06 comparing alternatives

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Comparing Alternatives

1

CHE40: ENGINEERING ECONOMY 2

Project Combination

Incremental B/C Analysis

Capitalized Worth Method

Case 2: Useful Lives are

Different Among Alternatives

Case 1: Useful Lives are Equal

to the Study Period

Alternatives

Learning Objectives

1. Differentiate the different types of alternatives2. Compare projects when the useful lives are equal to the study period and when the

useful lives are different among alternatives3. Compare alternatives using the capitalized worth method and incremental B/C

analysis4. Compare project combinations

Module 5: Comparing Alternatives


Alternatives

Mutually Exclusive

at most one project can be chosen

Independent

the choice is not dependent of the choice of any other project; all or none of the

projects may be selected

Contingent

the choice is conditional on the choice of one or more other projects

Investment Alternatives

with initial capital investments that produce positive cash flows from increased revenue,

savings through reduced costs, or both

Cost Alternatives

with negative cash flows, except for a positive cash flow element from disposal of assets at the end of the projects useful life


Alternatives

The alternative that requires the minimum investment of capital and produces satisfactory

functional results will be chosen unless the incremental capital associated with an alternative

having a larger investment can be justified with respect to its incremental benefits.

When revenues and other economic benefits are present and vary among the alternatives,

choose the alternative that maximizes overall profitability (i.e., greatest positive equivalent

worth at i=MARR and satisfies all project requirements.

When revenues and other economic benefits are not present or are constant among

alternatives, consider only the costs and select the alternative that minimizes total cost (least

negative equivalent worth at i=MARR and satisfies all project requirements.


Case 1: Useful Lives are Equal to the Study Period

Equivalent Worth Methods

for investment alternatives, the one with the greatest positive equivalent worth is selected

for cost alternatives, the one with the least negative equivalent worth is selected

An airport needs a modern material handling system for facilitating access to and from a busy maintenance hangar. A second-hand system will cost $75,000. A new system with improved technology can decrease labor hours by 20% compared to the used system. The new system will cost $150,000 to purchase and install. Both systems have a useful life of 5 years. The market value of the used system is expected to be $20,000 in 5 years, and the market value of the new system is anticipated to be $50,000 in 5 years. Current maintenance activity will require the used system to be operated 8 hours per day for 20 days per month. If labor costs $40 per hour and the MARR is 1% per month, which system should be recommended?



Rate of Return Methods

each increment of capital must justify itself by producing a

sufficient rate of return ( MARR) on that increment

compare a higher investment alternative against a lower

investment alternative only when the latter is acceptable

select the alternative that requires the largest investment of capital as

long as the incremental investment is justified by benefits

that earn at least the MARR

1

Arrange the feasible alternatives based on increasing capital investment.

2 Establish a base alternative.

3

Use iteration to evaluate differences (incremental cash flows) between alternatives until all alternatives have been considered.

4

If the incremental cash flow between the next alternative and the current selected alternative is acceptable, choose the next alternative.

5

Otherwise, retain the last acceptable alternative as the current best.



Two mutually exclusive diesel generators are considered for purchase by a power generation company. Information relevant to compare the alternatives are summarized below:

Use the ERR method to determine the better machine. MARR is 10% per year. The external reinvestment rate is 8%.

A B C

Capital Investment, $ 100,000 80,000 120,000

Salvage Value, $ 35,000 10,000 20,000

Annual Maintenance Expenses, $ 3,000 5,000 2,500

Service Life 10 10 10


Case 2: Useful Lives are Different Among Alternatives

Use the repeatability assumptionUseful Life < Study Period

Use the imputed market value techniqueUseful Life > Study Period

Repeatability Assumption

assumes that the economic estimates for an alternatives initial useful life will be repeated

in the subsequent replacement cycles

Coterminated Assumption

repeat part of the useful life and then use an estimated market value to truncate it at the

end



As the supervisor of a facilities engineering department, you consider mobile cranes to be critical equipment. The purchase of a new medium-sized truck-mounted crane is being evaluated. The economic estimates for the two best alternatives are shown below. Which of the two alternatives would you recommend? MARR is 15%.

A B

Capital Investment, $ 272,000 346,000

Annual Expenses, $ 28,800 19,300

Useful Life, years 6 9

Salvage Value, $ 25,000 40,000



MVT = PW at end of year T of remaining CR amounts + PW at end of year T of original market value at end of useful life

based on assumptions about the value of the remaining useful life for an asset

Imputed Market Value Technique

Use the imputed market value technique to develop an estimated market value at the end of year 5 for crane B in SP3. I = $346,000; S = $40,000; useful life = 9; MARR = 15%



A 50 hp motor is required to power a large capacity blower. Two motors, A and B, mutually exclusive, have been proposed. Their cost data are as follows.

The MARR is 5% per year. Determine which alternative should be selected if the analysis period is 10 years.

A B




Salvage Value, $ 0 1,000



Capitalized Worth

used when the period of needed service is indefinitely long = =

1

A firm is considering the purchase of one of two new machines. The data on each are given below:

If perpetual service from the machine is assumed, which machine would you recommend? The MARR is 10% per year.

A B




Salvage Value, $ 100 500



The city of Oak Ridge is evaluating three MEAs for refurbishing a public greenway. Benefits to the community have been estimated and summarized. The citys discount rate is 8% per year and the planning horizon is 10 years. Which plan is best?

A B C

Investment, $ 75,000 50,000 65,000

Annual maintenance cost, $ 4,000 5,000 4,700

Annual benefits, $ 20,000 18,000 20,000


Project Combination

Mutually Exclusive

at most one project can be chosen

Independent

the choice is not dependent of the choice of any other project; all or none

of the projects may be selected

Contingent

the choice is conditional on the choice of one or more other projects

Engineering projects A, B1, B2 and C are being considered with cash flows estimated over 10 years as shown. B1 and B2 are mutually exclusive, C depends upon B1 and A depends upon B2. The capital investment budget limit is $100,000 and the MARR is 12% per year. What combination of projects should be selected?

A B1 B2 C

Cap Inv, $ 30,000 22,000 70,000 82,000

Annual Profit, $ 8,000 6,000 14,000 18,000

Salvage Value 3,000 2,000 5,000 7,000


Project Combination

A small company has $20,000 in surplus capital that it wishes to invest in new revenue-producing projects. Three independent sets of mutually exclusive projects have been developed. The useful life of each is five years, and all market values are zero. You have been asked to perform ERR analysis to select the best combination of projects. MARR is equal to the external reinvestment rate (12%).

Project Cap Inv, $Net Annual Benefits, $

Mutually exclusive A1 5,000 1,500

A2 7,000 1,800

Mutually exclusive B1 12,000 2,000

B2 18,000 4,000

Mutually exclusive C1 14,000 4,000

C2 18,000 4,500


Project Combination



Case 2: Useful Lives are

Different Among Alternatives

Case 1: Useful Lives are Equal

to the Study Period

Alternatives

Learning Objectives

1. Differentiate the different types of alternatives2. Compare projects when the useful lives are equal to the study period and when the

useful lives are different among alternatives3. Compare alternatives using the capitalized worth method and incremental B/C

analysis4. Compare project combinations

Module 5: Comparing Alternatives

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY

Comparing Alternatives

17

06 comparing alternatives

Documents