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ME 291 Engineering Economy: Present Worth Analysis

The document discusses present worth analysis for evaluating mutually exclusive and independent project alternatives. It defines key terms like mutually exclusive, independent, revenue-based and service-based alternatives. Guidelines are provided for using present worth analysis to select among alternatives by choosing the one with the highest positive present worth value or least negative value.

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Ehsan Ur Rehman
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38 views13 pages

ME 291 Engineering Economy: Present Worth Analysis

The document discusses present worth analysis for evaluating mutually exclusive and independent project alternatives. It defines key terms like mutually exclusive, independent, revenue-based and service-based alternatives. Guidelines are provided for using present worth analysis to select among alternatives by choosing the one with the highest positive present worth value or least negative value.

Uploaded by

Ehsan Ur Rehman
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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ME 291

Engineering

ME-291 Engineering Economy


Economy
Lecture 13

Chapter 5
Present Worth Analysis

Faculty of Mechanical Engineering


Ghulam Ishaq Khan Institute, Topi, Swabi
© Faculty of Mechanical Engineering, GIKI
Formulating Mutually Exclusive
Alternatives

• Some projects are economically and

ME-291 Engineering Economy


technologically viable, and other are not.
• Once the viable projects are defined, it is
possible to formulate the alternatives.
• To help formulate alternatives, categorize
each project as one of the following
– Mutually Exclusive
– Independent

© Faculty of Mechanical Engineering, GIKI


Mutually Exclusive

• Only one of the viable projects can be

ME-291 Engineering Economy


selected by the economic analysis. Each
viable project is an alternative. Mutually
exclusive alternatives compete with one
another in the evaluation.

© Faculty of Mechanical Engineering, GIKI


Independent

• More than one viable projects may be

ME-291 Engineering Economy


selected by the economic analysis.
Independent projects do not compete with
one another in evaluation. Each is evaluated
separately. The comparison is only between
“one project at a time and the DO-Nothing
(DN) alternative.

© Faculty of Mechanical Engineering, GIKI


Independent Projects

• If we have “m” independent projects, then zero, one, two or

ME-291 Engineering Economy


more may be selected.
• There are a total of 2m alternatives. This include the DN
alternative.
For example, if we have three projects A,B,C, then we have
23 = 8 possible selections
DN, A,B,C,AB,AC,BC,ABC
• In real world problems, there is an upper budgetary limit,
that eliminate many of 2m alternatives.

© Faculty of Mechanical Engineering, GIKI


Nature or type of Alternatives

• It is important to recognize the nature or type

ME-291 Engineering Economy


of alternatives before starting an evaluation.
• There are two main types of alternatives
– Revenue Based
– Service Based

© Faculty of Mechanical Engineering, GIKI


Revenue Based

• Each alternative generates cost and revenue

ME-291 Engineering Economy


cash flow estimates, and possibly savings.
• The alternatives usually involve those that
require capital investment to generate
revenue or savings.
• To purchase new equipment to increase
productivity and sales is revenue alternative.

© Faculty of Mechanical Engineering, GIKI


Service Based

• In this case, each alternative has only cost

ME-291 Engineering Economy


cash flow estimates.
• These may be public sector (government)
initiatives. May be safety improvements.

© Faculty of Mechanical Engineering, GIKI


Present Worth analysis of Equal-Life
Alternatives

• In present worth analysis, the P value, now called PW, is

ME-291 Engineering Economy


calculated at the MARR for each alternative.
• This method is popular because future cost and revenue
estimates are transformed into equivalent worth now.
• This makes it easy to determine the economic advantage of
one alternative over another.
• The PW comparison of alternatives with equal lives is
straightforward. If both alternatives are used in identical
capacities for the same time period, they are termed equal-
service alternatives.

© Faculty of Mechanical Engineering, GIKI


Selecting one alternative

• Whether mutually exclusive alternatives involve

ME-291 Engineering Economy


disbursement only (service) or receipts and disbursement
(revenue), the following guidelines are applied to select one
alternative.
– One alternative: Calculate PW at the MARR. If PW≥0,
the requested MARR is met or exceed and the
alternative is financially viable.
– Two or more alternatives: Calculate the PW of each
alternative at the MARR. Select the alternative with the
PW value that is numerically largest, that is, less
negative or more positive, indicating a lower PW of cost
cash flows or larger PW of net cash flows of receipts
minus disbursements.

© Faculty of Mechanical Engineering, GIKI


ME-291 Engineering Economy
PW1 PW2 Selected
Alternative
$ -1500 $ -500 2

-500 +1000 2

+2500 -500 1

2500 1500 1

© Faculty of Mechanical Engineering, GIKI


Independent Alternatives

• For one or more independent projects, select

ME-291 Engineering Economy


all projects with PW ≥ 0 at the MARR
• This compares each project with the do-
nothing alternative. The project must have
positive and negative cash flows to obtain a
PW value that exceeds zero; that is, they
must be revenue projects.
• A PW analysis requires a MARR for use as
the “i” value in all PW relations.

© Faculty of Mechanical Engineering, GIKI


Example 5.1

• Perform a present worth analysis of equal-service

ME-291 Engineering Economy


machines with the cost shown below, if the MARR is
10% per year. Revenues for all three alternatives are
expected to be the same.

© Faculty of Mechanical Engineering, GIKI

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