Scribd
Upload
118 views

Lecture 09

This document presents methods for evaluating and comparing projects. It discusses minimum acceptable rate of return, present worth, and annual worth comparisons for independent and mutually exclusive projects. It also covers comparing alternatives with unequal lives using repeated lives or study period assumptions. The document defines payback period as a preliminary filter and provides examples of calculating standard and discounted payback periods. Recommended practice problems are listed at the end.

Uploaded by

api-26315128
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
118 views

Lecture 09

This document presents methods for evaluating and comparing projects. It discusses minimum acceptable rate of return, present worth, and annual worth comparisons for independent and mutually exclusive projects. It also covers comparing alternatives with unequal lives using repeated lives or study period assumptions. The document defines payback period as a preliminary filter and provides examples of calculating standard and discounted payback periods. Recommended practice problems are listed at the end.

Uploaded by

api-26315128
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

Objective:

Presenting methods for evaluating and comparing projects


Lecture 9 Topics Covered:
- Relations Among Projects
- Minimum Acceptable Rate of Return (MARR)
- Present Worth (PW) and Annual Worth (AW) Comparisons
Comparison Methods Part - Present Worth for Independent Projects
- Present Worth for Mutually Exclusive Projects
1, cont’d. - Annual Worth Comparisons

Topics to be Covered:
- Present Worth (PW) and Annual Worth (AW) Comparisons
- Comparison of Alternatives with Unequal Lives
- Payback Period
1 2

Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)

Comparison of Alternatives with Unequal Example 4.6 (p. 98):


Lives A mechanical engineer has decided to introduce automated
material-handling equipment for a production line. She
- PW comparisons can not be used with projects of different lives must choose between two alternatives, building the
equipment or buying the equipment off the shelf. Each
- Methods of transforming projects to equal lives: alternative has a different service life and a different set of costs.
- Repeated lives: Alternative 1: Build custom automated material-handling equipment
- Repeat the service life of each alternative to arrive at a common
with an expected service life of 10 years.
time period to all alternatives (least common multiple). First cost Labour Power Maintenance Taxes & Insurance
$15,000 $3,300/yr $400/yr $2,400/yr $300/yr
- Assume that each alternative can be repeated with the same costs
and benefits in the future. Alternative 2: Buy off-the-shelf standard automated material-handling
- Study period: equipment with an expected service life of 15 years.
First cost Labour Power Maintenance Taxes & Insurance
- Adopt a specific time period that is given for the analysis.
$25,000 $1,450/yr $600/yr $3,075/yr $500/yr
-Assume a specific salvage value whenever the life of one of the
alternatives exceeds that of a the given study period. 3
If the MARR is 9%, which alternative is better? 4

Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)

1
Repeated indefinitely Payback Period
assumption (AW method) - It is a rough estimate of the time it takes for an investment
to pay for itself when the interest rate is assumed to be zero
z There is a more convenient approach for an annual - It should be used as a preliminary filter rather than a sole criterion
worth comparison of projects of unequal lives if it for evaluating projects.
can be assumed that the alternatives are repeated
Payback period = (first cost)/(annual savings)
indefinitely.
z Since the project would repeat indefinitely, its Example 4.8 (p. 103):
annual costs would remain the same no matter A project with initial cost $5,000 and annual savings of $2,000.
how many times it is repeated, it is not necessary to
- Assuming that the savings occur over the whole year:
determine the LCM of the service lives.
Payback period = $5,000/$2,000 = 2.5 years
z The AW can be assessed for whatever time period
is most convenient for each alternative. - Assuming that the savings occur at the end of the year:
Payback period = 3 years
5 6

Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)

Payback Period, cont’d. Payback Period, cont’d.


- If the annual savings are not constant every year,
savings are deducted from the first cost until the first cost is
recovered. - The project with shorter payback period is the preferred
Example 4.9 (p. 103): investment.
A project of initial cost $8,000 and annual savings of $3,000, $2,000 - The maximum payback period is defined by the company
and $1,500 for the next 3 years and $1,000 for the following 2 years. depending on the type of project and the company’s financial
What is its payback period? situation.
- Paid amount after 3 years = $3,000+$2,000+$1,500=$6,500
- Payback periods are usually between 2 and 4 years.
- Paid amount after 5 years = $6,500+$1,000+$1,000=$8,500
- Payback period = 4.5 years assuming savings occur continuously
throughout the year
- Payback period = 5 years assuming savings occur at the end of
each year 7 8

Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)

2
Discounted Payback Period Recommended Problems
The present worth of each year’s savings is subtracted from
the first cost until the first cost is diminished to zero.
Problems: 4.1, 4.9, 4.13, 4.17, 4.25 & 4.42
Example (p. 104):
A project with initial cost $5000 and annual savings of $2000. If the
interest rate is 10%, the present worth of savings would be:
Year PW Cumulative
1 $2,000(P/F,10%,1)=$1,818 $1,818
2 $2,000(P/F,10%,2)=$1,653 $3,471
3 $2,000(P/F,10%,3)=$1,503 $4,974
4 $2,000(P/F,10%,4)=$1,366 $6,340

The discounted payback period is over 3 years, compared with 2.5


years calculated for the standard payback period
9 10

Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)

You might also like