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Lecture 8

This document discusses various methods for evaluating capital investment projects, including present worth, future worth, annual worth, and internal rate of return. It provides examples of how to use the present worth and future worth methods to determine if projects are economically justified given a minimum attractive rate of return. Key terms discussed include minimum attractive rate of return, capitalized worth, capital recovery, and uniform series calculations.

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youssef hossam
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68 views12 pages

Lecture 8

This document discusses various methods for evaluating capital investment projects, including present worth, future worth, annual worth, and internal rate of return. It provides examples of how to use the present worth and future worth methods to determine if projects are economically justified given a minimum attractive rate of return. Key terms discussed include minimum attractive rate of return, capitalized worth, capital recovery, and uniform series calculations.

Uploaded by

youssef hossam
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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4/16/2018

Engineering Economy
Lecture 8
Evaluating a Single Project
PW, CW, FW, and AW

NE 364 Engineering Economy


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Capital Projects Evaluation


1. Present worth (PW)
2. Future worth (FW)
3. Annual worth (AW)
4. Internal rate of return (IRR)
5. Payback period (generally not appropriate as a
primary decision rule)

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Minimum Attractive Rate of


Return (MARR)
A capital project must provide a return that exceeds a
minimum level established by the organization to be
attractive.

This minimum level is reflected in a firm’s Minimum


Attractive Rate of Return (MARR).

NE 364 Engineering Economy


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Elements contributing to MARR.


 Amount, source, and cost of money available
 Number and purpose of good projects available
 Perceived risk of investment opportunities
 Type of organization

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Determination of the MARR Based


on the Opportunity Cost Viewpoint

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Present Worth Method


 The most frequently used method.
 The present worth (PW) is found by discounting all
cash inflows and outflows to the present time at an
interest rate equal to MARR.
PW(MARR%)

 A positive PW for an investment project means that the


project is acceptable (it satisfies the MARR).
PW(MARR%) > 0 ✔

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Example 1
Consider a project that has an initial investment of
$50,000 and that returns $18,000 per year for the next
four years. If the MARR is 12%, is this a good
investment?

PW(12%) = -50,000 + 18,000 (P/A, 12%, 4)


PW(12%) = -50,000 + 18,000 (3.0373)

PW(12%) = $4,671.40  This is a good investment!

NE 364 Engineering Economy


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Example 2
A piece of new equipment has been
proposed by engineers to increase the
productivity of a certain manual welding
operation. The investment cost is
$25,000, and the equipment will have a
market value of $5,000 at the end of a
study period of five years.

Increased productivity attributable to the


equipment will amount to $8,000 per
year after extra operating costs have
been subtracted from the revenue
generated by the additional production.

If the firm's MARR is 20% per year, is


this proposal a sound one? Use the PW
method.

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Example 2 Solution
PW(20%)=

$8,000(P/A,20%,5) + $5,000(P/F,20%,5) – $25,000

=$934.29

This equipment is economically justified

NE 364 Engineering Economy


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Capitalized Worth
 The capitalized worth of a project with interest rate i%
per year is the annual equivalent of the project over its
useful life divided by i.
 If only expenses are considered this is sometimes
referred to as capitalized cost.
 The capitalized worth method is especially useful in
problems involving endowments and public projects
with indefinite lives.

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Capitalized Worth Cont.


The CW of a series of end-of-period uniform payments A,
with interest at i% per period, is A(P/A, i%, N). As N
becomes very large (if the A are never-ending payments),
the (P/A) term approaches 1/i.

(P/A,i%,very large N) ≈(1/i)

CW(MARR%) = A(1/MARR).

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Interest Tables

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Example 3
Betty has decided to donate some funds to her local
community college. Betty would like to fund an
endowment that will provide a scholarship of $25,000
each year in perpetuity (for a very long time), and also a
special award, “Student of the Decade,” each ten years
(again, in perpetuity) in the amount of $50,000.

How much money does Betty need to donate today, in


one lump sum, to fund the endowment? Assume the fund
will earn a return of 8% per year.

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Example 4
A new bridge across the Cumberland River is being planned
near a busy highway intersection in the commercial part of a
mid-western town. The construction (first) cost of the bridge is
$1,900,000 and annual upkeep is estimated to be $25,000.

In addition to annual upkeep, major maintenance work is


anticipated every eight years at a cost of $350,000 per
occurrence. The town government's MARR is 8% per year.

If the bridge has an expected life of 50 years, what is the


capitalized worth (CW) of the bridge over a 100-year study
period?

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Example 4 Solution

NE 364 Engineering Economy


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Future Worth Method

 FW is based on the equivalent worth of all cash


inflows and outflows at the end of the study period at
an interest rate equal to MARR.
 Decisions made using FW and PW will be the same.

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Example 2 again using FW


A piece of new equipment has been
proposed by engineers to increase the
productivity of a certain manual welding
operation. The investment cost is
$25,000, and the equipment will have a
market value of $5,000 at the end of a
study period of five years.

Increased productivity attributable to the


equipment will amount to $8,000 per
year after extra operating costs have
been subtracted from the revenue
generated by the additional production.

If the firm's MARR is 20% per year, is


this proposal a sound one? Use the FW
method.

NE 364 Engineering Economy


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Example 2 Solution
PW(20%)=

$8,000(P/A,20%,5) + $5,000(P/F,20%,5) – $25,000

=$934.29

FW(20%)=

$8,000(F/A,20%,5) + $5,000 – $25,000(F/P,20%,5)

=$2,324.80

This equipment is economically justified

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Annual Worth Method


 Annual worth is an equal periodic series of dollar
amounts that is equivalent to the cash inflows
and outflows, at an interest rate equal to MARR.
 The AW of a project is annual equivalent revenue
or savings minus annual equivalent expenses,
less its annual capital recovery (CR) amount.

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Capital Recovery
 CR is the annual equivalent cost of the capital invested.
 The CR covers the following items.
 Loss in value of the asset.
 Interest on invested capital (at the MARR).

 The CR distributes the initial cost (I) and the salvage


value (S) across the life of the asset.

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A project requires an initial investment of $45,000,


has a salvage value of $12,000 after six years, incurs
annual expenses of $6,000, and provides an annual
revenue of $18,000. Using a MARR of 10%,
determine the AW of this project.

Since the AW is positive, it’s a good investment.

NE 364 Engineering Economy


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Example 2 again using AW


A piece of new equipment has been
proposed by engineers to increase the
productivity of a certain manual welding
operation. The investment cost is
$25,000, and the equipment will have a
market value of $5,000 at the end of a
study period of five years.

Increased productivity attributable to the


equipment will amount to $8,000 per
year after extra operating costs have
been subtracted from the revenue
generated by the additional production.

If the firm's MARR is 20% per year, is


this proposal a sound one? Use the AW
method.

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Example 2 Solution
PW(20%)=

$8,000(P/A,20%,5) + $5,000(P/F,20%,5) – $25,000

=$934.29

FW(20%)=

$8,000(F/A,20%,5) + $5,000 – $25,000(F/P,20%,5)

=$2,324.80

AW(20%)= R–E Capital Recovery CR

$8,000 + $5,000(A/F,20%,5) – $25,000(A/P,20%,5)

=$312.40

This equipment is economically justified


NE 364 Engineering Economy
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NE 364 Engineering Economy


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