Assignment #16 | Engineering Economics #3

Solution

Question 1
Assume that you are planning to invest money at 7% per year as shown by the increasing gradient
below. Further, you expect to withdraw according to the decreasing gradient shown. Find the net
present worth and equivalent annual series for the entire cash flow sequence and interpret the results.
(Since there is no table for 7% interest rate, either use the equations or interpolate between 6% and 8%
to find the factors).

$5000
$4000
$3000
$2000
$1000 $1000 $1000

1 2 3 4 5 6 7 8 9 10 11 12

$2000
$2500
$3000 $3500
$4000

𝑁𝑃𝑊 𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠

𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 𝐴 𝑃/𝐴, 𝑖, 𝑛 𝐺 𝑃/𝐺 , 𝑖, 𝑛
𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 2000 𝑃/𝐴, 7%, 5 500 𝑃/𝐺 , 7%, 5
1 0.07 5 1 1 0.07 5 1 5
𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 2000 500
0.07 1 0.07 5 0.072 1 0.07 5 0.07 1 0.07 5

𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 $12,023.75
1 2 3

𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝐴 𝑃/𝐴, 𝑖, 𝑛 𝑃/𝐹, 𝑖, 𝑛 𝐺 𝑃/𝐺 , 𝑖, 𝑛 𝑃/𝐹, 𝑖, 𝑛 𝐴 𝑃/𝐴, 𝑖, 𝑛 𝑃/𝐹, 𝑖, 𝑛

#1

1 𝑖 1
𝐴 1 𝑖
𝑖 1 𝑖
1 0.07 1
5, 𝑂𝑂𝑂 1 0.07
0.07 1 0.07
5, 𝑂𝑂𝑂 4.1002 0.713
#2

1 𝑖 1 𝑛
𝐺 1 𝑖
𝑖 1 𝑖 𝑖 1 𝑖

1 0.07 1 5
1000 1 0.07
0.07 1 0.07 0.07 1 0.07

1, 𝑂𝑂𝑂 7.6467 0.713

#3

1 𝑖 1
𝐴 1 𝑖
𝑖 1 𝑖
1 0.07 1
1, 𝑂𝑂𝑂 1 0.07
0.07 1 0.07
1, 𝑂𝑂𝑂 1.8080 0.5083

𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 5000 𝑃/𝐴, 7%, 5 𝑃/𝐹, 7%, 5 1000 𝑃/𝐺 , 7%, 5 𝑃/𝐹, 7%, 5 1000 𝑃/𝐴,
7%, 2 𝑃/𝐹, 7%, 10

Using the equations, we get:

 𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠
5, 𝑂𝑂𝑂 4.1002 0.713 1, 𝑂𝑂𝑂 7.6467 0.713
1, 𝑂𝑂𝑂 1.8080 0.5083

𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 $10,084.12
𝑁𝑃𝑊 𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 10,084.12 12,023.75 $1,939.63

The Annual value can be computed using the NPW

𝐴 𝑃 𝐴/𝑃 , 𝑖, 𝑛 $1,939.63 𝐴/𝑃 , 7%, 12

Using the equation 𝐴 $244.20
Question 2
The maintenance expense on a piece of machinery is estimated to be as follows:

Year 1 2 3 4

Maintenance Cost $150 $300 $450 $600

If the interest rate is 8%, the equivalent annual maintenance cost is?

𝐸𝑈𝐴𝐶 𝐴 𝐺 𝐴/𝐺 , 𝑖, 𝑛 $150 $150 𝐴/𝐺, 8%, 4 $150 $150 1.404 $360.60
Question 3
In 2000, Bell Atlantic and GTE merged to form a giant telecommunications corporation named
Verizon Communications. As expected, some equipment incompatibilities had to be rectified,
especially for long distance and international wireless and video services. One item had two
suppliers, a U.S. firm (A) and an Asian firm (B). Estimates for vendors A and B were given for
each unit.

A B
Initial cost, $ ‐8,000 ‐11,000
Annual costs, $ ‐3,500 ‐1,600
Salvage value, $ 0 2,000
Life, years 10 5

Determine which vendor should be selected if the MARR is 15% per year. (Note: ROR analysis
requires equal‐service comparison between alternative. Therefore, develop the cash flow and
incremental cash flow series using the least common multiple of years, assuming reinvestment
in alternatives.)

Year A B B‐A (11,000 > 8,000)

0 ‐8,000 ‐11,000 ‐3,000
1 ‐3,500 ‐1,600 1,900
2 ‐3,500 ‐1,600 1,900
4 ‐3,500 ‐1,600 1,900
5 ‐3,500 ‐1,600 + 2000 ‐11,000 = ‐10,600 ‐7,100
6 ‐3,500 ‐1,600 1,900
7 ‐3,500 ‐1,600 1,900
8 ‐3,500 ‐1,600 1,900
9 ‐3,500 ‐1,600 1,900
10 ‐3,500 ‐1,600 + 2000 = 400 3,900
 𝑁𝑃𝑊 0

0 3,000 1,900 𝑃/𝐴, 𝑖, 10 – 9,000 𝑃/𝐹, 𝑖, 5 2,000 𝑃/𝐹, 𝑖, 10

0 3,000 1,900 9,000 1 𝑖 2,000 1 𝑖

Solve for i, we get 𝑖 39% 𝑀𝐴𝑅𝑅 → 𝑃𝑟𝑜𝑐𝑒𝑒𝑑 𝑤𝑖𝑡ℎ 𝑡ℎ𝑒 ℎ𝑖𝑔ℎ𝑒𝑟 𝑐𝑜𝑠𝑡 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒, 𝐵
 Question 4
A project will cost $50,000. The benefits at the end of the first year are estimated to be
$10,000, increasing $1000 per year in subsequent years. Assume a 12% interest rate, no
salvage value, and an eight‐year analysis period. What is the Benefit‐Cost Ratio?

$50,000

𝑃/𝐴,𝑖,𝑛 𝐺 𝑃/𝐴,𝑖,𝑛 , 𝑃/𝐴,12%,8 1000 𝑃/𝐴,12%,8

𝐵/𝐶
. .

, 4.968 1000 14.471

1.28
.
Question 5
A former student of an engineering department wishes to donate to the department’s scholarship
fund. Three options are available:
Plan A: $60,000 now
Plan B: $15,000 per year for 8 years beginning year 1 from now
Plan C: $50,000 three years from now and another $80,000, five years from now.
From the department’s perspective, it wants to select the plan that maximizes the buying power of
the dollars received today. If the donation earns 10% per year, which plan should be accepted

𝑃𝑊 $60,000

𝑃𝑊 15,000 𝑃/𝐴 ,10%, 8 15,000 5.3349 80,023.5

𝑃𝑊 50000 𝑃/𝐹, 10%, 3 80000 𝑃/𝐹, 10%, 5

𝑃𝑊 50,000 0.7513 80,000 0.6209 87,237

𝑆𝑖𝑛𝑐𝑒 𝑃𝑊 𝑖𝑠 𝑡ℎ𝑒 𝑙𝑎𝑟𝑔𝑒𝑠𝑡 𝑖𝑛 𝑡𝑜𝑑𝑎𝑦’𝑠 𝑑𝑜𝑙𝑙𝑎𝑟𝑠, 𝑔𝑜 𝑤𝑖𝑡ℎ 𝑝𝑙𝑎𝑛 𝐶.

Question 6
A company has an opportunity to invest in a piece of equipment for $50,000. It is anticipated that using
the equipment the company can save $16,000 annually over five years. The company has a MARR for all
investments of 14%. Should the company invest in the equipment? (Solve this problem using NPW, ROR,
and B/C analyses).

Cost = 50,000

Benefits = $16,000 annually

MARR = 14%

NPW
𝑁𝑃𝑊 𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠
𝑁𝑃𝑊 𝐴 𝑃/𝐴 , 𝑖, 𝑛 50,000
𝑁𝑃𝑊 16,000 𝑃/𝐴 , 14%, 5 50,000
.
𝑁𝑃𝑊 16,000 50,000 4929.3 0 → 𝐺𝑜𝑜𝑑 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
. .

ROR
𝑁𝑃𝑊 0
𝑃𝑊 𝑜𝑓 𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑃𝑊 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠 0
𝐴 𝑃/𝐴 , 𝑖, 𝑛 50,000 0
16,000 𝑃/𝐴 , 𝑖, 5 50,000 0

𝑃/𝐴 , 𝑖, 5 3.125

From 18% interest table, factor 𝑃/𝐴 , 18%, 5 3.127, indicating that I is slightly greater than 18% ‐>
greater than MARR  good investment

To get the value of i:

3.125

3.125 0

Solve for i

𝑖 0.180307 18.0307 14%

B/C
/ ,, , / , %, , .
𝐵/𝐶 1.1 1 𝐺𝑜𝑜𝑑 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
, , ,