Tutorial 8 Time Value Analysis

1. It is estimates that a certain piece of equipment can save $22,000 per year in labor and
material costs. The equipment has an expected life of five years and no market value. If
the company must earn a 15% annual return on such investment, how much could be
justified now for the purchase of this piece of equipment? Draw a cash flow diagram for
the company viewpoint. (P = $73,748.40)

2. Gerald just won 2 millions in his state lottery. He is informed the payout will be $100,000
per year for 20 years with the first payment occurring one year from now, or he can accept
a lump-sum payment of $1,000,000 right away. Gerald is disappointment that he will be
receiving less than an immediate lump-sum payout of $2,000,000. If his opportunity cost
of capital, i is 8% per year, how much less than 2 millions will Gerald be receiving if he
chooses to receive $100,000 per year for 20 years? Should he go for the lump-sum
$1,000,000 right away? ($1,018,190, yes)

3. Maintenance cost for a small bridge with an expected 50-year life are estimated to be
$1,000 each year for the first 5 years, followed by a $10,000 expenditure in the year 15
and a $10,000 expenditure in year 30. If i = 10% per year, what is the equivalent uniform
annual cost over the entire 50-year-period? (A=$681.86)

4. Determined the present equivalent value at time 0 in the accompanying cash flow
diagram. (Interest rate is 7% per year). Try to minimize the number if interest factors you
use.
(P0 = $433.28)
Tutorial 8 Time Value Analysis

5. Transform the cash flow on the left-hand side of the figure below to their equivalent F,
shown on the right-hand side. The interest rate is 8% per year. ($664.99)

6. Determined the value of W on the diagram that makes the two cash-flow diagram
equivalent when i = 12% per year. (W = $714.25)

7. A certain fluidized-bed combustion vessel has an investment cost of $100,000, a life of

10 years, and negligible market value. Annual costs of materials, maintenance, and
electric power for the vessel are expected to total $10,000. A major relining of the
combustion vessel will occur during the fifth year at a cost of $30,000. If the interest
rate is 15% per year, what is the lump sum equivalent cost of this project at the present
time? (P= -$165,104)

8. The detail of a project is listed in the table below.

Machine XYZ
Investment Cost $18,000
Useful Life 20 years
Market (Salvage) value $5,000
Annual Operating expenses $250
Overhaul cost – end of 7th year $500
Overhaul cost – end of 14th year $800
Determined the PW, given the 10% per year.
(PW=-$19,760.67)
Tutorial 8 Time Value Analysis

9. A drug store is looking into the possibility to installing a 24/7 automated prescription refill
system to increase its projected revenues by $17,500 per year over the next five years.
Annual expenses to maintain the system are expected to be $2,000. The system will cost
$35,000 and will have no market value at the end of the five-year study period. The store’s
looking for 15% rate of return per year. Use AW method to evaluate this investment.
(AW=$5,058.96)

10. A company is considering constructing a plant to manufacture a proposed new product.

The land costs $300,000, the building costs $600,000, the equipment costs $250,000 and
$100,000 additional working capital is required. It is expected that the product will result
in sales of $750,000 per year for 10 years, at which time the land can be sold for
$400,000, the building for $350,000, and the equipment for $50,000. All of the working
capital would be recovered at the EOY 10. The annual expenses for labor, materials, and
all other items are estimated to total $475,000. If the company requires a return of 15%
per year on projects of comparable risk, determine if it should invest in the new product
line. Use the AW method. (AW = $70,245)

11. Four mutually exclusive alternatives are being evaluated, and their costs and revenues are
itemized as below:
(a) If MARR is 15% per year, and the analysis period is 10 years, use the PW method to
determine which alternatives are economically acceptable and which one should be
selected?
(b) If the total capital investment budget available is $200,000, which alternatives
should be selected?
Mutually Exclusive Alternative
I II III IV
Capital Investment $100,000 $152,000 $184,000 $220,000
Annual Revenues less Expenses 15,200 31,900 35,900 41,500
Salvage Value 10,000 0 15,000 20,000
Useful Life (years) 10 10 10 10
(a: Alternative II, PW = $20,917; b: Alternative II)
12. At the Motorola plant in Mesa, Arizona, it is desired to determine whether one-inch-thick
insulation or two-inch-thick insulation should be used to reduce hear loss from a long
section steam pipe. The heat loss from this pipe without any insulation would cost $2.00
per linear foot per year. The one-inch insulation will eliminate 88% of heat loss and will
cost $0.60 per foot. Two-inch insulation will eliminate 92% of the heat loss and will cost
$1.10 per foot. The steam pipe is 1,000 feet in length and will last for 10 years. MARR = 6%
per year. Which insulation thickness should be recommended?
[P6.3: PW1=$12.35, PW2=$12.44]
Tutorial 8 Time Value Analysis
Tutorial 8 Time Value Analysis

13. Three mutually exclusive design alternatives are being considered. The estimated sales
and cost data for each alternative are given. The MARR is 20% per year. Determine
which selection is preferred

A B C
Investment Cost $30,000 $60,000 $40,000
Estimated Unit to be sold/year 15,000 20,000 18,000
Unit Selling Price, $/unit $3.10 $4.40 $3.70
Variable costs, $/unit $1.00 $1.40 $0.90
Annual expenses (Fixed Costs) $15,000 $30,000 $25,000
Market Value $10,000 $10,000 $10,000
Useful Life 10 years 10 years 10 years

[AWC=$16,245 Design C]
14. Two electric motors are being considered to drive a centrifugal pump. One of the motors
must be selected. Each motor is capable of delivering 60 horsepower (output) to the
pumping operation. It is expected that the motors will be use 800 hour per year. The
following data are available:

Motor A Motor B
Capital Investment $1,200 $1,000
Electrical efficiency 0.90 0.80
Annual Maintenance $160 $100
Useful Life 3 years 5 years

If the electricity costs $0.07 per kilowatt-hour, which motor should be selected if the MARR
is 8% per year? Recall that 1hp = 0.746kW. Assume repeatability.

[Motor A, AWA(8%) = -$3,410.67]

Tutorial 8 Time Value Analysis

15. As the supervisor of a facilities engineering department, you consider mobile cranes to
be critical equipment. The purchase of a new medium-sized truck-mounted crane is
being evaluated. The economic estimates for the two best alternatives are shown in the
table. You have selected the longest useful life (nine years) for the study period and
would lease a crane for the final three years under Alternative A. On the basis of
previous experience, the estimated annual leasing cost at that time will be $66,000 per
year (plus the annual expenses of $28,800 per year). The expected return rate is 15% per
year.

Alternatives
A B
Capital Investment $272,000 $346,000
Annual Expenses $ 28,800 $ 19,300
Useful Life 6 9
Market Value (at the end of life) $ 25,000 $ 40,000

Show that the same selection is made based on

a) the PW method
b) Would leasing crane A for nine years
[a: PWA =-$463,758, PW B=-$426,720; b: PWA =-$452,348 select B]

16. Three mutually exclusive alternatives are being considered for the production
equipment at a tissue paper factory. The estimated cash flow for each alternative are
given. (All costs are in thousands.)

A B C
Capital Investment $2,000 $4,200 $7,000
Annual revenues 3,200 6,000 8,000
Annual costs 2,100 4,000 5,100
Salvage value 100 420 600
Useful life (years) 5 10 10
Which equipment alternative, if any, should be selected? The firm’s is targeting 20% per
year. Please state your assumption if necessary.
[Alternative C]
Tutorial 8 Time Value Analysis

17. Consider the following two mutually exclusive alternatives related to an improvement
project. The MARR = 15% and the study period is 10 years. Recommend which one should
be implemented.
Machine
A B
Capital Investment $20,000 $30,000
Annual Cash Flow $ 5,600 $ 6,400
Useful Life 5 10
Market Value (at the end of life) $ 4,000 $0
[AWA=$226.95, AWB= $249.18]
Tutorial 8 Time Value Analysis

Advanced Analysis

18. Determine the present equivalent value of the cash-flow diagram, when the annual
interest rate ik, varies as indicated. (P=$4,605.65)

19. The world’s largest carpet maker has just completed a feasibility study of what to do with
the 16,000 tons of overruns, rejects and remnants it produces every day. The company’s
CEO launched the feasibility study by asking, why pay someone else to dig coal out of the
ground and then pay someone else to put our waste into a landfill? Why not just burn out
waste?

The company is proposing to build a $10-million power plant to burn its waste as fuel,
thereby saving $2.8million a year in coal purchase. Company engineers have determined
that the waste-burning plant will be environmentally sound, and after its four-year study
period, the plant can be sold to a local electric utility for $5million. What is the IRR of this
proposed power plant? Should be company invest into this project if the firm’s expecting
15% per year. (i’=18.5%)

20. You recently subscript to ASNOT, a satellite TV program. The monthly subscription rate is
$12.95. You can either pay on a monthly basis or prepay an entire year and receive the
13th month free. Assuming you will maintain your subscription at least 13months, what is
the effective annual rate of return on your investment if you choose to prepay for the
entire year? All payments are due at the beginning of the month. (ieff = 17.61%)