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Lesson Five Annual Worth Analysis: Formulas

This chapter discusses annual worth (AW) analysis and how to use it to evaluate investment alternatives. It will cover calculating capital recovery over a project's life cycle, selecting the best alternative based on AW, and using AW to evaluate long-life investments. The key points are: 1) AW converts all cash flows to equivalent uniform annual amounts over one life cycle. 2) Calculating AW for a single cycle provides the same result as calculating it over multiple cycles. 3) The AW of a long-life investment is equivalent to the capitalized cost (CC) of the project.

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335 views2 pages

Lesson Five Annual Worth Analysis: Formulas

This chapter discusses annual worth (AW) analysis and how to use it to evaluate investment alternatives. It will cover calculating capital recovery over a project's life cycle, selecting the best alternative based on AW, and using AW to evaluate long-life investments. The key points are: 1) AW converts all cash flows to equivalent uniform annual amounts over one life cycle. 2) Calculating AW for a single cycle provides the same result as calculating it over multiple cycles. 3) The AW of a long-life investment is equivalent to the capitalized cost (CC) of the project.

Uploaded by

Grantham University
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Lesson Five Annual Worth Analysis

We will look at several items in this chapter. We will talk about:

1. How to calculate Capital Recovery over a life chyle


2. How to select the best alternative based on AW
3. How to select the best long-life investment alternative using AW values
4. Again how to use the spreadsheet functions.

When we do AW calculations, we will convert all our cash flows to equivalent uniform
annual amounts over 1 life cycle. Remember from the last chapter when we talked
about infinite series, what we meant was that would do the calculations for one life
cycle. Because a life cycle contains at least one of all the costs, all repeating life cycles
are considered to have the same values. So dont get thrown by how do I calculate
infinity. We are not that good yet.

You should note that when you calculate the AW for 1 life cycle and the calculate for 2
cycles you get the same answer. Problem 1 of this chapter proves that point. Therefore
when you calculate a single c

cycle it is the same if you add all subsequent life cycles.

It is always possible determine the AW, PW, and FW using the formula

AW = PW(A/P, i , n ) - FW (A/F, i ,n) the n value in the equation is the LCM of lives

Formulas

AW = CR (capital recovery) +A of AOC

CR = -P(A/P, i ,n) + S(salvage value) (A/F, i, n)

AW = CC(i) = PW(i)

The annual amount (A of AOC) is determined from uniform recurring costs (and
possibly receipts) and non-recurring cost. The P/A and the P/F factors may be
necessary to first obtain a present worth amount, than the A/P factor converts this
amount to A.

Note: The AW is applicable to any situation where P/W, F/Wor Benefit/cost analysis.
Evaluating Alternatives Based on Annual Worth

When AW 0 The alternative is viable. Choose the numerically largest. Do the tweo
examples in the book, page 128. You will find that these are the simplest of the
solutions, but still should be done.

Dont forget that when you are looking at an infinite series evaluation, the AW for the
first cycle (includes all the revenues and incomes that you are given) is identical when
you do two cycles at once. It still comes out that the calculation for the first cycle is
identical to the total of the two. Problem 5.1 proves this point.

AW of a long life or infinite-life investment

When you find the AW value of its capitalized (CC of a project, this is equivalent to of
the annual worth of a long life project. Convert your cash flows that are at regular
intervals, to AW over one cycle. All other non regular cash flows are first converted to a
P value then multiplied by i to obtain the AW value over infinity.

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