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Lecture 10

This document discusses annual worth (AW) analysis for evaluating engineering project alternatives. It covers calculating the AW of alternatives, using the capital recovery rate and AW values, guidelines for AW analysis, examples of evaluating alternatives using AW, and an overview of life-cycle cost analysis. The key points are that AW converts all cash flows to an equivalent annual value, alternatives can involve costs or revenues, and life-cycle cost analysis considers total costs over a project's entire lifespan.

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Muhammad Usman
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© © All Rights Reserved
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Download as PPTX, PDF, TXT or read online on Scribd
21 views

Lecture 10

This document discusses annual worth (AW) analysis for evaluating engineering project alternatives. It covers calculating the AW of alternatives, using the capital recovery rate and AW values, guidelines for AW analysis, examples of evaluating alternatives using AW, and an overview of life-cycle cost analysis. The key points are that AW converts all cash flows to an equivalent annual value, alternatives can involve costs or revenues, and life-cycle cost analysis considers total costs over a project's entire lifespan.

Uploaded by

Muhammad Usman
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 16

LECTURE 10

1-1
Chapter 6
Annual
Worth
Analysis
Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

1-2
LEARNING OUTCOMES
1. Advantages of AW
2. Capital Recovery and AW values
3. AW analysis
4. Perpetual life
5. Life-Cycle Cost analysis
6. Capitalized cost (chapter 5 )
1-3
by McGraw-Hill All Rights Reserved 2012 ©
Advantages of AW Analysis
AW calculated for only one life cycle

Assumptions:
Services needed for at least the LCM of lives of alternatives
Selected alternative will be repeated in succeeding life cycles
in same manner as for the first life cycle
All cash flows will be same in every life cycle (i.e., will change
by only inflation or deflation rate)
1-4
by McGraw-Hill All Rights Reserved 2012 ©
Alternatives usually have the following
cash flow estimates

Initial investment, P – First cost of an asset


Salvage value, S – Estimated value of asset at end of
useful life
Annual amount, A – Cash flows associated with asset, such
as annual operating cost (AOC), etc.

Relationship between AW, PW and FW


AW = PW(A/P,i%,n) = FW(A/F,i%,n)
n is years for equal-service comparison (value of LCM or
specified
1-5study period)
by McGraw-Hill All Rights Reserved 2012 ©
Calculation of Annual Worth
AW for one life cycle is the same for all life cycles!!

An asset has a first cost of $20,000, an annual operating


cost of $8000 and a salvage value of $5000 after 3 years.
Calculate the AW for one and two life cycles at i = 10%

AWone = - 20,000(A/P,10%,3) – 8000 + 5000(A/F,10%,3)


= $-14,532
AWtwo = - 20,000(A/P,10%,6) – 8000 – 15,000(P/F,10%,3)(A/P,10%,6)
+ 5000(A/F,10%,6)
= $-14,532
1-6
by McGraw-Hill All Rights Reserved 2012 ©
Capital Recovery and AW
Capital recovery (CR) is the equivalent annual amount
that an asset, process, or system must earn each year to
just recover the first cost and a stated rate of return over
its expected life. Salvage value is considered when
calculating CR.
CR = -P(A/P,i%,n) + S(A/F,i%,n)
Use previous example: (note: AOC not included in CR )
CR = -20,000(A/P,10%,3) + 5000(A/F,10%,3) = $ – 6532
per year
Now AW = CR + A
1-7
AW = – 6532 – 8000 = $ – 14,532
by McGraw-Hill All Rights Reserved 2012 ©
Selection Guidelines for AW Analysis

1-8
by McGraw-Hill All Rights Reserved 2012 ©
ME Alternative Evaluation by AW
Not necessary to use LCM for different life alternatives

A company is considering two machines. Machine X has a first cost of


$30,000, AOC of $18,000, and S of $7000 after 4 years.
Machine Y will cost $50,000 with an AOC of $16,000 and S of $9000 after
6 years.
Which machine should the company select at an interest rate of 12% per
year?
Solution: AWX = -30,000(A/P,12%,4) –18,000 +7,000(A/F,12%,4)
= $-26,412
AWY = -50,000(A/P,12%,6) –16,000 + 9,000(A/F,12%,6)
= $-27,052
1-9
Select Machine X; it has the numerically larger AW value
by McGraw-Hill All Rights Reserved 2012 ©
AW of Permanent Investment
Use A = Pi for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives

Compare the alternatives below using AW and i = 10% per year


C D
First Cost, $ -50,000 -250,000
Annual operating cost, $/year -20,000 -9,000
Salvage value, $ 5,000 75,000
Life, years 5 ∞

Solution: Find AW of C over 5 years and AW of D using relation A = P i


AWC = -50,000(A/P,10%,5) – 20,000 + 5,000(A/F,10%,5)
= $-32,371
AWD = Pi + AOC = -250,000(0.10) – 9,000
= $-34,000 1-10 Select alternative C
by McGraw-Hill All Rights Reserved 2012 ©
Capitalized Cost (CC) Analysis
CC refers to the present worth of a project with a very long life, that
is, PW as n becomes infinite

Basic equation is: CC = P = A


i
“A” essentially represents the interest on a perpetual investment

For example, in order to be able to withdraw $50,000 per year forever


at i = 10% per year, the amount of capital required is 50,000/0.10 = $500,000

For finite life alternatives, convert all cash flows into


an A value over one1-11 life cycle and then divide by i
Example: Capitalized Cost
Compare the machines shown below on the basis of their
capitalized cost. Use i = 10% per year
Machine 1 Machine 2
First cost,$ -20,000 -100,000
Annual cost,$/year -9000 -7000
Salvage value, $ 4000 -----
Life, years 3 ∞

Solution: Convert machine 1 cash flows into A and then divide by i


A1 = -20,000(A/P,10%,3) – 9000 + 4000(A/F,10%,3) = $-15,834
CC1 = -15,834 / 0.10 = $-158,340

CC2 = -100,000 – 7000/ 0.10 = $-170,000


Select machine 1
12-5
Typical Life-Cycle Cost Distribution by
Phase

1-13
by McGraw-Hill All Rights Reserved 2012 ©
Life-Cycle Cost Analysis
LCC analysis includes all costs for entire life span,
from concept to disposal

Best when large percentage of costs are M&O

Includes phases of acquisition, operation, & phaseout

 Apply the AW method for LCC analysis of 1 or more cost


alternatives
 Use PW analysis if there are revenues and other
benefits considered 1-14
by McGraw-Hill All Rights Reserved 2012 ©
Summary of Important Points
PW method converts all cash flows to present value at MARR

Alternatives can be mutually exclusive or independent

Cash flow estimates can be for revenue or cost alternatives

PW comparison must always be made for equal service

Equal service is achieved by using LCM or study period

Capitalized cost is PW of project with infinite life; CC = P = A/i


1-15
Summary of Important Points
AW method converts all cash flows to annual value at MARR

Alternatives can be mutually exclusive, independent,


revenue, or cost

AW comparison is only one life cycle of each alternative

For infinite life alternatives, annualize initial cost as A = P(i)

Life-cycle cost analysis includes all costs over


a project’s life span 1-16
by McGraw-Hill All Rights Reserved 2012 ©

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