Engineering Economic Analysis

9th Edition

Chapter 5
PRESENT WORTH ANALYSIS

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1
Where we have been:
• Equivalence concept
• Cash flows
• Compound interest factors

Where we are going in this chapter:

• Understanding economic criteria
• Applying present worth techniques
• Assumptions in solving economic analysis
problems

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 2
 Economic Criteria
Projects are judged against an economic criterion.

Situation Criterion

Fixed input Maximize output

Fixed output Minimize input

Neither fixed Maximize difference

(output-input)

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 3
 Economic Criteria Restated
Present Worth Techniques

Situation Criterion
Fixed input Amount of Maximize
capital available present worth of
fixed benefits
Fixed output $ amount of Maximize
benefit is fixed present worth of
costs
Neither fixed Neither capital Maximize net
nor $ benefits present worth
are fixed (NPV)
Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 4
 Economic Criteria - Example
Purchasing Building Space

Alt Situation Example Criterion

A Fixed $150,000 max Maximum square feet of
input building for the price

B Fixed 20,000 ft2 Negotiate for minimum

output building cost/ft2
available
C Neither $150,000 max Simultaneously negotiate
fixed 15-20,000 ft2 for maximum building size
required & minimum cost/ft2

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 5
 Applying
Present Worth Techniques

• Analysis period must be considered

• Useful life of the alternative equals the analysis
period
• Alternatives have useful lives different from the
analysis period
• The analysis period is infinite, n = 

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 6
 Useful Lives
Equal the Analysis Period

1. Require a project to last Examples 5-1, 2, 3, & 4

five years. Examples

5-1
Applying present worth techniques

Interest rate 7.00 %

Alternative

2. The equipment and tooling

Year A B

0 -1000 -1000
1 300 400
2 300 350

will last five years.

3 300 300
4 300 250
5 300 200

3. Calculate the PW or NPW

PW of benefits $1,230.06 $1,257.75
NPW $230.06 $257.75

5-2 Interest rate 6.00 %

over a five year span and

Alternative
Year A B

0 -300 -400 <<<< Some cells are hidden.

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junk the equipment and PW of costs

NPW
($381.55)
($381.55)
($400.00)
($400.00)

tooling at the end of the 5-3 Interest rate

Year
7.00 %
Alternative
Speedy Allied Alternative Speedy
NPW
Allied
($1,357.40) ($1,368.28)

five years.
0 -1500 -1600
1 0 0
2 0 0
3 0 0
4 0 0
5 200 325

PW of costs ($1,500.00) ($1,600.00)

NPW ($1,357.40) ($1,368.28)

5-4 Interest rate 8.00 %

Alternative Alternative Atlas Tom Thumb
Year Atlas Tom Thumb NPW $143.31 $214.85

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 7
 Useful Lives Different
From the Analysis Period
1. Require a project to last 10 Based on example 5-3
years.
Based on 5-3 The lives of the equipment differ, one is a multiple of the other and we
can use the equipment as long as it will last.
Interest rate 7.00 %

2. The equipment and tooling

Alternative
Year Speedy Allied Alternative Speedy Allied
NPW ($2,325.21) ($1,434.79)

will last five years. Purchase new Speedy 0

1
2
-1500
0
0
-1600 Purchase new Allied
0
0

3. Calculate the PW or NPW Salvage old Speedy

3
4
5 -1300
0
0
0
0
0

over a 10 year span. Purchase new Speedy 6

7
8
0
0
0
0
0
0

1. Purchase new equipment Salvage old Speedy

9
10 200
0 0
325 Salvage old Allied

and tooling twice, at the PW of costs ($2,325.21) ($1,434.79)

NPW ($2,325.21) ($1,434.79)

beginning of year one and

six. Based on 5-3 The lives of the equipment differ and the least common multiple of the
lives is longer than we can use the equipment.

2. Junk the equipment and Interest rate 7.00 %

Alternative

tooling at the end of each five

Year Speedy Allied Alternative Speedy Allied
Life 7 13 NPW ($1,793.91) ($1,294.45)
Purchase new Speedy 0 -1500 -1600 Purchase new Allied

year period. 1
2
3
0
0
0
0
0
0
4 0 0
Salvage old Speedy 5 0 0
Purchase new Speedy 6 0 0
7 -1500 0
Salvage old Speedy 8 1100 525 Salvage old Allied

PW of costs ($1,793.91) ($1,294.45)

NPW ($1,793.91) ($1,294.45)

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 8
 Infinite Analysis Period
Capitalized Cost
Examples 5 - 5 & 6
For:
n=
A = Pi
Then:
Capitalized cost
P = A/i
This requires
first computing
the future cost
into an
equivalent A.
9
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Examples 5 - 7, 8, 9 & 10
Where more than one
5-7 Operating years 5
Operating hours/year 2000
MARR 7.00 %
0.07
Alternative A B C D
Description 2" Pipe 3" Pipe 4" Pipe 6" Pipe

alternative exists, we
Installed cost of pipeline and pump $22,000.00 $23,000.00 $25,000.00 $30,000.00
Cost per hour for pumping $1.20 $0.65 $0.50 $0.40
Annual cost of pumping $2,400.00 $1,300.00 $1,000.00 $800.00
PW of pumping costs ($9,840.47) ($5,330.26) ($4,100.20) ($3,280.16)
PW of pipeline costs ($31,840.47) ($28,330.26) ($29,100.20) ($33,280.16)

generally want to
5-8 Operating years 20
MARR 10.00 %
0.1
Alternative A B C D
Vegetable

compare the
Description Do nothing market Gas station Small motel
Total capital investment $0.00 ($50,000.00) ($95,000.00) ($350,000.00)
Uniform net annual benefit $0.00 $5,100.00 $10,500.00 $36,000.00
Terminal value at end of project $0.00 $30,000.00 $30,000.00 $150,000.00

PW investment $0.00 ($50,000.00) ($95,000.00) ($350,000.00)

alternatives in a single
PW of benefits $0.00 $43,419.17 $89,392.42 $306,488.29
PW of terminal value $0.00 $4,459.31 $4,459.31 $22,296.54
NPW of project $0.00 ($2,121.52) ($1,148.27) ($21,215.16)

5-9 Operating years 10

table.
MARR 10.00 %
0.1
Alternative A B C D
Strip mining
Description Do nothing project
Total capital investment $0.00 ($610,000.00)
Net annual benefit 1 $0.00 $200,000.00
2 $0.00 $200,000.00
3 $0.00 $200,000.00
4 $0.00 $200,000.00
5 $0.00 $200,000.00
6 $0.00 $200,000.00

The goal is to develop a

7 $0.00 $200,000.00
8 $0.00 $200,000.00
9 $0.00 $200,000.00
10 $0.00 $200,000.00
Terminal value at end of project $0.00 ($1,500,000.00)

single table that

PW investment $0.00 ($610,000.00) $0.00 $0.00
PW of benefits $0.00 $1,228,913.42 $0.00 $0.00
PW of terminal value $0.00 ($578,314.93) $0.00 $0.00
NPW of project $0.00 $40,598.49 $0.00 $0.00

automates as many of
5-10 Operating years 8
MARR 8.00 %
0.08
Alternative Null A B C
Description CE-1 CE-2

the calculations as
Total capital investment $0.00 ($2,000.00) ($1,500.00)
Net annual benefit 1 $0.00 $1,000.00 $700.00
2 $0.00 $850.00 $300.00
3 $0.00 $700.00 $300.00
4 $0.00 $550.00 $300.00
5 $0.00 $400.00 $300.00

possible.
6 $0.00 $400.00 $400.00
7 $0.00 $400.00 $500.00
8 $0.00 $400.00 $600.00
9 $0.00 $0.00 $0.00
10 $0.00 $0.00 $0.00
Terminal value at end of project $0.00 $0.00 $0.00

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1
0
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• End-of-year convention (simplifies calculations)

• Viewpoint (generally the firm)
• Sunk costs (past has no bearing)
• Borrowed money (consider investing only)
• Effect of inflation (prices are not stable)
• Income taxes (must be considered for realism)

Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1
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