7. A local council plans to purchase a new garbage truck.

Two models are equally

acceptable. Which truck would you recommend they purchase on economic grounds?

Model A Model B
Purchase Price ($) 50,000 60,000
Operating Cost (Annual)($) 9,000 7,000

The expected life of each truck is 5 years with zero salvage value and an interest rate of 7%.

NPV A  $50,000 

$9,000 1.07 5  1 NPVB  $60,000 

$7,000 1.07 5  1
0.07  1.07 5 0.07  1.07 5
 $50,000  $36,902  $60,000  $28,701
 $86,902  $88,701
Therefore recommend model A.

8. A building company has received a bid from a dealer to replace its fleet of trucks. Should
the company replace its fleet?

Old truck New Truck

Market Value ($) 50,000
Price ($) 80,000
Salvage Value ($) 5,000 6,000
Annual Operating Cost ($) 4,000 3,000
Life in years 3 5
Discount rate 10% 10%

Use the annual equivalent amount criteria since the number of years differs.

$50,000  0.1  1.13 $5,000  0.1

Annual Equivalent Amount old     $4,000

1.13  1 
1.13  1 
 $20,106  $1511  $4,000
 $22,595

$80,000  0.1  1.15 $6,000  0.1

Annual Equivalent Amount new     $3,000

1.15  1 
1.15  1 
 $21,103  $983  3,000
 $23,120

The company should keep the old fleet.

Engineering Economics Solutions to Economic Evauation Tutorial Page 1

 9. Compare the following two projects using present value analysis over a life of 25 years at
a discount rates of 15% and 8%. Comment on the difference. The capital costs and incomes for
each project are:

Project Capital Cost Annual Income

1 $100,000 $20,000
2 $30,000 $11,000

NPV1 @ 15%  $100,000 


$20,000 1.15 25  1  NPV2 @ 15%  $30,000 

$11,000 1.15 25  1 
0.15  1.15 25 0.15  1.15 25
 $100,000  $129,283  $30,000  $71,106
 $29,283  $41,106

NPV1 @ 8%  $100,000 

$20,000 1.08 25  1  NPV2 @ 8%  $30,000 

$11,000 1.08 25  1
0.08  1.08 25 0.08  1.08 25
 $100,000  $213,496  $30,000  $117,422
 $113,496  $87,423

Using a discount rate of 8% favours project 1, whereas a discount rate of 15% favours project 2.
This is because project 1 is a capital intensive project and the higher discount rate has a greater
effect on its benefits than on the smaller benefits from project 2.

10. Three alternative schemes are being considered for the provision of machinery for a
pumping station. For each scheme the capital cost, annual running cost and salvage value are
indicated below. Determine the most economical proposal, assuming a constant discount rate of
8%, to provide a pumping facility for an indefinite number of years.

Note The expected life of each scheme is different.

Scheme A B C
Capital Cost $25,000 $50,000 $35,000
Annual Cost $3,000 $2,000 $2,500
Salvage Value $5,000 $7,000 $6,000
Life (years) 10 29 16

Use the annual equivalent amount criteria since the number of years differs.

$25,000  0.08  1.0810 $5,000  0.08

Annual Equivalent Amount A    $3,000 

1.08  1
10
 
1.0810  1 
 $3,726  $3,000  $345
 $6,381

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 $50,000  0.08  1.08 29 $7,000  0.08
Annual Equivalent Amount B    $2,000 

1.08  1
29
 
1.08 29  1 
 $4,480  $2,000  $67
 $6,413
$35,000  0.08  1.0816 $6,000  0.08
Annual Equivalent Amount A    $2,500 

1.08  1
16
 
1.0816  1 
 $3,954  $2,500  $198
 $6,256
Therefore the cheapest option is Scheme C.

11. (After Hollick, 1993) Two alternative investments are available, both costing $1500
immediately. The first gives returns of $200, $400, $600, $800 and $1000 in the five-year
analysis period, while the second gives returns of $1500 in year 1 and $200 in each of the
remaining years. What is the internal rate of return for each investment? At what discount rate
are they equally attractive?

Answers: The first alternative has a rate of return of about 22 per cent, and the second has one of
about 29 per cent. The two have equal present values at a discount rate of about 16 per cent.

12. (After DeGarmo et al ,1984) Given: The Highridge Water District needs an additional
supply of water from Steep Creek. The engineer has selected two plans for comparison.

(a) Gravity plan: Divert water at a point 10 miles up Steep Creek and carry it through a pipeline
by gravity to the district.
(b) Divert water at a point near the district and pump it through 2 miles of pipeline to the district.
The pumping plant can be built in two stages, with one-half capacity installed initially and
the other one-half 10 years later.

All costs are to be repaid within 40 years, with interest at 8%. Salvage values can be ignored.
During the first 10 years, the average use of water will be less than the average during the
remaining 30 years. Costs are as follows:

Gravity Pumping
Initial investment $2,800,000 $1,400,000
Additional investment in None $200,000
tenth year
Operation, maintenance, $10,000/year $25,000/year
and replacements
Power cost:
Average first 10 years None $50,000/year
Average next 30 years None $100,000/year

Required: Select the more economical plan for a 40-year period on the basis of present worth.

Engineering Economics Solutions to Economic Evauation Tutorial Page 3

NPVGravity  $2,800,000 

$10,000 1.08 40  1 
0.08  1.08 40
 $2,800,000  $119,246
 $2,919,246
 
$125,000 1.08 30  1
NPVPumping  $1,400,000 

$75,000 1.08  110

 $200,000 
0.08  1.08 30
0.08  1.0810 1.0810
 $1,400,000  $503,256  $92,639  $651,816
 $2,647,711
Therefore use the pumping option.

13. The consumer price index at the end of each year from 1985 to 1988 is given in the
following table.

Year 1985 1986 1987 1988

st
CPI 31 December 72.7 79.8 85.5 92.0

a) What were the inflation rates for the calendar years 1986, 1987 and 1988?

79.8  72.7
Inflation rate for 1986   9.8%
72.7
85.5  79.8
Inflation rate for 1987   7.1%
79.8
92.0  85.5
Inflation rate for 1988   7.6%
85.5

b) If the nominal interest rate in 1986 was 17.5%, what was the real interest rate?

1  iN 1  0.175
Real interest rate for 1986  1   1  7.0%
1 f 1  0.098

14. (After DeGarmo et al, 1984) Two high-speed backhoes are being considered by the Apex
Construction Company to replace a present piece of equipment. The equipment will only be
needed three years. Use a discount rate of 12%. Which backhoe should the company choose if
any. Cost data for the proposed backhoes are as follows:

Backhoe M Backhoe N
Purchase price -$50,000 -$100,000
Annual savings +$25,000 +$60,000
Life of backhoe 3 years 5 years
Estimated salvage value at
end of year 3 +$20,000 +$10,000

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Note in this question the life is the same since the backhoes will be sold in 3 years anyway. Thus
the extra two years of life in backhoe N is irrelevant. Therefore either NPV or AEA can be used.

$50,000  0.12  1.12 3 $20,000  0.12

Annual Equivalent Amount M    $25,000 

1.12  1
3
 
1.12 3  1 
 $20,817  $25,000  $5927
 $10,110
$100,000  0.12  1.12 3 $10,000  0.12
Annual Equivalent Amount N    $60,000 

1.12  1
3
 
1.12 3  1 
 $41,634  $60,000  $2,964
 $21,330
Therefore the company should choose backhoe N. Note in this question it appears that the do
nothing option is viable (ie keep using the present piece of equipment). The fact that the AEA's
(or NPV's) are positive indicate that it is not optimum. However, to be fully rigorous the salvage
value of this piece of equipment should have been considered. In this case the NPV of the new
piece of equipment would have to be bigger than the salvage value of the old piece (the operating
costs of the old piece have already been considered since the annual costs of the new backhoes
are considered as savings over the old piece).

15. (After DeGarmo et al, 1984) You have been asked to evaluate the economic implications
of various methods for cooling condenser effluents from a 350-megawatt steam-electric plant. In
this regard, cooling ponds and once-through cooling systems have been eliminated from
consideration because of their adverse ecological effects. It has been decided to use cooling
towers to dissipate waste heat to the atmosphere. There are two basic types of cooling towers:
wet and dry. Furthermore, heat may be removed from condenser water by (1) forcing
(mechanically) air through the tower or (2) allowing heat transfer to occur by making use of
natural draft. Consequently, there are four basic cooling tower designs that could be considered.
Assuming that the cost of capital to the utility company is 12%, your job is to recommend the
best alternative (i.e., the least expensive during the service life) in view of the data below.
Further assume that each alternative is capable of satisfactorily removing waste heat from the
condensers of a 350-megawatt power plant. What non-economic factors can you identify that
might also play a role in the decision-making process?

Alternative Types of Cooling Towers for a 350-Megawatt Fossil-Fired Power Plant

Operating at Full Capacity

Alternative
Wet Tower Wet Tower Dry Tower Dry Tower
Mech. Draft Natural Draft Mech. Draft Natural Draft
Initial cost $3 million $8.7 million $5.1 million $9.0 million
Power for I.D. fans 40 200-hp None 20 200-hp I.D. None
induced-draft fans
fans

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Power for pumps 20 150-hp 20 150-hp 40 100-hp 40 100-hp
pumps pumps pumps pumps
Mechanical $0.15 million $0.10 million $0.17 million $0.12 million
maintenance/year
Service life 30 years 30 years 30 years 30 years
Salvage value 0 0 0 0

100hp = 74.6 kW; cost of power to plant is 2.2 cents per kWh or kilowatt-hour; induced-draft
fans and pumps operate around the clock for 365 days/year (continuously). Assume that electric
motors for pumps and fans are 90% efficient.

Alternative
Wet Tower Wet Tower Dry Tower Dry Tower
Mech. Draft Natural Draft Mech. Draft Natural Draft
Initial cost $3 million $8.7 million $5.1 million $9.0 million
Total power (40 * 200 + (20 * 150) (20 * 200 + (40 * 100)
required (kW) 20 * 150) / 0.9 / 0.9 40 * 100) / 0.9 / 0.9
* 0.746 * 0.746 * 0.746 * 0.746
= 9,118 kW =2,487 kW = 6,631 kW = 3,316 kW
Energy required 9,118 *365 * 24 21,786MW 58,088 MW 29,048 MW
per year = 79,874 MW
Energy cost per 79,874 * 22 $479,292 $1,277,936 $639,056
year =$1,757,228
Total annual cost 1.76M + 0.15M $0.58 million $1.44 million $0.76 million
$1.91 million
NPV of annual  
$1.911.12 30  1 $4.7 million $11.6 million $6.1 million
costs
0.12  1.12 30
=$15.4 million
Total NPV $18.4 million $13.3 million $16.7 million $15.1 million
Therefore the wet tower, natural draft solution is the cheapest.
Other non-economic factors may include: reliability of the various systems, jobs created by the
projects, aesthetic impacts of the various towers, etc.

16. (after Hollick, 1993) There are three alternatives for supplying water to a community
over the next 30 years, the real costs and benefits for which are shown in the table below.
Alternative A has an economic life of 30 years and sufficient capacity to meet increasing demand
over that period. Alternatives B and C require additional capital expenditure to build a second
stage after ten years and a third stage after twenty years to meet the same demand. Each stage of
B has an economic life of twenty years, and each stage of C has an economic life of fifteen years.
Construction of each new stage or replacement takes one year to complete. Assume that the
economic life of any stage starts on completion of construction, and that depreciation is linear.

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Project data question 16
Factor Time A($m) B($m) C($m)
Construction (not Year 1 15 10 5
including Year 11 0 10 20
replacement) Year 21 0 5 20
Operation and Years 2 - 11 3 2 1
maintenance Years 12 - 21 3 3 4
Years 22 on 3 4.5 6
Major repairs Years 11, 21 5 5 0
Salvage value 1 1/stage 1/stage
Benefits Year 2 3.5 3.5 3.5
(increasing at 3% pa)
For each alternative:

• Enter the data in a spreadsheet and create a cash flow diagram.

• Calculate the present worth, annual worth and benefit-cost ratio for a real discount rate of
10% per cent.
• Determine the rate of return.
• Calculate the incremental rate of return and benefit-cost ratio.
• Explore the effect of using discount rates from 2 to 15 per cent.
• Rework the evaluation using actual dollars and an inflation rate of 7 per cent.
• Recommend which alternative would be best.

Answers: Note that in specifying the problem so briefly, there is scope for legitimate differences
in interpretation and analysis which may result in slightly different answers to those given in the
table below. However, significant discrepancies would indicate that an error has been made.

Evaluation criterion A B C
Present worth @ 10% ($m) -2.6 1.30 4.32
Annual worth @ 10% ($m) -0.27 0.14 0.46
Benefit-cost ratio @ 10% 0.94 1.03 1.12
Rate of return 8.5% 11.8% 50%
Discount rate range over which 0-5.8% 5.8-7.3% >7.3%
alternative is best
B-C A-C A-B
Incremental ROR 7.25% 6.6% 5.8%
Incremental B/C @ 10% 0.77 0.71 0.64

If the minimum acceptable rate of return (MARR) is 10%, then C is best, but lower values of
MARR could lead to B or even A being selected.

17. (After DeGarmo et al, 1984) A construction company is going to purchase several heavy-
duty trucks. Its M.A.R.R. before taxes is 18%. It is considering two makes, and the following
relevant data are available.

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 Wiltsbilt Big Mack
Cost $10,000 $15,000
Life (estimated by manufacturer) 3 years 5 years
Salvage value at end of life $2,000 $3,000
Annual out-of-pocket costs $4,000 $3,000

(a) Which type of truck should be selected when the repeatability assumption is appropriate?
(b) Which type of truck would you recommend if the study period is limited to 3 years
(coterminated assumption) and it is estimated that a Big Mack truck will have a salvage
value of $5,600 at that time?

$10,000  0.18  1.18 3 $2,000  0.18

Annual Equivalent Amount Wiltsbilt    $4,000 

1.18  1
3
  
1.18 3  1
 $4,599  $4,000  $560
 $8,039
$15,000  0.18  1.18 5 $3,000  0.18
Annual Equivalent Amount Big Mack    $3,000 

1.18  1
5
  
1.18 5  1
 $4,797  $3,000  $419
 $7,378
$15,000  0.18  1.18 3 $5,600  0.18
Annual Equivalent Amount Big Mack    $3,000 

1.18  1
3
  
1.18 3  1
 $6,899  $3,000  $1568
 $8,331
(a) Big Mack
(b) Wiltsbilt

18. (After DeGarmo et al, 1984) A company has the opportunity to take over a redevelopment
project in an industrial area of a city. No immediate investment is required, but it must raze the
existing buildings over a 4-year period and at the end of the fourth year invest $2,400,000 for
new construction. It will collect all revenues and pay all costs for a period of 10 years, at which
time the entire project, and the properties thereon, will revert to the city. The net cash flow is
estimated to be as follows:

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 Year End Net Cash Flow
1 +$500,000
2 +$300,000
3 +$100,000
4 -$2,400,000
5 +$150,000
6 +$200,000
7 +$250,000
8 +$300,000
9 +$350,000
10 +$400,000

Tabulate net present worth versus the interest rate and determine whether multiple I.R.R.'s exist.

Discount rate NPV Discount Rate NPV

1 103331.6 29 -18919.8
2 63694.64 30 -12186.8
3 30228.16 31 -5479.09
4 2175.183 32 1182.768
5 -21130.3 33 7781.136
6 -40274.6 34 14300.87

150000

100000
Net Present Value

50000

0
0 10 20 30 40 50
-50000

-100000

-150000
Discount Rate

Two I.R.R.'s exist, one a little above 4% and one a little below 32%

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