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Present Worth Method of Comparison Lecture 7&8

The document discusses the present worth method of comparing engineering project alternatives. It explains that the present worth method discounts all cash flows to present value using a discount rate. It then provides examples of how to calculate the present worth of alternatives using revenue-dominated and cost-dominated cash flow diagrams. For revenue-dominated cash flows, alternatives with higher present worth are preferred. For cost-dominated cash flows, alternatives with lower present worth are preferred.

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Hammad Satti
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172 views20 pages

Present Worth Method of Comparison Lecture 7&8

The document discusses the present worth method of comparing engineering project alternatives. It explains that the present worth method discounts all cash flows to present value using a discount rate. It then provides examples of how to calculate the present worth of alternatives using revenue-dominated and cost-dominated cash flow diagrams. For revenue-dominated cash flows, alternatives with higher present worth are preferred. For cost-dominated cash flows, alternatives with lower present worth are preferred.

Uploaded by

Hammad Satti
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Present Worth Method of

Comparison

Engineering Economics
B(EEE)-6
Lecture 7&8
Introduction
• Present worth is an equivalence method of analysis in
which a project’s cash flows are discounted to a single
present value. It is perhaps the most efficient analysis
method we can use for determining project acceptability
on an economic basis.
• In this type of method comparison, the cash flows of each
alternative will be reduced to time zero by assuming an
interest rate i.
• Then, depending on the type of decision, the best
alternative will be selected by comparing the present
worth amounts of the alternatives.
Introduction
• The sign of various amounts at different points in time in a
cash flow diagram is to be decided based on the type of
the decision problem.
• In a cost dominated cash flow diagram, the costs
(outflows) will be assigned with positive sign and the
profit, revenue, salvage value (all inflows), etc. will be
assigned with negative sign.
• In a revenue/profit-dominated cash flow diagram, the
profit, revenue, salvage value (all inflows to an
organization) will be assigned with positive sign. The costs
(outflows) will be assigned with negative sign
Introduction
• In case the decision is to select the alternative
with the minimum cost, then the alternative
with the least present worth amount will be
selected.
• On the other hand, if the decision is to select
the alternative with the maximum profit, then
the alternative with the maximum present
worth will be selected.
Revenue Dominated Cash Flow Diagram

Definition

Revenue is the money a company earns from


the sale of its products and services.
Cash flow is the net amount of cash being
transferred into and out of a company.
Revenue Dominated Cash Flow Diagram
(notations)

P represents an initial investment and Rj the


net revenue at the end of the jth year. The
interest rate is i, compounded annually. S is
the salvage value at the end of the nth year.
Revenue Dominated Cash Flow Diagram
(Formula)

To find the present worth of the above cash flow


diagram for a given interest rate, the formula is

In this formula, expenditure is assigned a negative


sign and revenues are assigned a positive sign.
Revenue Dominated Cash Flow Diagram

If we have some more alternatives which are


to be compared with this alternative, then the
corresponding present worth amounts are to
be computed and compared. Finally, the
alternative with the maximum present worth
amount should be selected as the best
alternative.
Cost Dominated Cash Flow Diagram

Definition

Cost is the monetary value that has been spent by a


company in order to produce something. In a
business, Cost expresses the amount of money that is
spent on the production or creation of a good or service.

Cash flow is the net amount of cash being transferred


into and out of a company.
Cost Dominated Cash Flow Diagram
(notations)

P represents an initial investment, Cj the net cost of


operation and maintenance at the end of the jth
year, and S the salvage value at the end of the nth
year
Cost Dominated Cash Flow Diagram
(Formula)

To find the present worth of the above cash flow


diagram for a given interest rate, the formula is

In the above formula, the expenditure is assigned a


positive sign and the revenue a negative sign.
Cost Dominated Cash Flow Diagram

If we have some more alternatives which are


to be compared with this alternative, then the
corresponding present worth amounts are to
be computed and compared. Finally, the
alternative with the minimum present worth
amount should be selected as the best
alternative.
Revenue dominated cash flow (Examples)
Revenue dominated cash flow (Examples)
Revenue dominated cash flow (Examples)
Revenue dominated cash flow (Examples)
Cost dominated cash flow (Examples)
Cost dominated cash flow (Examples)
Cost dominated cash flow (Examples)
Cost dominated cash flow (Examples)

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