Scribd
Upload
3 views

L10- ch6 AW

Chapter 6 of the Engineering Economics & Management course focuses on Annual Worth (AW) analysis, highlighting its advantages and methodologies for evaluating alternatives with different life cycles. The chapter explains how to calculate AW, capital recovery, and the importance of cash flow estimates in decision-making. It also provides examples and guidelines for selecting alternatives based on AW values.

Uploaded by

Abdul Qudoos
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
3 views

L10- ch6 AW

Chapter 6 of the Engineering Economics & Management course focuses on Annual Worth (AW) analysis, highlighting its advantages and methodologies for evaluating alternatives with different life cycles. The chapter explains how to calculate AW, capital recovery, and the importance of cash flow estimates in decision-making. It also provides examples and guidelines for selecting alternatives based on AW values.

Uploaded by

Abdul Qudoos
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 23

Engineering Economics &

Management
MS490

Chapter 6
Annual Worth Analysis
Muhammad Ullah
Assistant Professor
Department of Management Sciences GIKI
Recap
• Formulate Alternatives
• PW of equal-life alternatives
• PW of different-life alternatives
– LCM Method to make them comparable
– Define Study Period
• Future Worth analysis
• Capitalized Cost analysis:
Learning Outcomes
• Advantages of AW
• Capital Recovery and AW values
• AW analysis
• Perpetual life
• Life-Cycle Cost analysis

3
AW Analysis

• The annual worth method offers a prime


computational and interpretation advantage
because the AW value needs to be calculated
for only one life cycle.
• The AW value determined over one life cycle is
the AW for all future life cycles.
• Therefore, it is not necessary to use the LCM of
lives to satisfy the equal-service requirement.
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)
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

is years for equal-service comparison (value


of LCM or specified study period)
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


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)
= $-14,532
+ 5000(A/F,10%,6)
Example 5.3

Consider the previous lecture example!


Cash Flow Diagram - LCM of 6 and 9 =
18
Solution

𝑀𝐴𝑅𝑅=15 %
Solution

𝑀𝐴𝑅𝑅=15 %

Vendor B is selected, since it costs less in PW


terms.
Solution
AW first cycle = -15000(A/P, i, n)+1000(A/F, i, n) - 3500
AW = -15000(A/P, 15%, 6)+1000(A/F, 15%, 6) - 3500
AW = - $7349
But we know that PW of alternative A for 18 years is given
as: ― $45,036
AW = ― 45,036(A/P, 15%, 18)
AW = - $7349
Hence, one-life-cycle AW value and the AW value based on
18 years (3 life-cycle) are equal.
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.
Capital Recovery and AW
Use previous example: (note: AOC not
included in CR )
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

Now
Example
Lockheed Martin is increasing its booster thrust power in order to
win more satellite launch contracts from European companies
interested in opening up new global communications markets. A
piece of earth-based tracking equipment is expected to require an
investment of $13 million, with $8 million committed now and the
remaining $5 million expended at the end of year 1 of the project.
Annual operating costs for the system are expected to start the
first year and continue at $0.9 million per year. The useful life of
the tracker is 8 years with a salvage value of $0.5 million.
Calculate the CR and AW values for the system, if the corporate
MARR is 12% per year.
Solution

Interpretation: It means that


each and every year for 8
years, the equivalent total net
revenue from the tracker must
be at least $2,470,000 just to
recover the initial present
worth investment plus the
required return of 12% per
year. This does not include
Solution

Annual worth: To determine AW, the cash flows must be


converted to an equivalent AW series over 8 years
Now, AW = ? CR = -$2.47 and A = -$0.9
AW = CR + A
AW = -2.47 + (-0.9)
AW = - $3.37 million per year
Selection Guidelines for AW Analysis
ONE Alternative: If , the required MARR is met or exceeded
and the alternative is economically justified.

TWO or MORE Alternatives: Select the alternative with the


AW that is numerically the largest. For example, choose 45
Mln over 41 Mln or -23 Mln over -27 Mln.
Mutually Exclusive 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
Solution:
AWX = -30,000(A/P,12%,4) –18,000 +7,000(A/F,12%,4)
year?
= $-26,412
AWY = -50,000(A/P,12%,6) –16,000 + 9,000(A/F,12%,6)
= $-27,052
Select Machine X; it has the numerically larger AW value
AW of Permanent Investment
Use for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives

Compare the alternatives below using AW and 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
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 Select
alternative C
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


Thank You

Any Questions?
Email: ,
[email protected]
References
• Engineering Economy 7th Edition by Leland Blank, Anthony
Tarquin [ISBN-10: 0073376302] and accompanying
PowerPoint slides

23

You might also like