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COMPARING

ALTERNATIVES
CHE40: Engineering Economy
Engr. Elisa G. Eleazar

Alternatives
Case

1: Useful Lives are Equal to the

Study Period
Case

2: Useful Lives are Different

Capitalized

Worth Method

Incremental

Project

Outline

B/C Analysis

Combination

Comparing Alternatives

Among Alternatives

Comparing 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

Alternatives

Investment Alternatives
those with initial capital
investments that produce positive
cash flows from increased
revenue, savings through reduced
costs, or both
Comparing Alternatives

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

Alternatives

Comparing 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.

Alternatives

Comparing Alternatives

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.

Alternatives

Comparing Alternatives

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.

Alternatives

Equivalent Worth Methods

Comparing Alternatives

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

Case 1: Useful Lives are Equal to the Study Period

Case 1: Useful Lives are Equal to the Study Period

Comparing Alternatives

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

Comparing Alternatives

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

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Case 1: Useful Lives are Equal to the Study Period

Incremental
1

Investment Analysis

Arrange the feasible alternatives based on increasing


capital investment.
Establish a base alternative.

If the incremental cash flow between the next alternative


and the current selected alternative is acceptable,
choose the next alternative.

Otherwise, retain the last acceptable alternative as the


current best.

Comparing Alternatives

Use iteration to evaluate differences (incremental cash


flows) between alternatives until all alternatives have
been considered.

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Case 1: Useful Lives are Equal to the Study Period

Two mutually exclusive diesel generators are considered


for purchase by a power generation company. Information
relevant to compare the alternatives are summarized
below:
A
B
Capital Investment, $

Annual Maintenance
Expenses, $
Service Life

80,000

35,000

10,000

3,000

5,000

10

10

Use the ERR method to determine the better machine.


MARR is 10% per year. So is the external reinvestment
Case
rate. 1: Useful Lives are Equal to the Study Period

Comparing Alternatives

Salvage Value, $

100,000

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Repeatability Assumption
assumes that the economic estimates for an
alternatives initial useful life will be repeated in the
subsequent replacement cycles

repeat part of the useful life and then use an estimated


market value to truncate it at the end

Comparing Alternatives

Coterminated Assumption

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Case 2: Useful Lives are Different Among Alternatives

Use the
Useful Life <
repeatability
Study Period
assumption

Comparing Alternatives

Use the imputed


Useful Life >
market value
Study Period
technique

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Case 2: Useful Lives are Different Among Alternatives

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%.
B

Capital Investment, $

272,000

346,000

Annual Expenses, $

28,800

19,300

Useful Life, years

Salvage Value, $

25,000

40,000

Comparing Alternatives

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Case 2: Useful Lives are Different Among Alternatives

Imputed Market Value Technique

based on assumptions about the value of the


remaining useful life for an asset
Comparing Alternatives

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

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Case 2: Useful Lives are Different Among Alternatives

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%

Comparing Alternatives

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Case 2: Useful Lives are Different Among Alternatives

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.
B

Capital Investment, $

9,000

8,000

Annual Expenses, $

5,000

6,000

Useful Life, years

10

15

Salvage Value, $

1,000

The MARR is 5% per year. Determine which alternative


should be selected if the analysis period is 10 years.

Comparing Alternatives

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Case 2: Useful Lives are Different Among Alternatives

Capitalized Worth
used when the period of needed service is
indefinitely long

Comparing Alternatives

CW i % PW N

1
A
i

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Capitalized Worth Method

A firm is considering the purchase of one of two new


machines. The data on each are given below:
B

Capital Investment, $

3,400

6,500

Annual Expenses, $

2,000

1,800

Useful Life, years

Salvage Value, $

100

500

If perpetual service from the machine is assumed, which


machine would you recommend? The MARR is 10% per
year.

Comparing Alternatives

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Capitalized Worth Method

Criterion:

larger-cost alternative as long

B/C 1

Investment, $

75,000

50,000

65,000

Annual
maintenance cost

4,000

5,000

4,700

Comparing Alternatives

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

Annual benefits

20,000

18,000

20,000

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Incremental B/C Analysis

Comparing 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

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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%).

Mutually exclusive

Mutually exclusive

Cap Inv, $

Net Annual
Benefits, $

A1

5,000

1,500

A2

7,000

1,800

B1

12,000

2,000

B2

18,000

4,000

C1

14,000

4,000

C2

18,000

4,500

Project Combination

Comparing Alternatives

Mutually exclusive

Project

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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?
B1

B2

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

Comparing Alternatives

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Project Combination

Alternatives
Case

1: Useful Lives are Equal to the

Study Period
Case

2: Useful Lives are Different

Capitalized

Worth Method

Incremental

Project

Outline

B/C Analysis

Combination

Comparing Alternatives

Among Alternatives

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COMPARING
ALTERNATIVES
CHE40: Engineering Economy
Engr. Elisa G. Eleazar