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Decisions Under Certainty Part 1

The document discusses methods for evaluating mutually exclusive alternatives and independent projects in engineering economy. It provides rules for evaluating mutually exclusive alternatives, such as selecting the alternative with the highest profitability or lowest cost. It also discusses assumptions used to evaluate alternatives with unequal lifetimes, such as coterminated and repeatability assumptions. Sample problems demonstrate calculating present worth, annual worth, and benefit-cost ratios to select the best alternative. The key points are evaluating alternatives over a common time period, and for independent projects, selecting all projects with a benefit-cost ratio greater than one.

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Janinay Ruidera
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39 views

Decisions Under Certainty Part 1

The document discusses methods for evaluating mutually exclusive alternatives and independent projects in engineering economy. It provides rules for evaluating mutually exclusive alternatives, such as selecting the alternative with the highest profitability or lowest cost. It also discusses assumptions used to evaluate alternatives with unequal lifetimes, such as coterminated and repeatability assumptions. Sample problems demonstrate calculating present worth, annual worth, and benefit-cost ratios to select the best alternative. The key points are evaluating alternatives over a common time period, and for independent projects, selecting all projects with a benefit-cost ratio greater than one.

Uploaded by

Janinay Ruidera
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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DECISIONS UNDER

CERTAINTY

DISCUSSANT: SIGUE, SHARMAINE B.


INSTRUCTOR: ENGR. JALENE MAY PANOTES

04/04/2023
Topic
Topic Content
Content
Evaluation of Mutually Exclusive Alternatives 01

Evaluation of Independent Projects 02

Depreciation and After-Tax Analysis 03


EVALUATION OF MUTUALLY
EXCLUSIVE ALTERNATIVES

Rule 1: When revenues and other economic benefits are present and vary
among the alternatives, choose the alternative that maximizes overall
profitability. That is, select the alternative that has the greatest positive
equivalent worth at i=MARR and satisfies all project requirements.

Rule 2: When revenues and other economic benefits are not present or
are constant among the alternatives, consider only the costs and select
the alternative that has the least negative worth at i=MARR and satisfies
all project requirements.
STUDY (ANALYSIS PERIOD)
The study (analysis) period, sometimes called the planning horizon, is the selected
time period over which mutually exclusive alternatives are compared. The useful
lives of alternatives being compared, relative to the selected study period, can
involve two situations:

·Useful lives are the same for all alternatives and equal study period.
·Useful lives are unequal among the alternatives, and at least one does not match
the study period.

The most straightforward technique for comparing mutually exclusive alternatives


when all useful lives are equal to the study period is to determine the equivalent
worth (AW, PW, or FW) of each alternative based on total investment at i=MARR.
Then, for investment alternatives, the one with the greatest positive equivalent
worth is selected. And, in the case of cost alternatives, the one with the least
negative equivalent worth is selected.
Unequal lives among alternatives somewhat complicate their analysis and
comparison. To conduct engineering economy analysis in such cases, we adapt the
rule of comparing exclusive alternatives over the same period of time.

Two types of assumptions use for these comparisons:

1. Coterminated Assumption
2. Repeatability Assumption

COTERMINATED ASSUMPTION
The coterminated assumption uses a finite and identical study period for all
alternatives. This planning horizon, combined with appropriate adjustments to the
estimated cash flows, puts the alternatives on a common and comparable basis.
When the useful life of an alternative is equal to the selected study period,
adjustments to the cash flows are NOT required. Use FW method in this assumption.
REPEATABILITY ASSUMPTION
This assumes that the economic estimates for an alternative’s initial life cycle will be
repeated in all subsequent replacement cycles. Another viewpoint is to consider the
repeatability assumption as a modeling convenience for the purpose of making a
current decision. When this assumption is applicable to a decision situation, it
simplifies comparison of the mutually exclusive alternatives.
Compute the AW of each alternative over it’s own useful life and recommend the
one having the most economical value (i.e., the alternative with the highest positive
AW for investment alternatives and the alternative with the least negative AW for
cost alternatives.)
SAMPLE PROBLEMS:

1.For the table below, select the best option using MARR=10% per year for 4 years.
Which of these is the base alternative?
Solution:

For Alternative A:
For Alternative B:

Ans: Alternative B is the best option for this project since it has a larger PW. Because
Alternative A has the lower PW, it is called the base alternative.
2. For the table below, select the best option using MARR=10% per year.
Solution:
For Alternative C:
For Alternative D:

Ans: Since D has the lesser negative PW, this is the best option for this project.
3. The following data have been estimated for two mutually exclusive investment
alternatives. A and B, associated with a small engineering project for which revenues
as well as expenses are involved. They have useful lives of four and six years,
respectively. If MARR=10% per year, show which alternative is more desirable. Use
repeatability assumption.
Solution:
For Alternative A:
For Alternative A:
For Alternative B:
For Alternative B:

Ans: Alternative B is more desirable since it has larger AW.


Direct Solution:
For Alternative A:
For Alternative B:

Ans: Alternative B is more desirable since it has larger AW.


4. Suppose that Sample Problem 3 is modified such that an analysis of six years is
used (coterminated assumption) instead of 12 years, which was based on
repeatability and the least common multiple of the useful lives. Perhaps the
responsible manager did not agree with the repeatability and wanted a six-year
analysis period because it is the planning horizon used in the company for small
investment projects.
Solution:
For Alternative A:
Solution:
For Alternative B:

Ans: Alternative B is more desirable since it has larger FW.


EVALUATION OF INDEPENDENT
PROJECTS

Independent projects are categorized as groupings of projects for which the choice to select
any particular project in the group is independent of choices regarding any and all other
projects within the group. Because any or all projects from an independent set can be
selected, formal comparisons of independent projects are unnecessary.

The issue of whether one project is better than another is unimportant if those projects are
independent, the only criterion for selecting each of those projects is whether their
respective B-C ratio are equal to or greater than 1.0.
Below is the procedure in selecting the preferred alternative in an incremental B-C ratio.
SAMPLE PROBLEM:

The required investments, annual operating and maintenance costs, and annual
benefits for two mutually exclusive alternative project are shown subsequently.
Both conventional and modified B-C ratios are included for each project. Note that
Project A has the greater conventional B-C, but Project B has the greater modified B-
C. Given this information, which project should be selected?
Solution:

For Project A:
For Project B:
For Project A:
For Project B:
Select do-nothing alternative as the baseline B-C ratios must be computed. As given
in the table, A has a B-C ratio greater than 1, then this becomes the new baseline. (A is
selected since it has the least cost).

Ans: Because both options show that the increment is greater than 1, Project B is
the better choice.
Thank
you!!

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