06 comparing alternatives
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asdasdaTRANSCRIPT
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Engr. Elisa G. Eleazar
CHE40: ENGINEERING ECONOMY
Comparing Alternatives
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CHE40: ENGINEERING ECONOMY 2
Project Combination
Incremental B/C Analysis
Capitalized Worth Method
Case 2: Useful Lives are
Different Among Alternatives
Case 1: Useful Lives are Equal
to the Study Period
Alternatives
Learning Objectives
1. Differentiate the different types of alternatives2. Compare projects when the useful lives are equal to the study period and when the
useful lives are different among alternatives3. Compare alternatives using the capitalized worth method and incremental B/C
analysis4. Compare project combinations
Module 5: Comparing Alternatives
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CHE40: ENGINEERING ECONOMY 3
Alternatives
Mutually Exclusive
at most one project can be chosen
Independent
the choice is not dependent of the choice of any other project; all or none of the
projects may be selected
Contingent
the choice is conditional on the choice of one or more other projects
Investment Alternatives
with initial capital investments that produce positive cash flows from increased revenue,
savings through reduced costs, or both
Cost Alternatives
with negative cash flows, except for a positive cash flow element from disposal of assets at the end of the projects useful life
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CHE40: ENGINEERING ECONOMY 4
Alternatives
The alternative that requires the minimum investment of capital and produces satisfactory
functional results will be chosen unless the incremental capital associated with an alternative
having a larger investment can be justified with respect to its incremental benefits.
When revenues and other economic benefits are present and vary among the alternatives,
choose the alternative that maximizes overall profitability (i.e., greatest positive equivalent
worth at i=MARR and satisfies all project requirements.
When revenues and other economic benefits are not present or are constant among
alternatives, consider only the costs and select the alternative that minimizes total cost (least
negative equivalent worth at i=MARR and satisfies all project requirements.
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CHE40: ENGINEERING ECONOMY 5
Case 1: Useful Lives are Equal to the Study Period
Equivalent Worth Methods
for investment alternatives, the one with the greatest positive equivalent worth is selected
for cost alternatives, the one with the least negative equivalent worth is selected
An airport needs a modern material handling system for facilitating access to and from a busy maintenance hangar. A second-hand system will cost $75,000. A new system with improved technology can decrease labor hours by 20% compared to the used system. The new system will cost $150,000 to purchase and install. Both systems have a useful life of 5 years. The market value of the used system is expected to be $20,000 in 5 years, and the market value of the new system is anticipated to be $50,000 in 5 years. Current maintenance activity will require the used system to be operated 8 hours per day for 20 days per month. If labor costs $40 per hour and the MARR is 1% per month, which system should be recommended?
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CHE40: ENGINEERING ECONOMY 6
Case 1: Useful Lives are Equal to the Study Period
Rate of Return Methods
each increment of capital must justify itself by producing a
sufficient rate of return ( MARR) on that increment
compare a higher investment alternative against a lower
investment alternative only when the latter is acceptable
select the alternative that requires the largest investment of capital as
long as the incremental investment is justified by benefits
that earn at least the MARR
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Arrange the feasible alternatives based on increasing capital investment.
2 Establish a base alternative.
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Use iteration to evaluate differences (incremental cash flows) between alternatives until all alternatives have been considered.
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If the incremental cash flow between the next alternative and the current selected alternative is acceptable, choose the next alternative.
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Otherwise, retain the last acceptable alternative as the current best.
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CHE40: ENGINEERING ECONOMY 7
Case 1: Useful Lives are Equal to the Study Period
Two mutually exclusive diesel generators are considered for purchase by a power generation company. Information relevant to compare the alternatives are summarized below:
Use the ERR method to determine the better machine. MARR is 10% per year. The external reinvestment rate is 8%.
A B C
Capital Investment, $ 100,000 80,000 120,000
Salvage Value, $ 35,000 10,000 20,000
Annual Maintenance Expenses, $ 3,000 5,000 2,500
Service Life 10 10 10
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CHE40: ENGINEERING ECONOMY 8
Case 2: Useful Lives are Different Among Alternatives
Use the repeatability assumptionUseful Life < Study Period
Use the imputed market value techniqueUseful Life > Study Period
Repeatability Assumption
assumes that the economic estimates for an alternatives initial useful life will be repeated
in the subsequent replacement cycles
Coterminated Assumption
repeat part of the useful life and then use an estimated market value to truncate it at the
end
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CHE40: ENGINEERING ECONOMY 9
Case 2: Useful Lives are Different Among Alternatives
As the supervisor of a facilities engineering department, you consider mobile cranes to be critical equipment. The purchase of a new medium-sized truck-mounted crane is being evaluated. The economic estimates for the two best alternatives are shown below. Which of the two alternatives would you recommend? MARR is 15%.
A B
Capital Investment, $ 272,000 346,000
Annual Expenses, $ 28,800 19,300
Useful Life, years 6 9
Salvage Value, $ 25,000 40,000
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CHE40: ENGINEERING ECONOMY 10
Case 2: Useful Lives are Different Among Alternatives
MVT = PW at end of year T of remaining CR amounts + PW at end of year T of original market value at end of useful life
based on assumptions about the value of the remaining useful life for an asset
Imputed Market Value Technique
Use the imputed market value technique to develop an estimated market value at the end of year 5 for crane B in SP3. I = $346,000; S = $40,000; useful life = 9; MARR = 15%
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CHE40: ENGINEERING ECONOMY 11
Case 2: Useful Lives are Different Among Alternatives
A 50 hp motor is required to power a large capacity blower. Two motors, A and B, mutually exclusive, have been proposed. Their cost data are as follows.
The MARR is 5% per year. Determine which alternative should be selected if the analysis period is 10 years.
A B
Capital Investment, $ 9,000 8,000
Annual Expenses, $ 5,000 6,000
Useful Life, years 10 15
Salvage Value, $ 0 1,000
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CHE40: ENGINEERING ECONOMY 12
Capitalized Worth Method
Capitalized Worth
used when the period of needed service is indefinitely long = =
1
A firm is considering the purchase of one of two new machines. The data on each are given below:
If perpetual service from the machine is assumed, which machine would you recommend? The MARR is 10% per year.
A B
Capital Investment, $ 3,400 6,500
Annual Expenses, $ 2,000 1,800
Useful Life, years 3 6
Salvage Value, $ 100 500
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CHE40: ENGINEERING ECONOMY 13
Incremental B/C Analysis
The city of Oak Ridge is evaluating three MEAs for refurbishing a public greenway. Benefits to the community have been estimated and summarized. The citys discount rate is 8% per year and the planning horizon is 10 years. Which plan is best?
A B C
Investment, $ 75,000 50,000 65,000
Annual maintenance cost, $ 4,000 5,000 4,700
Annual benefits, $ 20,000 18,000 20,000
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CHE40: ENGINEERING ECONOMY 14
Project Combination
Mutually Exclusive
at most one project can be chosen
Independent
the choice is not dependent of the choice of any other project; all or none
of the projects may be selected
Contingent
the choice is conditional on the choice of one or more other projects
Engineering projects A, B1, B2 and C are being considered with cash flows estimated over 10 years as shown. B1 and B2 are mutually exclusive, C depends upon B1 and A depends upon B2. The capital investment budget limit is $100,000 and the MARR is 12% per year. What combination of projects should be selected?
A B1 B2 C
Cap Inv, $ 30,000 22,000 70,000 82,000
Annual Profit, $ 8,000 6,000 14,000 18,000
Salvage Value 3,000 2,000 5,000 7,000
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CHE40: ENGINEERING ECONOMY 15
Project Combination
A small company has $20,000 in surplus capital that it wishes to invest in new revenue-producing projects. Three independent sets of mutually exclusive projects have been developed. The useful life of each is five years, and all market values are zero. You have been asked to perform ERR analysis to select the best combination of projects. MARR is equal to the external reinvestment rate (12%).
Project Cap Inv, $Net Annual Benefits, $
Mutually exclusive A1 5,000 1,500
A2 7,000 1,800
Mutually exclusive B1 12,000 2,000
B2 18,000 4,000
Mutually exclusive C1 14,000 4,000
C2 18,000 4,500
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CHE40: ENGINEERING ECONOMY 16
Project Combination
Incremental B/C Analysis
Capitalized Worth Method
Case 2: Useful Lives are
Different Among Alternatives
Case 1: Useful Lives are Equal
to the Study Period
Alternatives
Learning Objectives
1. Differentiate the different types of alternatives2. Compare projects when the useful lives are equal to the study period and when the
useful lives are different among alternatives3. Compare alternatives using the capitalized worth method and incremental B/C
analysis4. Compare project combinations
Module 5: Comparing Alternatives
-
Engr. Elisa G. Eleazar
CHE40: ENGINEERING ECONOMY
Comparing Alternatives
17