Chapter 6 Annual Equivalence Analysis Chapter Contents Chapter 6 Annual Equivalence Analysis 208 6.

1 Annual Equivalent Worth Criterion 210 6.1.1 Benefits of AE Analysis 214 6.1.2 Capital (Ownership) Costs versus Operating Costs 214 6.2 Applying Annual-Worth Analysis 218 6.2.1 Unit-Profit or Unit-Cost Calculation 218 6.2.2 Make-or-Buy Decision 221 6.3 Comparing Mutually Exclusive Projects 224 6.3.1 Analysis Period Equals Project Lives 224 6.3.2 Analysis Period Differs from Project Lives 229 Summary 232 Problems 232

Name Variations AE AOC AW EAC EAW annual equivalent annual operating cost annual worth equivalent annual cost equivalent annual worth

EUAB equivalent uniform annual benefit EUAC equivalent uniform annual cost EUAW equivalent uniform annual worth O&M operations and maintenance costs

Advantages and Uses of AW analysis Add to our repertoire of alternative comparison tools. Commonly considered the more desirable to PW methods because the AW value is easy to calculate. AW value has to be calculated for only 1 life cycle. So it is not necessary to use the LCM of lives as it is for PW and FW analysis. When alternatives being compared have different lives the AW method makes the assumption that: The services provided are needed for at least the LCM of the lives of the alternatives. The selected alternative will be repeated for succeeding life cycles in exactly the same manner as for the 1st life cycle. All cash flows have the same estimated values in every life cycle. If 1 and 2 are not reasonable a study period must be established for the analysis The AW method is especially useful in certain types of studies: - Asset replacement and retention time studies to minimize overall annual costs - Breakeven studies and make-or-buy decisions and - All studies dealing with production or manufacturing costs where a cost/unit or profit/unit measure is the focus

Three important points concerning AW cash flow calculations There is a direct relationship between the PW of a cost and the EUAC. In a problem, an expenditure of money increases the EUAC, a receipt decreases it. Where there are irregular cash disbursements it is usually necessary to 1st determine the PW of cost, and then calculate EUAC.

Calculation of Capital Recovery (CR} and EUAC Values EUAC = - CR - A A is often the Annual O&M Cost CR is the equivalent annual cost of owning the asset plus the return on the initial investment. CR Factor is a factor used to calculate the sum of money required at the end of a series of periods to regain the net investment plus the compound interest on the unrecovered balance Capital Recovery and Treatment of Salvage Values Up to press we have treated salvage values, S, as follows: PWCR = P S (P/F, i, n) where PWCR is the PW of the capital recovery costs (ignoring for now any ongoing O&M costs). EUAC, the equivalent uniform annual cost, can be found from: (1) EUACCR = P (A/P, i, n) S (A/F, i, n) When dealing with annual values we can make use of a relationship between the factors to derive alternative ways of dealing with the capital recovery portion of costs. (2) (A/P, i, n) = P ([i (1+i) n]/ [(1+i) n -1]) (3) (A/F, i, n) = F ([i]/ [(1+i) n-1]) (4) F = P (1+i) n Substituting (4) into (3) one obtains: (5) (A/P, i, n) = (A/F, i, n) + i or (6) (A/F, i, n) = (A/P, i, n) i Substituting in (1) for (A/F, i, n), (6), we obtain: (7) EUAC = P (A/P, i, n) S ((A/P, i, n) - i) = (P-S) (A/P, i, n) + Si Substituting in (1) for (A/P, i, n), (7), we obtain: (8) EUAC = P ((A/F, i, n) + i) S (A/F, i, n) = P (A/F, i, n) + Pi S (A/F, i, n) = (P-S) (A/F, i, n) + Pi The 1st and 7th alternatives are the most often used

Selection Criteria For mutually exclusive alternatives, calculate AW at the MARR - 1 alternative; AW 0 - 2 or more alternatives; Choose the lowest cost or highest income AW value Input/ output Fixed input Situation Amount of money or other input resources is fixed Fixed output There is a fixed task, benefit or other output to be accomplished Neither input nor output is fixed Neither amount of money or other inputs nor amount of benefits or other outputs is fixed Analysis Period Analysis period equal to alternative lives Analysis period a common multiple of alternative lives. Analysis period for a continuing requirement. Analysis Period Infinite Some other analysis period Maximize EUAB EUAC Minimize EUAC Criterion Maximize EUAB

Park Problems 6.1-6.7 6.8-6.11Capital Recovery (Ownership Cost) 6.12-6.16 Annual Equivalent Worth Criterion 6.17-6.23 Unit-Profit or Unit-Cost Calculation 6.17 Motors (Spreadsheet) 6.21 No 6.24-6.28 Break-Even Analysis 6.24 Not, Payback 6.28 No 6.29-6.38 Comparing ME Alternatives Using the AE Method Finite and Infinite lives 6.29 Motors (Spreadsheet) 6.30 6.31 No.Effective Interest Rate for Payment Period 6.32 6.33 No, Geometric Gradient 6.34 6.35 Part b 6.36 6.37-6.38 No

Newnan Problems Ch 6 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Newnan Basic " " " " " " Repeating Series Sync I=S S>I Basic S>I Basic Trust Fund No - Sync No - Sync Basic-2 " No -CC Trust Fund Basic-2 Basic-2 No - Sync No - Sync

26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50-59

No - Sync No - Sync No Annuity Due, Sync Replacement ME No - Sync No -CC

Diff Useful Lives No " " Basic-2 " " No - correct Basic-2 " Excel Problems