2,000 4,800
Annual increase 450 950
First-yea.r labor costs 72,000 47,500
Annual. increase 5% 5%
Salvage value (EOY15) 2,500 20,000
5- In an anaJysis one alternative has a net present worth of $4200, based on a 6-year anaJysis period that matches its useful life. A 9%
35 interest rate was used. The replacement wiU be an identical item with the same eost, benefits, and useful life. Usin~ a 9% in terest
36 of 49 1/25/2020, 10:48 AM
~::. m~eres1 ra1e was usea. 1 ne rep1acemem ,,;iu oe an iaem1ca1 rnem w1rn me same cosr, oenems, ana usernJ me. usmg a ::.to/o 1meres1
rate, compute the net present worth for a 12-year analysis period.
Lives Differ
5- Use a 10-year analysis period and an 8% in terest rate to detennine whkh alternative should be selected:
•
3G
A B
First cost $6500 $12,000
Uniform annual benefit $1800 $2000
Useful life, in years 5 10
5- The Larkspur Furniture Company needs a new grin der. Compute the present worth for these mutually exd usive altem atives and
37 identify whkh you would recommend given i = 6% per year. Larkspur uses a 10-year planning horizon.
Alternative A B
Initial cost $4500 $5500
Annual costs $300 $400
Salvage value $500 $0
Life 5 years 10 years
Contributed by Gillian Nicholls, Southeast Missouri State University
5- Which process line should be built for a new chemical? The expected market for the chem ical fa 16 years. An 18% mte is used to
•
38 evaluate new process facilities, which are com pared with present worth . How much does the better choice save?
First Cost 0 & M Cost/year Salvage Life
A $14M $3.5 1 $2M B years
B 22M 3M 7.SM 16 years
5- Which equipment is preferred if the firm's interest rate is 15%? In PW terms how great is the diffel'ence?
39 Alternative A B
First cos t $45,000 $35,000
Annual O&M 3,900 4,200
Salvage value 0 5,000
Overhaul {Year 6) 10,000 Not required
Life, in years 10 5
5- A weekly business magazine offers a 1-year subscription for .$24.99 and a 4-year subscription for $85. If you thought you would
40 read the magazine for at least the next 4 years, and consider 18% as a minimum rate of return, whlch way would you purchase the
C.,magazine: With four 1-year subscriptions or a. single 4-year subscription?
5- A man had to have the muffler replaced on his 2-year-old car. The repairman offered two alternatives. For $250 he would instan a
41 muffler guaranteed for 2 yea.rs. But for $400 he would instaU a muffler gua.ranteed "for as Jo ng as you own the car." Assumjng the
present owner expects to keep the car for about 3 more years, which muffler would you advise him to have instaUed if you thought
10% was a suitable interest rate and the .less expensive muffler would only last 2 years?
5- orth City must choose between two new snow-removal machines . The SuperBlower has a $70,000 first cost, a 20-year life, and
42 an $8000 salvage val ue. At the end of 9 years, it wiJI ne;ed a major overltauJ costing $19,000. Annual maintenance and operating
C.,costs are $9000. The Sno--Mover will cost $50,000, has an expected li fe of 10 years, and has no salvage value. The annual
maintenance and operating costs are expected to be $12,000. Using a 12% interest rate, which machine should be chosen?
5- A new aUoy can be produced by Process A, whkh costs $200,000 to implement. The operating cost will be $10,000 per quarter
43 with a salvage value of $25,000 after its 2-year life. Process B will have a fi rst cost of $250,000, an operating cost of $15,000 per
quarte1~ and a $40,000 salvage val ue after its 4-year life. The 1nterest rate is 8% per year compo unded quarterly. What is th,e
present value difference between A and B?
Contributed by Hamed Kashani, Saeid Sadri, and Baabak Ashuri, Georgia Institute of Technology
5- An elevator company has redesigned thei.r product to be 50% more energy ,e ffident than hydraulic designs. Tvm designs are being
44 considered for imple·mentation in a new building.
CD (a) Given an interest rate of 20% which bid should be accepted?
Alternatives A B
InstaJled cost $45,000 $54,000
37 of 49 1/25/2020, 10:48 AM
---------- ·- ---
""'I" --, - - - ~- · 1- - -
Annual cost 2700 2850

Salvage value 3000 4500
Life, in years 10 15
(b) Research and list a few attributes that the company mjght be using in the eJevators' major systems: drive, cab, hoist, and
control mechanisms that make them more energy effident.
5- The Crockett Lan d Winery must l'eplace its present grape-pressing equipment. The two aJtematives are the Quik-Skwish and the
45 Stomp-Master. The annual operating costs increase by 12% each year as the machines age. If the interest rate js 9%, whkh press
should be chosen?
Quik-Skwish Stomp~ Master
First cost $350,000 $500,000
Annual operating costs 28,000 22,500
I Salvage value 35,000 50,000
Useful life, in years 5 10
5- A railroad branch line to a landfil.l site is to be constructed. It is expected that the railroad line wiU be used for 15 years, after
46 which the landfill site will be closed and the land tumed back to agricultural use. The railroad track and ties will be removed at
(9 that time.
In building the railroad l.i.ne,. either treated or untl'eated wood ties may be used. Treated ties have an installed cost of $6 and a
10-year Life; untreated ties al'e $4.50 with a 6-year Life. lf at the end of 15 years the ti.es then in place have a remaining useful life
of 4 years or more, they will be used by the railroad elsewhere and have an estimated salvage value of $3 each. Any ties that are
removed at the end of their service life, or too close to the end of their service life to be used elsewhere, can be sold for 50¢ each.
(a) Determine the most economical plan for the initial raUroad ti es and their replacement for the 15-year period. Make a present
worth analysis assuming 8% intel'es t.
(b) Plastics in landfills do not degrade quickly and the land may not be useful for agriculture. ReseaKh and write a summary of
what is being done with landfills now to make them more ea1th friendly and l'educe negative impacts.
Perpetual Life
5- Dr. Fog E. Professor is l'etiring and wants to endow a chair of engineering economics at his university. It is expected that he wiU
47 need to cover an annual cost of $250,000 fol'ever. What Ju.mp sum must he donate to the university today if the endowment will
earn 5% .interest?
5- An elderly lady decided to distribute most of her considerable wea.lth to charity and to keep for herself only enough mo ney to
48 provide for her living. She feels that $4500 a month wilJ amply provide for her needs. She will establish a trust fund at a bank that
I pays .6% interest,. compounded monthly. Upon her death, the bafance is to be paid to her niece, Susan. H she deposits enough
money to last foreve r~ how much will Susan receive when her aunt dies?
5- A focaJ symphony association offers memberships as follows:
49 Continuing membership, per year $ 300
Patron lifetime membership 5000
The patron membership has been based on the symphony a.ssodation's belief that it can obtain a 3% ra ~e of return. If you agree
that 3% is appropriate, would you be willing to puKha.se the patron members hip? Explain why or why not.
5- A depositor puts $30,000 in a savings account that pays 4% interest, compounded quarterly. Equal annual withdrawals a.re to be
50 made from the account, beginning one year from now and continuing forever. What is the maximum annual withdrawal?
I
5- The local botanical society wants to ensure that the gardens in the town park al'e properly cared for. The group recently spent
51 $100,000 to plant the gardens. The members want to set up a perpetual fund to provide $100,000 for future 1seplantings every 10
years.
(a) If interest ls 5%, how much money is needed for the fund?
(b) If the last replanting is in year 100, how much is needed for the fund?
5- What amount of money dep osited 40 years ago at 5% interest would provide a perpetual payment of $50,000 a year beginning this
5.2 year?
I
5- A subdivision developer must consnuct a sewage n-eatment plant and deposit sufficient money in a pe1petuaJ l:!ust fund to pay the
53 $5000 per year operating cost and to replace the l:!seatment plant every 40 years. The plant and futul'e replacement plants wiJJ cost
$150,000 each. If the trust fund earns 8% inte1sest, what is the developer's capitali2ied cost?
38 of 49 1/25/2020, 10:48 AM
5- Use capitalized cost to determine which type of road sudac,e is prefeJTed on a particular sec:tio11 of highway. Use a 12% interest
54 rate.
I A B
Initial cost $500,000 $700,000
Annual maintenance 35,000 25,000
A B
Periodic resurfadng 350,000 450,000
Resurfacing interval 10 years 15 years
5- A new bridge proj ect is being evaluated at i = 5%. Recommend an altemative based on the capitalized cost for eadJ..
55 Construction GDSt Annual O&M Life (years)
Concrete $50 mill.ion $250,000 70
I Steel 40 mJUfon 500,000 50
5- A new stadium is being evaluated at i = 3%. Recommend an a.ltemative for the main strnctural material based on the capital.ized
5G cost fo r each.
Construction Cost Annual O&M Life (years)
Concrete $28 mill.ion $1.4 mHlion 55
Steel 24 miUfon 1.5 million 45
5- An open-pit min e must fund an account now to pay for maintenance of a tarnng pond in perpetuity (after the mine shuts down in
57 30 years). The costs until shutdown are part of the mine's operating costs. The maintenance costs begin in 31st year at $300,000
(9 annually.
(a) How mudJ. must be deposited now if the fund wm earn 5% interest? How mudJ. does this change if the interest rate is 4%?
(b) What is a tail.ing pond? Is the mine buUding this because they are a good corporate citize.n or because they are required to do
so? By whom? Could it be both?
5- A firm wants to sponsor a new engineering lab at a local university. This requires $4.0M to co11struct the ]ab, 1.5M to equip it,
58 and $750,000 every 6 years for new equipment. What is the required endowment if the university will ea.m 8% interest 011 the
I funds?
5- A city has developed a plan to provide for futu re• municipal water needs. The plan proposes an aqueduct that passes throu gh 500
59 feet of tunnel in a nearby rnounta.in . The fi.rst altemative is to buj]d a full-capacity tunnel now fo r $556,000. The second alterna tive
is to buil d a half-capacity tunnel now (cos t = $40 2,000), which should be adequate for 20 years, and then to build a second parallel
half-capacity tu11nel. T he maintenance cost of the tunnel linin gs every 10 years fo r the fuJI-capacity tunnel is $40,000 and for each
half-capacity tunnel it is $32,000.
T he friction losses in the half~capadty tunnels will be greater than in the full-capacity tunnel. The estimated additional
pumping costs in each half-capacity tunnel wrn be $2000 per year. Based on capitalized cost and a 7% interest rate, which
allemative should be selected?
5- A rather wealthy man decides to a1nnge fo r his descendants to be wen ,educated. He wants each dJ.ild to have $65,000 for his or
GO her education. He plans to set up a perpetual trust fu11d so that five chlldren wiJJ receive this assistance in ,each generation. He
I estimates that generations will be spaced 25 years apart. He expects the trust to be able 10 obtain a 5% rate of return a11d the first
recipients to rec-eive the money 1 years hence. How much money should he now set aside in the trust?
5- Kansas Public Se1vice Company wishes to determin e the capitalized worth of a new windmHJ at an interest rate of 9% and
61 following costs.
Purchase $725,000 InstaUation $ 143,000
AnnualO&M 12,000 Overhaul 260,000
(Year 25)
Expected life 40 years Salvage value 32,000
5- Compute the present value, P, for the following cash flows (assume series repeats forever).
6.2
IOOO 1000
tt
400 300 200 ·1 400t 300 2.00 1
t t +
0--1 - - - 3- 4- 5- 6- 7- 8- 9- IO- l l- 12- 13--+-oo
39 of 49 1/25/2020, 10:48 AM
i = 8%
Multip,le Alternatives
5- A steam boder .is needed as part of the design of a new plant. The boiler can be fired by natural gas, fuel oil, or roal. A cost
63 analysis shows that natural gas wo uld be the cheapest at $30,000· for fuel oil it would be $ 5 000; and for coal it would be
(I $180,000. If natural gas is used rather than fuel oil, the annual fuel cost will decrease by $7500. If coal is used rather than fuel oil,
the annual fuel cost will be $15,000 per year less.
(a) Assuming 8% interest, a 20-year analysis period, and no salvage value,. which is the m ost econom ical instaJJation?
(b) Find resources and build a green effects table to compare the major advantages and d isadvantages of using natural gas, fuel
oU, or coal to heat the steam boiler. Use Advantages an d Disadvantagesas the column headers and then each choice as a row.
5- Austin General Hospital is ,evaluating new lab eq uipment. The interes t rate is 12% and in each c:ase the equipment's useful li fe is 5
64 years. se PW analysis to pick which company you should purchase from.
1
I Company A B C
First cost $13,500 $20,000 $15,000
0 &Mcosts 1,500 1,800 1,100
Annual benefit 9,500 11,000 9,000
Salvage value 3,500 6,000 4,000
5- A build ing contractor obtained bids fo r some asphaJt paving, based on a specification. Three paving subcontractors q uoted the
65 following prices and terms of payment:
The bui.ld ing contractor uses a 12% nominal interest rate, compounded monthly. Which paving subcontractor should be awarded
the paving job?
Paving Co. Price Payment Schedule
Quick $35,000 50% payable im med iately
25% payable in 6 months
25% payable at year end
Tartan 82,000 Payable immediately
Faultless 84,000 25% paya ble im med iately
75% payable in 6 months
5- Six mutual.Ly exclusive alternatives, A-F, are being examined. For an 8% interest rate, whi.c h alternative should be selected? What
GG is the highest present worth? Each aJternative has a 6-year useful life.
I Initial Uniform Annual Benefit
A $20 $6.00
B 35 9.25
C 55 13.38
D 60 13.78
E 80 24.32
F 100 24.32
5- The management of an ,el ectronics manufacturing firm believes it is des.irable to automate its production facility. The automated
67 equipment would have no salvage val ue at the end of a I O-year life. The plant engineering department has suggested eight
mutuaJly exclusive a.hernatives . If the firm expects a 12% rate of return, which plan, if any,. should it adopt?
Plan Initial Cost (thousands) et Annual Benefit (thousands)
1 $265 $51
2 220 39
3 180 26
4 100 15
s 300 57
6 130 23
7 ?4~ 47
40 of 49 1/25/2020, 10:48 AM
5- Consider A-E, five mutually ,exclusive alternatives:
•
68 A B C D E
Initial cost $800 $800 $800 $800 $800
Uniform annual benefits
A B C D E
For first 6 yea.rs 125 150 100 125 150
For last 6 years 40 80 120 so 50
The interest ra te is 8%. If all the alternatives have a 12-year useful Ufe and 110 sa.l vage value, whkh alternative should be selected?
5- A film is considering three mutually exclusive alte rnatives as part of a production improvement program. The aJternatives are:
69 A B C
InstaJJed cost $10,000 $15,000 $20,000
Annual benefit 1,625 1,530 1,890
Useful life (yrs) 10 20 20
The saJvage value of each alternative is zero. At the end of 10 years, Altemative A couJd be replaced with another A with identicaJ
cost and benefits.
(a) Which alternative should be selected if interest is 6%?
(b) 3%,
(c), If there is a difference betv,een parts (a) and (b) can you explain it?
5- The following costs are associated wi th three tomato-peeling machines being considered for use in a canning plant. If the canning
70 company uses an interest rate of 12%, which is the best altemative? Use NPW to make your decision. (Note: Consider the least
I common multiple as the study period. )
Machine A B C
First cost $52,000 $63,000 $67,000
0 &Mcosts 15,000 9,000 12,000
Annual benefit 38,000 31,000 37,000
Salvage value 13 ,000 19,000 2.2,000
Useful Hfe· (yrs) 4 6 12
5- Consider the fo llowing three alternatives. There is aJso a "do no thing" alternative.
71 A B C
Cost $50 $30 $40
Net annual benefit 12 4.5 6
Useful life, in years 5 10 10
At the end of the 5-year useful life of A, a replacement is made. If a 10-year analysis period and a 8% interest rate are selected,
which is the preferred alternative?
5- A rnst analysis 1s to be made to determine what, if anything. should be done in a situation offering three "do-something" and one
72 ''do-nothing" alternatives. Estimates of the cost and ben efits a.re as follows.
Alternatives Cost Uniform Annual Benefit End-o(-Us-eful-Life Salvage Value Useful Li(e (years)
1 $450 $150 $0 4
2 550 125 300 4
3 800 135 250 8
4 0 0 0 0
Use an 8-year anaJysis period. At the end o f 4 years, Alternatives 1 and 2 m ay be replaced with identicaJ alternatives. 'Nhich
alternative should be selected?
(a) If a 7% interest rate is used?
(b) If a 14% interest rate is used?
5- Given the foJfow ing data, use present worth analysis to find the best alternative, A, B, or C.
73 1 I A I ~ I r I
41 of 49 1/25/2020, 10:48 AM
,., A B C
Initial cost $10,000 15,000 $12,000
Annual benefit 6,000 10,000 5,000
Salvage value 1,000 -2,000 3,000
Useful life 2 years 3 years 4 years
Use an analysis period of 12 yea.rs and 15% interest.
5- An investor has carefully studied a number of companies and their common stock. From his analysis, he has decided that the
74 stocks of six firms are the best of the many he has examined. They rep11esent about the same a.m ount of risk, and so he wouJd like
I to dete1m1ne one single stock in which to invest. He plans to keep the stock fo r 4 yea.rs and requi.res a 10% minimum attractive
ra~e of return .
Which stock if any, should the investor consider buying?
Comm1m StDck Price per Share Annual End-of-Year Dividend pe:r Share Estimated Price at End of 4 Years
Western House $2:33/4 $1.25 $32
Fine Foods 45 4.50 45
Mobile Motors 3o'/B 0 42
Spartan Products 12 0 20
U.S . TI11e 333/B 2.00 40
Wine Products s2 112 3.00 60
N mninal and Effective Interest

5- Assume monthly car payments o( $500 per month for 4 yea.rs and an interest r,He of 0. 75% per month. What inkial principal or
75 PW will this repay?
5- Assume annuaJ car payments of $6000 fo r 4 years and an interest rate of 9% per year. What initial p1incipaJ or PW will this
76 repay?
I
5- Assume annual car payments of $6000 for 4 years and an interest rate of 9.381 % per year. What initial principal or PW wiU this
77 repay?
5- Why do the values in Problems 5-75, 5-76, and 5-77 differ?

78
5- Assume mortgage payments of $1000 per month for 30 years and an interest rate of 0.5% per month . \Vhat initial principal or PW
79 will this repay?
5- Assume annual mortgage payments of $12,000 or 30 years and an interest rate of 6% per year. What initial principal or PW wiU
•
80 this 11epay?
5- Assume annual mortgage payments of $12,000 for 30 years and an interest rate of 6.168% per year. What initial. principal or PW
81 will this repay?
5- \Vhy do the values in Problems 5-79, 5-80, and 5-81 differ?

ll2
J:l. AppUcations and Complications

5- A construction project has the fol.lowing end-of-month costs. Calculate the PW at a nominal interest rate of 18%.
S3 January $30,000 May $620,000
February 50,000 June 460,000
Ma.!'Ch 210,000 July 275,000
April 530,000 August 95,000
5- A factory has averaged the following monthly heating and cooling costs over the last 5 years. Calculate the PW at a nominal
oA :- +.............. • ,.._......... ,... .i= n nL
42 of 49 1/25/2020, 10:48 AM
84 interest rate of 9%.
I January $23,000 July $15,000
February 18,000 August 25,000
March 16,000 September 19,000
April 9,000 October 10,000
May 28,000 November 15,000
June 12,000 December 21,000

5- Ding Bell Imports requires a retum of 15% on all projects. If Ding is plannjng an overseas development project with these cash
85 flows, what is the project's net present value?
Year 1 2 3 4 5 6 7
Net Cash ($) - 60,000 - 110,000 20,000 40,000 80,000 100,000 60,000
5- averick Enterprises is plannjng a new product. Annua.l sales, unit costs, and unit revenues are as tabulated; the firs t cost of R&D
•
86 and setting up the assembly line is $42,000. If i is 10%, what is the PW?
Year Annual Sales Cost/unit Price/unit
1 $4,000 $3.50 $6
2 6,000 2.75 5.75
3 8,000 3.00 5.45
4 10,000 2.15 5.25
5 9,000 2.5 4.6
6 4,000 3.25 3.9
5- orthem Engineering is analyzing a mining project. Annual prod uction, unit costs, and unit revenues are in the table. The first cost
87 of the mine setup is $6 mil.lion . If i is 15%, what is the PW?
Annual Cost Price
Year Production (tons) per Ton per Ton
1 90,000 $25 $35
2 120,000 20 36
3 120,000 22 37
4 100,000 24 38
5 80,000 26 39
6 60,000 28 40
7 40,000 30 41
XNPV
5- An investment has the foUowing cash flows. Use the XNPV function to find the present wmth as of December 1, 2019. The
38 interest rate is 6%.
I Date Cash Flow
12/1/20 19 - $11,000
1/1 2/2020 100
7/15/2020 200
1/15/2021 375
7/1 5/2021 425
1/16/2022 12,500
5- An engineering firm is doing design work on a client's project. It has $40,000 in expenses at the beginning of each month starting
89 in February 2018 th.rough December 2018. The client has agreed to a payment schedule, if the firm meets milestone delivery dates.
Use the X PY function to find the p~esent worth as of December 11, 2017. The interest rate is 12%.
Date Inrnme
1/1/2018 $150,000
r- 1-t ,. J..,_,,, .. n -1 r n nn,n,
43 of 49 1/25/2020, 10:48 AM
5/14/20 18 150,000
8/6/2018 150,000
10/22/2013 150,000
1/1/2019 200,000
5-- Use the X PV function to find the present worth on January 1, 2018. The in terest rate is 10%.
98 Date IC
ash Flow I
I Date Cash Flow
4/16/20 18 -$5000
12/10/2013 1500
4/1/2019 1800
7/22/20 19 2000
11/11/2019 1900
2/4/2020 1500
6/2/2020 1200
5- A coJd remedy's cash flows for one season's cycle are shown below. Use XNPV to find the present worth as of June 1, 20 18 if the
91 MARR is 15%.
Date Cash Flow (in SM)
6/1/2018 -$30
9/1/2018 12
11/1/2018 2
12/17/2013 6
1/7/20 19 8
2/25/2019 5
4/1/2019 2
Bonds
5-- A corporate bond has a face value of .$1000 with maturi ty date 1 years fm m today. The bond pays in terest semiannuaUy at a rate
92 of 6% nominal per year based on the face vaJue. The interest rate paid on similar corporate bonds has decreased to a Clm-ent ra te of
I 3%. Determine the market vaJ ue of the bond.
5- You bought a $1000 co rporate bond for $900 th.ree years ago. It is paying .$30 fo interest at the end of every 6 months, and it
93 matUJ""eS in 5 more years.
(a) Compute its coupon rate.
(b) Compute its cmTent value, assuming the market interest rate fo r such in vestments is 4% per year, compounded semiannually.
Contributed by D. P. Loucks, Cornell University
5-- An investor is considering buying a 20-year corp orate bond. The bond has a face va.lue of $1000 and pays 4% interest per year in
94 two semiannual payments. To rece.ive 6% interest, compounded semiannually, how much shouJd be paid for the bond?
I Problems 5-95 to 5-98 contributed by Meenakshi Sundaram, Tennessee Tech University
5- A 4% coupon rate bond has a face va]ue of .$1000, pays interest semfannuaUy, and will mature in 10 years . If th,e current market
95 rate is 2% interest compounded semiannually, what is the bond's price?
5-- A Treasury bond with a face value of $5000 and a coupon rate of 6% payable semian nuaHy was bought when the market's
•
96 nominal rate was 8%. The bond matures 20 years from now. What was paid for the bond?
5-- A zero-coupon bond (coupon rate= 0%) has a face vaJue of $10,000 and a maturity date in 5 years. The cun-ent market interest
97 rate is a nominal 6%, compounded quarterly. How much shouJd be paid for the bond?
5- A city government wants to raise $3 miUion by issuing bonds. By baUot proposition, the bond's coupon inte11est rate was set at 8%
9.8 per year with semiannual payments. However, market interest rates have risen to a nominal 9% interest rate. If the bonds mature in
20 years, how much wiU the city raise from issuing $3M in bonds.
44 of 49 1/25/2020, 10:48 AM
Minicases
5- Bayview's growth is constrained by mountains on one side and the bay on the other. A b1idge across the bay is planned, but which
'9 plan is best? 1t can be built with a single deck to meet the needs of the next 20 years, or it can be built with two decks to me.et the
needs of the next 50 years. The piers can also be b uilt to support two decks, but with only one· deck being bui.lt now.
Build ing it aJJ now will cost $160M, and leaving the top deck for later wiU save $40M. Building that top deck later wm cost
$70M including the cost of traffic disruption . A single-deck brid ge will cost $105M now and $120M in 20 years. Deck
maintenance is $1.4M per year per deck. Pier ma.in tenance fa $1.2M per year p.er bridge.
1f the interest rate is 5%, which design should be built?If the two~d.eck bridge is built im med iately, then dedi.cated lanes for
buses, carpools, and bicycles can be added. To econom ically evaluate this use, estimate the cost of the underutilized capacity fo r
the brid ge .
5- Florida Power and Light has committed to building a solar power plant. JoAnne, an IE working for FPL, has been tas ked with
100 eva.luating the three current designs. FPL uses an interest rate of 10% and a 20-year horizon.
Design l : Flat Solar Panels
A field of "flat" solar panels angl ed to best catch the sun will yield 2.6 MW of power and will cost $87 million initialJy with first-
year operating costs at $2 million, growing $250,000 annually. It wiIJ produce electricity worth $6.9 million the first year and wiIJ
increase by 8% each year thereafter.
Design 2: echanized Solar Panels
A field of mechan ized solar panels rotates fro m side to side so tha t they are always positioned paraJJel to the sun's rays,
maximjzing the production of electricity. This design wiJJ yield 3.1 MW of power and will cost $101 million initiaUy with first-
year operatin g costs at $2.3 mill.ion, growing $300,000 annuaUy. It wm produce electricity worth $8.8 miJlion the first year and
will increase 8% each year thereafter.
Design 3: Solar Collector Field
This design uses a field of m i.rrors to focus the sun's rays onto a boiler mounted in a tower. The boiler then p roduces steam and
generates electricity the same way a coaJ-flred plant operates. T his system wiH yield 3.3 MW of power and wiU cost $9 1 m il.lion
injtially with firs t-year operating costs at $3 m.iUion, growing $350,000 annually. It win produce electricity worth $9. 7 million the
first year and wm increase 8% each year thereafter.
5- Your grandparents are asking you fo r advice on when they should sta1i collectin g social secwity paym ents. If they wait untiJ age
101 66, they will collect $200 0 per m onth; but if they start collecting at age 62, they wiJJ collect $1500 per month. Assume they live
to be 85, and simplify by assuming anmrnJ payments.
(a) When do the higher payments catch up in total dollars received with tile lower payment that starts earlier?
(b) If their interest rate i:s 6%, wl'li.c h plan has a higher PW?
CASES
The following cases from Cases in Engineering Economy (www.oup.com/us/newnan) are suggested as matched with
this chapter.
The B0ard L0oks to Y:ou
CASE Bond valuation with realistic lm~iness details including early-call premiu m.
7 I Med ium difficulty. Good example of employer taking a small fact and m a.king big assumptions about individual talen ts w hich
implies why engin eering students must keep Jeaming.

CASE Picking a Price
8 Simplified rea) estate ana]ysis. Dem onstrates analysis to screen befo re acquiliag more data and further decision making.
CASE Recycling?
9 Financial ana.lysis o f recycUng cardboard and selling unusable pallets to recycler.
45 of 49 1/25/2020, 10:48 AM
CHAPTER6
ANNUAL CASH FLOW ANALYSIS
US. (»,'Ulrlilf1 fcllnill--~Sft'nllti
---
~~R~GU~~
• f'l:rJiMl'~Ooo"J ~
Estimated Yea tty OperatingCost
S67
T
I
$11'
I I I I
I'/~
CDl1 l 1nil!I af~mllar lfo~Lf•s
630 ~wti
fi!UfflMtd Yut\r-lCil'/ Uo
• CD!t~~cdym~d1
- -· ,d".....,,.,.._n..Gnll~~,-rl
1tlfl...,.p0' <,.,
..
• E:etn."Q!lll~ri;i::i.t-.tor,-11:taJ
• fiJ'll'l:fll~tt.S ll'MVI. I ? ~
- --
Yoor ros! will depend on your u fy ra1es and use,
Typical FTC required EnergyGuide label for a clothes washer. According to the California Energy Commission, the
typical American household does 400 loads of laundry per year us1ng 40 gallons of water per load with a typical, non-
E ERGY STAR clothes washer. An ENERGY STAR appHance would reduce water and energy consumption by 40%.
For more information see: lm p://wvvw.energystar.gov/.
Are Mol'e Efficient Appliances Cost Effectiive?
A typical residence is used for 75 years, and its major appliances last from 10 to 30 years. The long-term trend in energy
prices (1-3% per year) and reduced operating costs are not usually enough to induce home owners to replace existing
appliances-except when repladng failed appliances.
One driver in the slow adoption of energy efficient appliances is that many investment decisions are made by
homebuilders, landlords, and property managers, rather than those who pay the monthly energy hills . When consumers do
decide to replace appliances, EnergyGuide labels show the typical energy cost so that different models can be compared
by all consumers, not just by those who have studied engineering economy.
From the EnergyGuide label for a clothes washer, the range of energy usage for comparable ENERGY STAR clothes
washers goes from 113 kWh/year to 680 kWh/year. The energy consumption estimate is based on ratings of electlicity
and water usage factors. If elecnidty costs $0.08/kWh, the estimated elecni city costs for mmparable models range from
$9.04/year to $54.40/year.
When selecting a clothes washer, the consumer should consider initial cost, the annual energy wmth (benefit or cost?),
and select a model that suits the need. Choices are based on needs; making choices requires tools that are part of the skill
set provided by engineering economics. ■ ■ ■
Contributed by Gene Dixon, East Carolina University
QUESTIONS TO C ONSIDER
46 of 49 1/25/2020, 10:48 AM
Should average use be based on family size or lifestyle? How can Ufestyle be properly analyzed? For example, a
family of two in which one or more work outdoors in construaion may have larger laundry demands than a
1. family of four in which the parents work in offices. What about the impact of geography and climate~ for
example, does wearing shmts year-round (versus jeans) create a significant difference in laundry demands?
2. How would a homebuilder, landlord, or property manager justify the use of ENERGY STAR appliances in
p1idng properties and competing with other home...:builders, landlords, or property managers who may use less
efficient but still ENERGY STAR-rated appliances?
3. Based on type, major appliances have life spans of 7 to 15 years, with refrigerators having the longest life. If a
famiJy stays in a residence on average for 8 years, what considerations should a family use in deciding whether
or not to keep their major appliances when moving?
4. Which appliance replacement decisions would be more sensitive to changes in the cost of electricity? How
would you explain your answer to someone not skilled in engineering economics?
5. EnergyGuide labels are not required for TVs, ranges, ovens, and clothes d11rers. Why do you think this is true?
After Completing This Chapter ...

The student should be able to:
• Define equivalent uniform annual cost (EUAC), equivalent uniform annllal benefits (EUAB), and equivalent
uniform annual worth (EUAW).
• Resolve an engineering economic analysis problem into its annual cash flow equiva]ent.
• Calculate equivalent annual values for irregular cash flows such as oved1aul costs.
• Use EUAW, EUAC, and EUAB to compare alternatives with equal, common multiple, or continuous lives, or
over some fixed study period.
• Develop and use spreadsheets to analyze loans for purposes of building an amortization table, calculating
interest versus pdncipa], finding the balance due, and determining whether to pay off a loan ear1y.
• Use annuity due for beginning of pe1iod cash flows such as leases, insurance, and tuition payments.
Key Words
amortization schedule
annuity due
capital recovery cost
equivalent unifonn annua] benefit (EUAB), cost (EUAC), worth (EUAW)
infinite ana]y:sis period
salvage value
This chapter is devoted to annual cash flow ana]ysis- the second of the three major analysis techniques. With present
worth analysis, we resolved an alternative into an equivalent net present wmt h, a present worth of cost, or a present worth
of benefit. Here we compare alternatives based on thei.r equivalent annual cash flows: the equivalent uniform annual
m st (EUAC) , the equivalent uniform annual benefit (EUAB), or their difference, the equivalent uniform annual
worth: (EUAW) = (EUAB - EUAC).
To prepare for a discussion of annual cash flow analysis, we will review some annual cash flow calculations, then
examine annual cash flow criteria.
ANNUAL CASH FLOW CALCULATIONS
Resolving Cash Flows to an Annual Equivalent

In annual cash fl ow analysis, the goal is to convert money to an equivalent uniform annual cost or benefit. The simplest
case is to convert a present sum P to a series of equivalent unifmm end-of-period cash flows . This is illustrated in
47 of 49 1/25/2020, 10:48 AM
Example 6-1.
EXAMPLE 6-1 (Example 3-1 and 4-5 Revisited)

A machine will cost $30,000 to purchase. Annual operating and maintenanc,e costs (O&M) will be $2000. The machine
will save $10,000 per year in labor costs. The salvage value of the machine after 5 years wil] be $7000. Calculate the
machine's equiva]em uni:fonn annual wmth (EUAW) for an interest rate of 10%.
S.I0,000 $ I0,000 $10;000 S I0,000 t

$7 000
f I I
0- -1- - 2- -3- -4 - -5
I 1
1 L L ,L ,L ,L
S30,000
TABLE SOLUTION
Because there are multiple types of cash flows, the capital recovery factor (Eq. 4-6) must be used for the initial cost
and the sinking fund factor (Eq. 4-5) for the salvage value. No factor is needed for the annual savings and O&M costs
since they are already annual cash f1ows.
EUAW = - 30,000(A/ P, 10%.5) + 10,000 - 2000 ,+ 7000(A / F, 10% , 5)

= - 30,000(0.2638) + 8000 + 7000 0.1638
= $1232
5-BUITON SOLUTION
The n is 5 for both the inidal cash flow of -$30,000 and the salvage value of $7000, so the annual equivalent of both
can be found in one step.
A B C D E F G H I
1 Problem i n PMT PV PV Solve for Answer Fornmla
2 Exp. 6-1 10% 5 -30,000 7000 PMT $-6,767 =P T(B2,C2,E2,F2)
3 change sign -6,.767 =-H2
4 annual revenue 10,000
5 annualO&M -2,000
6 EUAW $1,233 =SUM(H3:H5)
Figure 6-1 generalizes Example 6-1, and Equation 6-1 converts the cash flows to annual equivalents one by one from
left to right.
48 of 49 1/25/2020, 10:48 AM
l
Sah•age
Value
r---i----r----r-------
Annual Saving;s/Re,·enue
0- -1- - 2- -3- -4----Jit-----n
j l ___ J____l___ J________ J

A1mual Co.sts/DisbursemenlS
lm'estmenl
Co.st
FIGURE 6-1 Common cash flows in EUAW problems.
EUA W = - P(A J P. i, n) (R - E) + S(Af F, i, n) (6-1)

Where. P = in vestment cost
R = annual revenue (or avings)
E = annual expense (or di bur ements ,
S = aJvage valu e
49 of 49 1/25/2020, 10:48 AM

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Engineering Economic Analysis - Pages 150 - 199 https://print.vitalsource.com/print/9780190931940?brand=Yuzu&from=...

Year Cash Flow

Nmninal and Effective Interest Rates

(b) Compute the equivalent interest rate per 1/ 252 of a year.

Q Spreadsheets for Loans

Q Spreadsheets for Gradients

Co1npounding and Payn1ent Periods Differ

Tbe Present Value of 30 Years of Henefits

After Completing This Chapter ...

ASSUMPTIONS IN SOLVING ECONOMIC ANALYSIS PROBLEMS

Viewpoint of Econonuc Analysis Studies

Borrowed Money Viewpoint

Effect of Inflation and UeOation

Tuli>ll" 5-1 Present Worth Analysis

TIME PERIOD FO,R ANALYSIS

Useful Lives Equal the Analysis Period

0-----1- -2- -3- -4- -5

PWA = - 10,000 + 3000(P/ A, 7%, 5)= - 10,000 3000 4.100 2300

PW of cost = $300 million 350 million P/ F, 6%, 25)

PW of cost = $400 million

Useful Lives Different from the Analysis Period

PWA = - 7000 + 1200(PJF, 7 %. 12

PW8 = - 5000 + 1000(PJF , 7% 6) - 5000(PJF, 7% 6)

PW (Alt. 1 = - 50,000 + (10,000 - 50,000)(P / F, 8% 7) + 20,000(P JF, 8 • 10

PW (Alt. 2 = - 75,000 + 15,000(P / F , 8%, 10)

To minimize PW of costs the diesel manufacturer should select Ah. 1.

Infinite Analysis Period: Capitalized Cost

Year I.: 200 initial P ➔ 200 + 8 = 208

Year 2.: $200 ➔ 200 + 8 = 208

One should set aside $125,000.

Capi tal ized Cost 8 mill ion $8 rnillio11 $8 million $8 million

A = PA / P,i n) = 8 million(A/ P 7%. 70)

h oyr = 1 + ir yr)70 - 1 = (1 + 0.07 70 - 1 = 112.989

Alternative B, Vegetable Market

NPW =- 50,000 + 5100 PJA, 10%, 20) + 30,000(PJF, 10%,20)

= - 50,:000 + 5100(8.514 + 30,000(0.14&6)

=- 50,000 + 43,420 4460

Alternative C, Gas Station

NPW = - 95,000 + 10,500 PJA, 10%, 20) + 30,000 PJF, 10%,20 ,

Alternative D, SmaJl Motel

APPLICATIONS AND COMPLICATIONS

PW of benefit = 4000(PJA 8%, 5) + (5000 - 4000 PJA, 8%, 3) - 500 PJG, 8~ 3)

PW of benefits = 3500 P/ A,8% 5) + 100 P/ G,8%, 3 PJF,8% 2 ·

Year Cash Fh1w (thousands)

NPW = - 610+200(P/A 10%, JO - 1500(P/ F, 10%, 10)

IS / D12°(1+SAS.3) PW (SM) sso2

With a present wmt h of over $500M, thfa is a desirable proj ect.

STUDENT STUDY GUIDE

100 150 150 100

Annual savings 0,000 24,000

Annual insurance>!< 2,000 2,200

Present Value of One Alternative

0- -1- -2- -3- -4

0- -1- -2- -3- -4- -5

He started the eq uation

5- Two alternative coUl'Ses of action have the following schedules of disbursements:

Foxhill $70,000 $5000 $6500 $10,000

Annual cost 2700 2850

5- Consider A-E, five mutually ,exclusive alternatives:

j l _ Jl_ J________ J