CVE 267: Civil Engineering Cost Analysis

Outline
5. Present Worth Analysis
5.1 Formulating Alternatives
5.2 Present Worth of Equal-Life Alternatives
? 5.3 Present Worth of Different-Life Alternatives
5.4 Future Worth Analysis
5.5 Capitalized Costs

Dr. Sami W. Tabsh, P.E.

Civil Engineering
AUS
1 2
Reference: Engineering Economy, Blank & Tarquin, McGraw-Hill

5.1 Formulating Alternatives 5.1 Formulating Alternatives

 Until now, present worth (PW) calculations have  Alternatives are normally developed from project
been carried out for a project (with one proposals to achieve a specified purpose (e.g.
alternative). In this chapter, techniques for solve a problem such as building a bridge).
comparing 2 or more mutually exclusive  Some projects are economically and technically
alternatives by the “Present Worth” method are feasible, while others are not.
addressed.  Once the viable projects are defined, it is
 Many expansions to the present worth method possible to formulate the cash flow diagrams of
are covered in this chapter, including the future the possible alternatives.
worth and capitalized cost.
3 4
 5.1 Formulating Alternatives
 Gold Strike Canyon Alternative is a steel arch bridge that
 Real-life example! would cross the Colorado River about 1 mile downstream of
Hoover Dam. The highway would follow Gold Strike Canyon
The Hoover Dam Bypass to the river. From the abutment of the river bridge on the
project is considering 3 Arizona side, the highway would cross a spoil site created
alternative crossing during the original construction of Hoover Dam. The route
would then follow the hillside to tie in with U.S. 93.
locations to bypass the
Hoover Dam. The "No-
Build" alternative is the 4th
alternative. These
alternatives differ in cost,
engineering scope, and
environmental
5 impact. 6

 Promontory Point Alternative is a steel suspension bridge  Sugarloaf Mountain Alternative is a steel arch bridge that
that would begin 1,000 feet east of the Goldstrike Casino, would cross the Colorado River about 1,500 feet
following a route just south of existing U.S. 93; it would downstream of Hoover Dam. The new highway would begin
cross the Reclamation warehouse area and then cross about 1,000 feet east of the Goldstrike Casino, following a
Lake Mead about 1,000 feet upstream of Hoover Dam. It route just south of existing U.S. 93 to the Reclamation
would then curve to rejoin the existing U.S. 93 near the first warehouse area. It would then curve to the southeast and
major curve at the crest of Black Canyon. cross the new bridge perpendicular to the Colorado River.

7 8
 5.1 Formulating Alternatives 5.1 Formulating Alternatives
Engineering/Construction features of the 3 alternatives.
Constr. Bridge Bridge Bridge
Cost Other
Duration Length Elevation Types
Gold Strike $215 5-6 years 1,700 ft 100 ft lower steel deck Poorest roadway
Canyon million than Hoover arch geometrics, most
Dam difficult construction,
least disturbance to
traffic during Sugarloaf Mountain Alternative
construction
Promon- $204 5 years 2,200 ft 230 ft higher Steel Most complex bridge
tory Point million than Hoover suspension design & construction
Dam
Sugarloaf $198 5 years 1,900 ft 250 ft higher Steel deck Best roadway
Mountain million than Hoover arch geometrics, requires
Dam relocation of 4
transmission towers
9
From: http://www.hooverdambypass.org/Old%20Version/alts.html#gs 10

5.1 Formulating Alternatives 5.1 Formulating Alternatives

 To formulate alternatives, we classify each 2. Independent – where more than one project
project as either “mutually exclusive” or may be selected in the economic analysis (i.e.
“independent”. they do not compete against each other). In this
1. Mutually exclusive – where only one of the case, some projects may be dependent or
alternatives can be selected in the economic contingent upon each other. The comparison is
analysis for a given project (e.g. the Hoover essentially between each project at a time and
dam bypass project). Hence, mutually exclusive the do-nothing alternative. There are a total of
alternatives compete against each other in the 2m mutually exclusive alternatives for a group of
economic evaluation. m projects (including the “do-nothing”
alternative).
11 12
 5.1 Formulating Alternatives 5.1 Formulating Alternatives
 The cash flows dictate whether the alternative is
 Note that no new costs, savings, or profits are
revenue-based or service-based. Alternatives
generated in the “do-nothing” alternative. evaluated in one economic study must be of the
However, the “do-nothing” may not always be an same type:
option due to legal, health, environmental, 1. Revenue-based alternatives: Such
societal, or safety requirements. alternatives involve costs and revenues, and
probably savings, and require capital investment
to generate savings (e.g. new products, etc.).
2. Service-based alternatives: Here, alternatives
have only cost cash flow estimates (e.g.
13
governmental
14
or public sector initiatives). The
revenues are the same in all the alternatives.

5.2 Present Worth of Equal- 5.2 Present Worth of Equal-

Life Alternatives Life Alternatives
 In the present worth method, the future cash flow  For mutually exclusive alternatives, the following
approach is used to select the best alternative:
estimates are transformed into equivalent money
now.  One alternative:
Calculate PW at the MARR. If PW ≥ 0, then the
 If the alternatives are used in similar capacities
alternative is financially viable. The analysis here
(i.e. providing the same benefits) for the same requires a cash flow diagram with both revenues
period, they are called equal-service alternatives. and costs (i.e. revenue-based alternative).
 The Minimum Attractive Rate of Return (MARR),  Two or more alternatives:
defined in Chapter 1, is used in the Present Calculate the PW for each alternative at MARR and
Worth analysis. select the alternative with the largest PW (least
15
negative
16
or most positive).
 5.2 Present Worth of Equal- 5.2 Present Worth of Equal-
Life Alternatives Life Alternatives
 For independent projects, the selection  Example 1:
approach is as follows (more details on this in
chapter 11): An engineering firm needs
to buy a photocopy
- For one or more independent projects, select machine. Perform a
all projects with PW ≥ 0 at MARR. present worth analysis to
- This basically compares each project with the select one of the following
do-nothing alternative! two alternatives. Assume
 The background behind choosing a realistic that MARR is 9% per year.
MARR was discussed earlier (in Chapter 1). Note that both machines
17 provide18 the same benefit.

5.2 Present Worth of Equal- 5.2 Present Worth of Equal-

Life Alternatives Life Alternatives
 Solution:
Cost Item Xerox Cannon
Cash flows for the 2 alternatives are shown:
First Cost ($) -10,000 -9,000
$2,000 $1,500
Warranty (Years) 1 2
Annual Maintenance/Repair ($) -500 -700 0 1 2 3 4 0 1 2 3 4
Salvage Value ($) 2,000 1,500
$500 $700
Useful Life (Years) 4 4
$10,000 Xerox $9,000 Cannon
19 20
 5.2 Present Worth of Equal- 5.2 Present Worth of Equal-
Life Alternatives Life Alternatives
 The two considered alternatives are service  PWCANNON = -9,000 + 1,500(P/F,9%,4)
alternatives. The salvage values are positive
-700(P/A,9%,2)(P/F,9%,2)
since the machines are assumed to have value
at the end of their useful lives. or PWCANNON = -$8,974
 PWXEROX = -10,000 + 2,000(P/F,9%,4)  Based on the above, the Cannon machine
should be selected because the PW of its costs
-500(P/A,9%,3)(P/F,9%,1)
is the lowest (i.e. it has numerically the largest
or PWXEROX = -$9,744
PW value).

21 22

5.3 Present Worth of 5.3 Present Worth of

Different-Life Alternatives Different-Life Alternatives
 When mutually exclusive alternatives of unequal  The equal service criterion can be accomplished
lives are evaluated, the previous method is by one of two approaches:
used, except that the PW of the alternatives 1. LCM Approach:
must be compared over the same number of In this method, the alternatives are compared
years. over a time period equal to the least common
 A fair comparison between alternatives can only multiple (LCM) of their lives.
be satisfied if the PW values represent cash For example, three alternatives with lives of 3, 4
flows associated with equal service. and 6 years are compared over a 12-year
23
period.24
 5.3 Present Worth of 5.3 Present Worth of
Different-Life Alternatives Different-Life Alternatives
 How to Find LCM by Listing Multiples
 The LCM approach requires some
 List the multiples of each number until at least
assumptions to be used in the PW analysis: one of the multiples appears on all lists
a. The service provided by the alternatives will be  Find the smallest number that is on all of the lists
required for the LCM of years (or beyond).  This number is the LCM
b. The selected alternative will be exactly  Example: LCM(6,7,21)
repeated over each life cycle of the LCM,  Multiples of 6: 6, 12, 18, 24, 30, 36, 42, 48, 54, 60
c. The cash flows will be identical in every life  Multiples of 7: 7, 14, 21, 28, 35, 42, 56, 63

cycle.  Multiples of 21: 21, 42, 63

 Find the smallest number that is on all of the lists.
25 26
We have it in bold above. So LCM(6, 7, 21) is 42

5.3 Present Worth of 5.3 Present Worth of

Different-Life Alternatives Different-Life Alternatives
2. Planning Horizon Approach:
 In the planning horizon approach a relatively
Here, the alternatives are compared using a short time horizon is chosen (often taken as the
selected study period of length “n” years, smallest life among the considered alternatives),
irrespective of the useful lives of the alternatives. and only those cash flows which occur during that
This approach is used when the LCM of the time period are considered in the analysis. Cash
alternatives gives very high evaluation period flows outside of the time horizon are ignored, but
(e.g. lives of 7 and 9 years). The planning an estimated market value at the end of the study
horizon is somewhat more subjective compared period (time horizon) must be made.
with the LCM approach, and the outcome will
highly 27depend on the length of the study period. 28
 5.3 Present Worth of 5.3 Present Worth of
Different-Life Alternatives Different-Life Alternatives
 Example 2:
Bids Engineer’s estimates
An engineer has received
three bids for a central A/C
Alternatives Installed Service Annual Salvage
equipment to be installed in a Cost ($) Life (yrs) Cost ($) Value ($)
new office building. Which bid
Carrier -20,000 6 -1,000 2,500
should be accepted if MARR
is equal to 12% per year? General -14,000 4 -1,500 1,500
Consider: (a) the LCM
Westinghouse -18,000 6 -1,200 2,000
approach, and (b) planning
horizon approach with a study
period29of 4 years. 30

5.3 Present Worth of 5.3 Present Worth of

Different-Life Alternatives Different-Life Alternatives
 Solution: 1,500 a. LCM Approach:
2,500
0 1 2 3 Since the alternatives have different lives, we
0 1 2 3 4 5 6 4
need to compare them over the LCM of 12 years
$1,000 $1,500 (which is divisible by 4 and 6). Hence, the
$20,000 Carrier $14,000 General Carrier and Westinghouse alternatives will be
repeated once, while the General alternative will
2,000
be repeated twice over a 12-year period.
0 1 2 3 4 5 6
$1,200
31 32
$18,000 Westinghouse
 5.3 Present Worth of 5.3 Present Worth of
Different-Life Alternatives Different-Life Alternatives
1,500 1,500 1,500
2,500 2,500
0 1 2 3 4 5 6 7 8 9 10 11 12
0 1 2 3 4 5 6 7 8 9 10 11 12
$1,500
$1,000 $1,000
$20,000 $14,000 $14,000 $14,000
$20,000
General
Carrier
PWG = -14,000 - 1,500(P/A,12%,12)
PWC = -20,000 - 1,000(P/A,12%,12) + (1,500-14,000)(P/F,12%,4)
+ (2,500 - 20,000)(P/F,12%,6) + (1,500-14,000)(P/F,12%,8)
+2,500(P/F,12%,12) = -$34,418 + 1,500(P/F,12%,12) = -$35,899
33 34

5.3 Present Worth of 5.3 Present Worth of

Different-Life Alternatives Different-Life Alternatives
2,000 2,000
 Based on the above, the Westinghouse
0 1 2 3 4 5 6 7 8 9 10 11 12
equipment must be selected for the new building
$1,200 $1,200 since it results in the largest PW (least negative).
$18,000
$18,000
Westinghouse
PWW = -18,000 - 1,200(P/A,12%,12)
+ (2,000 - 18,000)(P/F,12%,6)
+ 2,000(P/F,12%,12) = -$33,025
35 36
 5.3 Present Worth of 5.3 Present Worth of
2,500
Different-Life Alternatives Different-Life Alternatives
0 1 2 3
4
b. Planning Horizon Approach: PWC=-20,000-1,000(P/A,12%,4)
$1,000
+2,500(P/F,12%,4)
Here, the study period is given, equal to 4 years. = -$21,449
$20,000 1,500
We will assume that the salvage value of the
0 1 2 3
Carrier and Westinghouse equipment after 4 PWG=-14,000-1,500(P/A,12%,4) 4
years is the same as at the end of their service +1,500(P/F,12%,4) $1,500
lives, since no other information is provided. In = -$17,606 $14,000 2,000
reality, a higher salvage value may be warranted
PWW=-18,000-1,200(P/A,12%,4) 0 1 2 3
since the machines can still operate for an extra +2,000(P/F,12%,4)
4
couple of years. = -$20,374 $1,200
37 38 $18,000

5.3 Present Worth of 5.3 Present Worth of Different-

8,333

Different-Life Alternatives Life Alternatives 2,500

0 1 2 3
4
 Unlike the LCM method, the planning horizon  If the market value of the
$1,000
approach indicates that the “General” AC machines is assumed
$20,000 1,500
equipment must be selected for the new to decline linearly from the
building since it results in the largest PW (least installed cost to the salvage 0 1 2 3
4
negative). value over its useful lives,
$1,500
 It should be noted that better results would
we obtain the following 7,333
$14,000
have been obtained if more accurate salvage cash flow diagrams. A PW 2,000

values after 4 years for the Carrier and analysis over a 4-year 0 1 2 3
4
Westinghouse equipment are available. study period may result in a
$1,200
39
different
40
outcome!
$18,000
 5.4 Future Worth Analysis 5.4 Future Worth Analysis

 The future worth (FW) method is an extension of  Future worth analysis is usually used if the asset
the PW method. It can be obtained directly from might be sold after it is initiated, but before the
the cash flow diagram, by multiplying the PW useful life is reached.
value by the F/P-factor at the specified MARR.  After computing the FW, the selection guidelines
 The “n” value in the F/P-factor depends on the are the same as in the PW analysis. That is, the
time period used to find the PW value, which is alternative with the largest FW value at MARR is
either the LCM value or a specified study period
the best alternative.
(if the planning horizon is used).

41 42

5.4 Future Worth Analysis 5.4 Future Worth Analysis

Year Buy Existing Factory Build New Factory
 Example 3:
0 Buy Factory $15,000,000 Buy Land $4,000,000
The Ford company needs a
1 1st year 1st year Construction
new factory. It has 2 options: Remodeling Cost $3,000,000 Cost $9,000,000
(a) buy an existing one from 2 2nd year 2nd year Construction
GM for $15,000,000 with Remodeling Cost $5,000,000 Cost $9,000,000
3 3rd year 3rd year Construction
extensive remodeling, or (b) buy a land for Remodeling Cost $7,000,000 Cost $9,000,000
$4,000,000 and build a new factory on it. Either 4 Setup Production Setup Production
way, it will be 4 years before Ford can start Equipment $9,000,000 Equipment $9,000,000
production. The timing and details are provided.
Which alternative should be selected if MARR=11%?
43 44
 5.4 Future Worth Analysis 5.4 Future Worth Analysis
 Solution:
 The future worth analysis will be used to evaluate
The cash flow diagrams for the 2 alternatives
the 2 alternatives:
are shown below:
FWB-E = -15(F/P,11%,4) - 3(F/A,11%,4)
0 1 2 3 4 0 1 2 3 4
- 2(F/G,11%,4) = -$49.8 M
$3M
$4M FWB-N = -4(F/P,11%,4) - 9(F/A,11%,4)
$9M $9M
$2M = -$48.6 M
$15M Based on the above, Ford must build a new
Buy Existing (B-E) Build New (B-N) factory instead of buying an existing one.
45 46

5.5 Capitalized Costs 5.5 Capitalized Costs

 Many public sector infrastructure projects (such  The present worth of an alternative that will last
as dams, subways, tunnels, hydro-electric power “forever” is referred to as the Capitalized Cost
generation facilities, water sewer treatment (denoted by CC). In such cases, the
plants, and roadways, etc.) have very long alternatives will have infinite analysis period.
expected useful lives, more than 40-50 years.
An infinite (or perpetual) life is often used as the
1 2 3 4 5 1 2 3 4 5
planning horizon. =

8
 Permanent endowments for charitable
A
organizations and educational institutions also CC
have perpetual lives
47 48
 5.5 Capitalized Costs 5.5 Capitalized Costs
 CC is derived starting from the relation P =
A(P/A,i%,n):  Hence,
1
(1 + i)n - 1 CC = A -------------- (5.1)
P=A i
i(1 + i)n
 If A is the annual worth (AW) computed from
Divide both the numerator and denominator by equivalence relations of the cash flows over a
(1 + i)n and set n = ∞: number of years within a cycle, then CC is:
0
1 – 1/(1 + i)n 1
P=A =A 1 CC = AW -------------- (5.2)
i i i
49 50

5.5 Capitalized Costs 5.5 Capitalized Costs

 Mathematically, the amount A of new money
 To calculate the CC for an alternative with an
generated in each consecutive interest period for
infinite sequence of cash flows, we:
an infinite number of periods is:
1. Draw a cash flow diagram showing all
A = P i = CC (i) ----------------- (5.3)
nonrecurring (or one-time) cash flows and at
which is the same as Eq. 5.1, with CC taken least 2 cycles of all recurring (or periodic) cash
equal to P. CC flows.
2. Find the PW of all nonrecurring amounts
1 2 3 4 5 (which is going to be their CC value).
8

51
A 52
 5.5 Capitalized Costs 5.5 Capitalized Costs

3. Find the equivalent annual worth (A) through  For comparing several alternatives with infinite
one life cycle of the recurring cash flows. Add lives, the CCT is obtained for each alternative.
it to all other infinite uniform amounts. This The alternative with the smallest CCT (least
results in the total annual worth (AW). cost) will be the most economical choice.
4. Get the CC from Eqn. 5.2 (i.e. CC = AW/i)  Calculations can be simplified by ignoring
5. Add the CC values from steps 2 and 4 to get elements of the cash flows which are common
the total capitalized cost, CCT. to all considered alternatives (such the same
revenues).
53 54

5.5 Capitalized Costs 5.5 Capitalized Costs

 If two alternatives, one with a finite life and  Example 4:
another with an infinite life, are considered, then A municipality plans to build a large irrigation
they are compared over the LCM of lives (∞). system for an arid area. The system will initially
For the alternative with finite life, the cash flows cost $50 million to build, with annual operating
over the finite life will be repeated to infinity. To costs of $1 million.
determine the CC for the resulting cash flows,
we compute the equivalent A value for one
cycle and divide it by the interest rate.

55 56
 5.5 Capitalized Costs 5.5 Capitalized Costs
 Solution:
 Repair to the system will be done every 10 years
at a cost of $5 million, with one major upgrade in The cash flow diagram for the irrigation system is
year 20 at a cost of $20M. Although the design shown below:
life of the system is 80 years, it is expected that it 0 2 4 6 8 10 11 12 14 16 18 20 78 80
will be in service indefinitely. Find the capitalized
cost if i = 6% per year. ∞
$1M $1M
$5M
$5M $5M
 Determine whether the irrigation project is
feasible if it will yield annual benefits of $5M.
Given:57MARR = 6% per year. 58 $20M
$50M

5.5 Capitalized Costs 5.5 Capitalized Costs

 Find the present worth of the nonrecurring  The two annual costs A1 and A2 are now
costs ($50M now and $20M at t=20 yr): converted into capitalized cost CC2 using Eq. 5.1:
CC1 = -$50M - $20M(P/F,6%,20) = -$56.2M CC2 = (A1 + A2)/i = (-1 - 0.38)/0.06 = -$23M
 Finally, the total capitalized cost CCT is:
 The annual operating cost, A1, is given:
CCT = CC1 + CC2 = -$56.2M - $23M = -$79.2M
A1 = -$1M
 Note: The equivalent A value is obtained from
 Now, convert the recurring repair costs of $5M
Eq. 5.3 as:
every 10 years into annual worth A2: A = CCT (i) = -$79.2(0.06) = -$4.75M.
A2 = -$5M(A/F,6%,10) = -$0.38M

59 60
 5.5 Capitalized Costs 5.5 Capitalized Costs
 Example 5: Costs Items Suspension Cable-Stayed
 Initial Construction: $100 Million $90 Million
The ministry of transport  Right-of-way purchase: $3 Million $5 Million
plans to build a major bridge  Annual maintenance: $0.6 Million $0.8 Million
across a river. Two different  Painting (every 3 years): $0.5 Million $1 Million
types of bridges are  Deck replacement
considered: (every 10 years): $1.5 Million $2 Million
(a) Suspension bridge, and  Useful Life (years) ∞ ∞
(b) Cable-stayed bridge. Use the capitalized costs approach to select the
The expected costs for each best alternative. It is expected that the bridge will
last for a62 very long time. Assume i = 8% per year.
bridge is61provided. http://www.bearwoodphysics.com

5.5 Capitalized Costs 5.5 Capitalized Costs

 Solution:  Capitalized Costs of Suspension Bridge:
The cash flow diagrams for the alternatives are: CC1 = capitalized cost of initial construction
0 2 4 6 8 10 12 14 16 18 20 and land purchase
Suspension
$0.6M = -100 – 3 = -$103M
$100M $0.5M The annual maintenance cost is
$1.5M $1.5M
A1 = -$0.6M
$3M
0 2 4 6 8 10 12 14 16 18 20 The equivalent annual painting cost is
Cable-stayed
$0.8M A2 = -0.5(A/F,8%,3) = -0.5(0.30803) = -$0.154M
$90M $1M
$2M $2M
63 64
$5M
 5.5 Capitalized Costs 5.5 Capitalized Costs
 Capitalized Costs of Cable-stayed Bridge:
The equivalent annual deck replacement cost is
CC1 = capitalized cost of initial construction and
A3 = -1.5(A/F,8%,10)= -1.5(0.06903)= -$0.104M
land purchase
Capitalized costs of recurring costs:
= -90 - 5 = -$95M
CC2 = (A1+A2+A3)/i = (-0.6 - 0.154 - 0.104)/0.08
The annual maintenance cost is:
= -$10.7M
A1 = -$0.8M
Therefore, total capitalized cost is:
The equivalent annual painting cost is
(CCT)s = -103 – 10.7 = -$113.7M
A2 = -1(A/F,8%,3) = -1(0.30803) = -$0.308M
65 66

5.5 Capitalized Costs

The equivalent annual deck replacement cost is
A3 = -2(A/F,8%,10)= -2(0.06903)= -$0.138M
Capitalized costs of recurring costs:
CC2 = (A1+A2+A3)/i = (-0.8 - 0.308 - 0.138)/0.08
= -$15.6M
Therefore, total capitalized cost is:
(CCT)c = -95 – 15.6 = -$110.6M
 Conclusion: Select the cable stayed alternative
since 67it has lower total capitalized cost.