Chapter 6
Annual Worth
Analysis
Lecture slides to accompany
Engineering Economy
7th edition
Leland Blank
Anthony Tarquin
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LEARNING OUTCOMES
1. Advantages of AW
2. Capital Recovery and AW values
3. AW analysis-equal life and
different life
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Advantages of AW Analysis
AW calculated for only one life cycle
Assumptions:
Services needed for at least the LCM of lives of alternatives
Selected alternative will be repeated in succeeding life cycles
in same manner as for the first life cycle
All cash flows will be same in every life cycle (i.e., will change
by only inflation or deflation rate)
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Alternatives usually have the following
cash flow estimates
Initial investment, P – First cost of an asset
Salvage value, S – Estimated value of asset at end of
useful life
Annual amount, A – Cash flows associated with asset, such
as annual operating cost (AOC), etc.
Relationship between AW, PW and FW
AW = PW(A/P,i%,n) = FW(A/F,i%,n)
n is years for equal-service comparison (value of LCM or
specified study period)
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Calculation of Annual Worth
AW for one life cycle is the same for all life cycles!!
An asset has a first cost of $20,000, an annual operating
cost of $8000 and a salvage value of $5000 after 3 years.
Calculate the AW for one and two life cycles at i = 10%
AWone = - 20,000(A/P,10%,3) – 8000 + 5000(A/F,10%,3)
= $-14,532
AWtwo = - 20,000(A/P,10%,6) – 8000 – 15,000(P/F,10%,3)(A/P,10%,6)
+ 5000(A/F,10%,6)
= $-14,532
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Capital Recovery and AW
Capital recovery (CR) is the equivalent annual amount that
an asset, process, or system must earn each year to just
recover the first cost and a stated rate of return over its
expected life. Salvage value is considered when calculating
CR.
CR = -P(A/P,i%,n) + S(A/F,i%,n)
Use previous example: (note: AOC not included in CR )
CR = -20,000(A/P,10%,3) + 5000(A/F,10%,3) = $ – 6532 per year
Now AW = CR + A
AW = – 6532 – 8000 = $ – 14,532
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Selection Guidelines for AW Analysis
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ME Alternative Evaluation by AW
Not necessary to use LCM for different life alternatives
A company is considering two machines. Machine X has a first cost of
$30,000, AOC of $18,000, and S of $7000 after 4 years.
Machine Y will cost $50,000 with an AOC of $16,000 and S of $9000 after
6 years.
Which machine should the company select at an interest rate of 12% per
year?
Solution: AWX = -30,000(A/P,12%,4) –18,000 +7,000(A/F,12%,4)
= $-26,412
AWY = -50,000(A/P,12%,6) –16,000 + 9,000(A/F,12%,6)
= $-27,052
Select Machine X; it has the numerically larger AW value
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AW of Permanent Investment
Use A = Pi for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives
Compare the alternatives below using AW and i = 10% per year
C D
First Cost, $ -50,000 -250,000
Annual operating cost, $/year -20,000 -9,000
Salvage value, $ 5,000 75,000
Life, years 5 ∞
Solution: Find AW of C over 5 years and AW of D using relation A = Pi
AWC = -50,000(A/P,10%,5) – 20,000 + 5,000(A/F,10%,5)
= $-32,371
AWD = Pi + AOC = -250,000(0.10) – 9,000
= $-34,000 Select alternative C
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Summary of Important Points
AW method converts all cash flows to annual value at MARR
Alternatives can be mutually exclusive, independent,
revenue, or cost
AW comparison is only one life cycle of each alternative
For infinite life alternatives, annualize initial cost as A = P(i)
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Examples 1
Given two alternatives. Assuming that alternatives
are replaced at the end of their useful life,
determine the better alternative using annual cash
flow analysis at an interest rate of 9%.
Alternative A (RM) Alternative B (RM)
First Cost 4,000 6,000
Annual Cost 1,000 500
Annual Benefit 2,000 2,200
Life 4 10
Salvage Value 3,000 1,000
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Example 2
Two types of power converters are under consideration
for a specific application. An economic comparison is
to be made using a MARR of 20% and the following
cost estimates:
(a). Determine the Equivalent Annual Costs of the two
alternatives and recommend the economically superior
system.
(b). Determine a Salvage Value for the Beta system such
that the Beta system will have an Equivalent Uniform
Annual Cost equal to the Alpha system.
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Data of example 2
Alfa System (RM) Beta system (RM)
First cost 10,000 20,000
Annual operating cost 2,500 1,200
Salvage value 0 5,000
Service life 5 years 9 years
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Example 3
Use data in example 2. Which alternative is to be
selected if 5 year analysis period is being
used. Market value for Beta system at the end
of year 5 is RM 8,000.
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