Contemporary Engineering Economics, Fifth Edition, by Chan S. Park.

ISBN: 0-13-611848-8
2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Chapter 12 Projects Risk and Uncertainty

Sensitivity Analysis
12.1
(a) Project cash flows based on most-likely estimates:
0
Income Statement
Labor Savings
Depreciation
Taxable Income
Income Tax (40%)
Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage
Salvage
Gains Tax

$45,000
20,000
$25,000
10,000
$15,000

$45,000
32,000
$13,000
5,200
$7,800

$45,000
9,600
$35,400
14,160
$21,240

15,000
20,000

7,800
32,000

21,240
9,600

-100,000
30,000
3,360

Net Cash Flow

-100,000

PW (15%) =

35,000

39,800

64,200

$2,741.84

(b) If MARR = 25%

0
Income Statement
Labor Savings
Depreciation
Taxable Income
Income Tax (40%)
Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage
Salvage
Gains Tax
Net Cash Flow
PW (25%) =

$56,661
20,000
$36,661
14,664
$21,997

$56,661
32,000
$24,661
9,864
$14,797

$56,661
9,600
$47,061
18,824
$28,237

21,997
20,000

14,797
32,000

28,237
9,600

(100,000)
30,000
3,360
(100,000)

41,997

46,797

71,197

$0.00

If MARR is increased to 25%, the required savings would be at least $56,661

(with Goal Seek in Excel) so that the project remains profitable.
Page | 1

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.2
(a) Project cash flows based on most-likely estimates: without working capital
0
Income Statement
Labor Savings
Depreciation
Taxable Income
Income Tax (40%)
Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage
Gains Tax

$35,000
21,600
$13,400
5,360
$8,040

$35,000
34,560
$440
176
$264

$35,000
20,736
$14,264
5,706
$8,558

$35,000
6,221
$28,779
11,512
$17,268

8,040
21,600

264
34,560

8,558
20,736

17,268
6,221
30,000
-2,047

29,640

34,824

29,294

51,442

-108,000

Net Cash Flow

-108,000

PW (10%) =

$4,870

The project is acceptable.

(b) Project cash flows based on most-likely estimates: with working capital
0
Income Statement
Labor Savings
Depreciation
Taxable Income
Income Tax (40%)
Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage
Gains Tax
Working Capital
Net Cash Flow
PW (10%) =

$35,000
21,600
$13,400
5,360

$35,000
34,560
$440
176

$35,000
20,736
$14,264
5,706

$35,000
6,221
$28,779
11,512

$8,040

$264

$8,558

$17,268

8,040
21,600

264
34,560

8,558
20,736

17,268
6,221
30,000
-2,047
5,000

29,640

34,824

29,294

56,442

-108,000
-5,000
-113,000
$3,285

The project is still acceptable.

Page | 2

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(c) Required annual savings (X): $43,370 through the table below.
1

Income Statement
Labor Savings
Depreciation

$43,370
21,600

$43,370
34,560

$43,370
20,736

$43,370
6,221

Taxable Income
Income Tax (40%)

$21,770
8,708

$8,810
3,524

$22,634
9,053

$37,149
14,860

Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment &Salvage
Gains Tax

$13,062

$5,286

$13,580

$22,289

13,062
21,600

5,286
34,560

13,580
20,736

22,289
6,221
30,000
(2,047)

34,662

39,846

34,316

56,463

Net Cash Flow

PW(18%) =

(108,000)
(108,000)
$0

12.3
Projects IRR if the investment is made now:

PW (i) = $500, 000 + $200,000( P / A, i,5) = 0

i = 28.65%
Let X denote the new after-tax annual cash flow:

PW (28.65%) = $500, 000 + X ( P / A, 28.65%, 4)( P / F , 28.65%,1) = 0

X = $290, 248
The needed additional flow is $290,248 - $200,000 = $90,248.
12.4
(a) Economic building height
5% < i < 20% : The optimal building height is 5 floors.
20% i < 30% : The optimal building height is 2 floors.

Page | 3

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Net Cash Flows

n
0
1
2
3
4
5

2 Floors
($500,000)
$199,100
$199,100
$199,100
$199,100
$799,100

3 Floors
($750,000)
$169,200
$169,200
$169,200
$169,200
$1,069,200

4 Floors
($1,250,000)
$149,200
$149,200
$149,200
$149,200
$2,149,200

5 Floors
($2,000,000)
$378,150
$378,150
$378,150
$378,150
$3,378,150

Sensitivity Analysis
PW(i) as a Function of Interest Rate
i (%)
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30

2 Floors
$832,115
$787,037
$744,141
$703,298
$664,388
$627,298
$591,924
$558,167
$525,937
$495,148
$465,720
$437,580
$410,657
$384,885
$360,205
$336,557
$313,889
$292,150
$271,292
$251,271
$232,044
$213,572
$195,817
$178,745
$162,323
$146,519

3 Floors
$687,721
$635,264
$585,441
$538,091
$493,067
$450,230
$409,452
$370,612
$333,599
$298,309
$264,644
$232,512
$201,829
$172,516
$144,496
$117,701
$92,066
$67,527
$44,029
$21,516
($62)
($20,753)
($40,601)
($59,650)
($77,939)
($95,505)

4 Floors
$963,010
$873,011
$787,722
$706,879
$630,199
$557,428
$488,330
$422,686
$360,291
$300,953
$244,495
$190,751
$139,565
$90,792
$44,298
($46)
($42,357)
($82,746)
($121,319)
($158,173)
($193,399)
($227,084)
($259,308)
($290,148)
($319,674)
($347,955)

5 Floors
$1,987,770
$1,834,680
$1,689,448
$1,551,593
$1,420,666
$1,296,250
$1,177,957
$1,065,427
$958,321
$856,326
$759,148
$666,513
$578,166
$493,867
$413,393
$336,533
$263,091
$192,883
$125,737
$61,490
($9)
($58,903)
($115,327)
($169,407)
($221,261)
($271,002)

Best
Floor Plan
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
2
2
2
2
2
2
2
2
2
2
2

(b) Effects of overestimation on resale value:

Resale
value
Base
10% error
Difference

Present Worth as a Function of Number of Floors

2 Floors
$465, 720
$435,890
$29,831

3 Floors
$264, 644
$219,898
$44,746

4 Floors
$244, 495
$145, 060
$99, 435

5 Floors
$759,148
$609,995
$149,153

Page | 4

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.5
Note: In the problem statement, the current book value for the defender is given
as $13,000. This implies that the machine has been depreciated under the
alternative MACRS with half-year convention. In other words, the allowed
depreciation is based on a 10-year recovery period with straight-line method
(with $0 salvage). Note that, if you decide to retain the old machine, the current
book value will be $13,000 as you continue to depreciate the asset without any
adjustment.
(a) Defender versus Challenger:

Keep the old machine

n
Financial Data
Depreciation
Book value
Market value
Gain/loss
Removal cost
Operating cost

4
0

5
6
7
8
9
10
1
2
3
4
5
6
$2,000 $2,000 $2,000 $2,000 $2,000 $2,000
$13,000 $11,000 $9,000 $7,000 $5,000 $3,000 $1,000
$1,000

2,000

Cash Flow Statement

Removal
+(.4)*(Depreciation)
Net proceeds from sale
-(1-0.40)*(Operating cost)
Net Cash Flow
PW (10%) = ($1,686)

2,000

2,000

2,000

2,000

1,500
2,000

($900)
800 800 800 800 800 800
1,000
-1,200 -1,200 -1,200 -1,200 -1,200 -1,200
$0

($400) ($400) ($400) ($400) ($400) ($300)

AE (10%) = ($387)

With the half-year convention mandated, the book value that should be used
in determining the gains tax for the defender (if sold now) is
Total depreciation = $1, 000 + $2, 000 + $2, 000 + $1, 000 = $6, 000
Book value = $20,000 $6, 000 = $14, 000
Taxable gain (loss) = $6, 000 $14, 000 = ($8,000)
Net proceeds from sale = $6,000 + $8, 000 0.4 = $9, 200
Comments: We will consider the various replacement problems in Chapter 14,
where the net proceeds from sale of the old machine is treated as an opportunity
Page | 5

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

cost of retaining the old machine, or simply the new investment required to keep
the old machine.

Buy a new machine

Financial Data
Depreciation
Book value
Market value
Gain/loss
Operating cost

1
2
3
4
5
$2,400 $3,840 $2,304 $1,382 $1,382
$12,000 9600 5760 3456 2074
691

Cash Flow Statement

Sale of old equipment
Investment
+(.4)*(Depreciation)
-(1-0.40)*(Operating cost)
Net proceeds from sale

1000

1000

1000

1000

1000

960
-600

1,536
-600

922
-600

553
-600

553
-600

$360

$936

$322

($47)

($47) $876

9,200
-12,000

Net Cash Flow

($2,800)

PW (10%) = ($1,024)

6
$691
0
2000
2000
1000

276
-600
1,200

AE (10%) = ($235)

Incremental cash flows:

Net Cash Flow
n
0
1
2
3
4
5
6

New Machine
$2,800
360
936
322
47
47
876

Old Machine

Incremental Cash flow

(new-old)

400
400
400
400
400
300

$2,800
760
1,336
722
353
353
1,176

IRR newold = 18.22%, PW (10%)newold = $662

The defender should be replaced now.

Page | 6

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Sensitivity analysis: The answer remains unchanged. In fact, it (an increase in
O&M) will make the challenger more attractive.
IRR newold = 24.25%, and PW (10%) newold = $1, 280
(c) Break-even salvage value: Let X denote the minimum salvage value for the
old machine. Then, the net proceeds from sale of the old machine will be
Total depreciation = $6, 000
Book value = $14, 000
Salvage value = X
Taxable gain = X $14, 000
Net proceeds = X (0.40)( X $14, 000)
= 0.6 X + $5,600
To find the break-even salvage value,

PW (10%)old = $400( P / A,10%,5) $300( P / F ,10%, 6) = $1, 686

PW (10%)new = [$12, 000 (0.6 X + $5, 600)]
+$360( P / F ,10%,1) + " + $877( P / F ,10%, 6)
= 0.6 X $4, 624
Let PW (10%)old = PW (10%) new and solve for X .
X = $4,897

Page | 7

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.6
(a) Transmission distance of 5 miles:
Option 1 (Copper wire):
5 miles = 5 5,280 = 26,400 feet
First cost = (1.692 + 0.013 2,000) 26,400 = $731,069
Annual operating cost = $731,069(0.184) = $134,517
PW (15%)1 = $731, 069 $134,517( P / A,15%,30) = $1,614,305

Option 2 (Fiber optics):

Cost of ribbon = $15,000/mile 5 miles = $75,000
Cost of terminators = $30,000 3 2 = $180,000
Cost of modulating system = ($12, 092 + $21, 217)(21)(2) = $1,398,978
Cost of repeater = $15,000
Total first cost = $75,000 + $180,000 + $1,398,978 + $15,000 = $1,668,978
Annual operating costs = $1,398,978(0.125) +$75, 000(0.178) = $188, 222
PW (15%)2 = $1, 668,978 $188, 222( P / A,15%,30) = $2,904,840
Option 1 is the better choice.

(b) Either 10 miles or 25 miles of transmission distance:

10 miles: two repeaters need for option 2
PW (15%)1 = $3, 228, 610
PW (15%) 2 = $1,808,904
Option 2 is the better choice.
25 miles: five repeaters need for option 2
PW (15%)1 = $8, 071,512
PW (15%)2 = $1,853,904
Option 2 is the better choice.

Page | 8

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.7
(a) With infinite planning horizon: We assume that both machines will be available in the future with the same cost.
Model A
Financial Data
n
Depreciation
Book value
Market value
Gain/Loss
Operation Cost

0
$6,000

Cash Flow Statement

Investment
+(.30)*(Depreciation)
-(1-0.30)*(Operation cost)
Net proceeds from sale

1
$857
$5,143

2
$1,469
$3,673

3
$1,049
$2,624

4
$749
$1,874

5-7
$536
$1,339

8
$268
$0
$500
$500
$700

$700

$700

$700

$700

$700

$257
($490)

$441
($490)

$315
($490)

$225
($490)

$161
($490)

$80
($490)
$350

($233)

($49)

($175)

($265)

($329)

($60)

($6,000)

Net Cash Flow

($6,000)
PW (10%) = ($7,152)

AE (10%) = ($1,341)

Model B
Financial Data
n
Depreciation
Book value
Market value
Gain/Loss
Operation Cost

0
$8,500

Cash Flow Statement

Investment
+(.30)*(Depreciation)
-(1-0.30)*(Operation cost)
Net proceeds from sale
Net Cash Flow

2
$2,082
$5,204

3
$1,487
$3,717

4
$1,062
$2,655

5-7
$759
$1,896

8
$379
($0)

$520

$520

$520

$520

$520

$520

$520

$364
($364)

$624
($364)

$446
($364)

$318
($364)

$228
($364)

$114
($364)

$0
($364)

$0
($364)
$700

($46)

($136)

($250)

($364)

$336

($0)

10
($0)
$1,000
$1,000
$520

($8,500)

($8,500)
PW (10%) = ($8,627)

1
$1,215
$7,285

$0

$260

$82

AE (10%) = ($1,404)

Model A is preferred

Page | 9

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Break-even annual O&M costs for machine A: Let X denotes a before-tax
annual operating cost for model.
PW (10%) A = $6, 000 + ($257 0.7 X )( P / F ,10%,1) + "
+ ($430 0.7 X )( P / F ,10%,8)
= $4,538 3.734 X
AE (10%) A = $851 0.7 X

Let AE (10%) A = AE (10%) B , and solve for X.

$851 0.7 X = $1, 404

X = $791 per year
Model A
Financial Data
n
Depreciation
Book value
Market value
Gain/Loss
Operation Cost

0
$6,000

Cash Flow Statement

Investment
+(.30)*(Depreciation)
-(1-0.30)*(Operation cost)
Net proceeds from sale

1
$857
$5,143

2
$1,469
$3,673

3
$1,049
$2,624

4
$749
$1,874

5-7
$536
$1,339

8
$268
$0
$500
$500
$791

$791

$791

$791

$791

$791

$257
($553)

$441
($553)

$315
($553)

$225
($553)

$161
($553)

$80
($553)
$350

($296)

($113)

($239)

($329)

($393)

($123)

($6,000)

Net Cash Flow

($6,000)
PW (10%) = ($7,490)

AE (10%) = ($1,404)

(c) With a shorter service life:

n
0
1
2
3
4
5
PW(10%)

Net Cash Flow

Model A
Model B
-$6,000
-$8,500
-233
0
-49
260
-175
82
-265
-46
2,172
2,883
-$5,216
-$6,464

Model A is still preferred over Model B.

Page | 10

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.8 Assuming that all old looms were fully depreciated

(a)
Project cash flows: Alternative 1

Alternative 1
Financial Data
n
Depreciation
Book value
Market value
Gain/Loss
Annual sales
Annual labor cost
Annual O&M cost
Cash Flow Statement
Investment
+(0.40)*Dn
+(0.60)*Sales
-(0.60)*Labor
-(0.60)*O&M
Net proceeds from sale
Net Cash Flow

1
$306,669
$2,146,036 1,839,367

2
$525,564
1,313,803

3
$375,342
938,462

4
$268,040
670,422

5
$191,641
478,781

5
$191,426
287,354

7
$191,641
95,713

8
$95,713
0
169,000
169,000
7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

7,915,748
261,040
1,092,000

122,667
4,749,449
-156,624
-655,200

210,226
4,749,449
-156,624
-655,200

150,137
4,749,449
-156,624
-655,200

107,216
4,749,449
-156,624
-655,200

76,656
4,749,449
-156,624
-655,200

76,571
4,749,449
-156,624
-655,200

76,656
4,749,449
-156,624
-655,200

38,285
4,749,449
-156,624
-655,200
101,400

($2,108,836) $4,060,292

$4,147,850

$4,087,761

$4,044,841

$4,014,281

$4,014,195

$4,014,281

$4,077,310

($2,108,836)

PW (18%) = $14,471,800

AE (18%) = $3,549,127

Note: Cost basis for the new looms = $ 2,119,170 + $ 26,866 = $ 2,146,036
Net investment required = Cost basis - Net proceeds from sale of the old looms
= $ 2,146,036 - $ 62,000 (1-0.40) = $ 2,108,836
Sensitivity analysis for alternative 1
Change

MARR

Labor cost

O&M

Revenue

-30%
-20%
-10%
0%
10%
20%
30%

$17,662,515
$16,496,280
$15,436,786
$14,471,800
$13,590,722
$12,784,336
$12,044,608

$14,511,620
$14,498,347
$14,485,073
$14,471,800
$14,458,527
$14,445,254
$14,431,981

$14,638,377
$14,582,851
$14,527,326
$14,471,800
$14,416,275
$14,360,749
$14,305,224

$13,264,313
$13,666,809
$14,069,305
$14,471,800
$14,874,296
$15,276,792
$15,679,287
Page | 11

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Project cash flows: Alternative 2

Alternative 2
Financial Data
n
Depreciation
Book value
Market value
Gain/Loss
Annual sales
Annual labor cost
Annual O&M cost
Cash Flow Statement
Investment
+(0.40)*Dn
+(0.60)*Sales
-(0.60)*Labor
-(0.60)*O&M
Net proceeds from sale
Net Cash Flow

1
$160,083
$1,120,242 960,159

2
$274,347
685,812

3
$195,930
489,882

4
$139,918
349,964

5
$100,038
249,926

5
$99,926
150,000

7
$100,038
49,963

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

7,455,084
422,080
1,560,000

64,033
4,473,050
-253,248
-936,000

109,739
4,473,050
-253,248
-936,000

78,372
4,473,050
-253,248
-936,000

55,967
4,473,050
-253,248
-936,000

40,015
4,473,050
-253,248
-936,000

39,970
4,473,050
-253,248
-936,000

40,015
4,473,050
-253,248
-936,000

($1,083,042) $3,347,835

$3,393,541

$3,362,175

$3,339,770

$3,323,817

$3,323,773

8
$49,963
0
54,000
54,000
7,455,084
422,080
1,560,000

($1,083,042)

PW (18%) = $12,575,319

19,985
4,473,050
-253,248
-936,000
32,400

$3,323,817 $3,336,188

AE (18%) = $3,084,026

Note: Cost basis for the new looms = $ 1,071,240 + $ 49,002 = $ 1,120,242
Net investment required = Cost basis - Net proceeds from sale of the old looms
= $ 1,120,242 - $ 62,000 (1-0.40) = $ 1,083,042

Sensitivity analysis for alternative 2

Change

MARR

Labor cost

O&M

Revenue

-30%
-20%
-10%
0%
10%
20%
30%

$15,205,898
$14,244,385
$13,370,886
$12,575,319
$11,848,941
$11,184,155
$10,574,337

$12,885,109
$12,781,846
$12,678,582
$12,575,319
$12,472,055
$12,368,792
$12,265,528

$13,720,299
$13,338,639
$12,956,979
$12,575,319
$12,193,658
$11,811,998
$11,430,338

$7,103,571
$8,927,487
$10,751,403
$12,575,319
$14,399,234
$16,223,150
$18,047,066

Page | 12

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Sensitivity graph

Sensitivity Graph for Alt 1

MARR
Labor
O&M
Revenue

Sensitivity Graph for Alt 2

$20,000,000

NPW

$15,000,000

$10,000,000

MARR
Labor

$5,000,000

O&M
Revenue
$-30%

-20%

-10%

0%

10%

20%

30%

Change

Page | 13

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.9 Sensitivity graph

V = 6000

V = 5000

V = 4000
V = 3000
V = 2000
V = 1000

12.10
NPW(10%)s for 200 shift:
NPW (10%) Electric = $38, 058
NPW (10%) LPG = $69,345
NPW (10%)Gasoline = $54,971
NPW (10%) Diesel = $49,994
0

Electric Power
O&M
Initial cost

($2,025) ($2,025) ($2,025) ($2,025) ($2,025) ($2,025) ($2,025)

($29,739)

Salvage

$3,000

Net cash flow ($29,739) ($2,025) ($2,025) ($2,025) ($2,025) ($2,025) ($2,025)

$975

NPW(10%) = ($38,058)
LPG
O&M
Initial cost

($10,100) ($10,100) ($10,100) ($10,100) ($10,100) ($10,100) ($10,100)

($21,200)

Salvage

$2,000

Net cash flow ($21,200) ($10,100) ($10,100) ($10,100) ($10,100) ($10,100) ($10,100) ($8,100)
NPW(10%) = ($69,345)
Page | 14

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Gasoline
O&M

($7,372) ($7,372) ($7,372) ($7,372) ($7,372) ($7,372) ($7,372)

Initial cost

($20,107)

Salvage

$2,000

Net cash flow ($20,107) ($7,372) ($7,372) ($7,372) ($7,372) ($7,372) ($7,372) ($5,372)
NPW(10%) = ($54,971)
Diesel Fuel
O&M

($5,928) ($5,928) ($5,928) ($5,928) ($5,928) ($5,928) ($5,928)

Initial cost

($22,263)

Salvage

$2,200

Net cash flow ($22,263) ($5,928) ($5,928) ($5,928) ($5,928) ($5,928) ($5,928) ($3,728)
NPW(10%) = ($49,994)

NPW(10%)s for 260 shift:

NPW (10%) Electric = $40, 285
NPW (10%) LPG = $82, 635
NPW (10%)Gasoline = $64, 277
NPW (10%) Diesel = $57,192

Sensitivity graph
Electric Power
LPG
Gasoline
Diesel Fuel

$90,000
$80,000
$70,000
$60,000
$50,000
$40,000
$30,000
200

260

Shifts

Page | 15

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Break-Even Analysis
12.11
PW of net investment:
P0 = $2, 200, 000 $600, 000 $400, 000 = $3, 200, 000

PW of after-tax revenue:

P1 = $4, 000(365) X (1 0.31)( P / A,10%, 25)

= $9,144, 210 X
PW of after-tax operating costs:

P2 = ($230, 000 + $170, 000 X )(1 0.31)( P / A,10%, 25)

= $1, 440,526 1, 064, 737 X

PW of tax credit (shield) on depreciation:

n
1

Depreciation
Building
Furniture
$54,060
$57,160

Combined
Tax savings
$111,220(0.31) = $34,478

56,410

97,960

154,370(0.31) = 47,855

56,410

69,960

126,370(0.31) = 39,175

56,410

49,960

106,370(0.31) = 32,975

56,410

35,720

92,130(0.31) = 28,560

56,410

33,680

92,090(0.31) = 28,548

56,410

35,720

92,130(0.31) = 28,560

56,410

17,840

74,250(0.31) = 23,018

9-24

56,410

56,410(0.31) = 17,487

25

54,060

54,060(0.31) = 16,759

P3 = $34, 478( P / F ,10%,1) + $47,855( P / F ,10%, 2)

+ " + $16, 759( P / F ,10%, 25)
= $247, 461

Page | 16

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

PW of net proceeds from sale:

Property
(asset)
Furniture

Cost basis

Building

2,200,000

794,450

(794,450)

(246,280)

600,000

2,031,813

600,000

1,431,813

443,862

Land

Salvage
Book value
value
$0
$0

$400,000

Gains
(losses)
$0

Gains
Taxes
$0

Net proceeds from sale = $2, 031,813 + $246, 280 $443,862

= $1,834, 231

P4 = $1,834, 231( P / F ,10%, 25)

= $169, 292
PW (10%) = P0 + P1 + P2 + P3 + P4
= $4, 223, 772 + 8, 079, 473 X
=0
X = 52.28%

12.12 Useful life of the old bulb:

14, 600 /(19 365) = 2.1 years

For computational simplicity, lets assume a useful life of 2 years for the old
bulb. Then, the new bulb will last 4 years. Let X denote the price for the new
light bulb. With an analysis period of 4 years, we can compute the equivalent
present worth cost for each option as follows:
PW (15%)old = (1 0.40)[$45.90 + $45.90( P / F ,15%, 2)]
= $48.36
PW (15%)new = (1 0.40)( X + $16)

The break-even price for the new bulb will be

0.6 X + 9.6 = $48.36
X = $64.6

Since the new light bulb costs only $60, it is worth switching to the new
light bulb. It is fairly close call, though.

Page | 17

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.13
PW of net investment:
P0 = $250, 000

PW of after-tax rental revenue:

P1 = X (1 0.30)( P / A,15%, 20)

= $4.3815 X
PW of after-tax operation costs:

P2 = (1 0.30)$12, 000( P / A,15%, 20)

= $52,578
PW of tax credit (shield) on depreciation: (In this problem, we assume that the
purchasing cost of $250,000 does not include any land value. Therefore, the
entire purchasing cost will be the cost basis for depreciation purpose.)
Depreciation
Building
n
1
$6,143
2-19
6,410
20
6,143

Combined
Tax savings
$6,143(0.30) = $1,843
6,410(0.30) = 1,923
6,143(0.30) = 1,843

P3 = $1,843( P / F ,15%,1) + $1,923( P / A,15%,18)( P / F ,15%,1)

+$1,843( P / F ,15%, 20)
= $11,962
PW of net proceeds from sale:
Total depreciation = $127,666
Book value = $250, 000 $127, 666 = $122,334
Salvage value = $250, 000(1.05) 20 = $663,324
Taxable gain = $663,324 $122,334 = $540,990
Gains tax = $540,990(0.30) = $162, 297
Net proceeds from sale = $663,324 $162, 297 = $501, 027

P4 = $501, 027( P / F ,15%, 20)

= $30, 613

Page | 18

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

The break-even rental:

PW (15%) = P0 + P1 + P2 + P3 + P4
= $260, 003 + 4.3815 X
=0

X = $59,341

12.14 Let X denotes the additional annual revenue (above $14,000) for model A that
is required to break even.
Generalized cash flow for model A:
End of Year
Cash flow
elements
0
1
2
3
4
5
6
Investment ($80,000)
Net proceeds
12,000
+0.6X
+0.6X
+0.6X
+0.6X
+0.6X
+0.6X
+0.6Rn
$6,400 $10,240 $6,144
$3,686
$3,686 $1,843
+0.4Dn
-(0.6)O&M
($13,200) ($13,200) ($13,200) ($13,200) ($13,200) ($13,200)
-$6,800 -$2,960 -$7,056 -$9,514 -$9,514 $634
Net cash flow ($80,000)
+0.6X
+0.6X
+0.6X
+0.6X
+0.6X
+0.6X

PW (20%) A = $100, 005.29 + 2 X

Generalized cash flow for model B:
Cash flow
elements

0
($52,000)

End of Year
3

Investment
Net proceeds
9000
$0
$0
$0
$0
$0
$0
+0.6Rn
$4,160 $6,656
$3,994
$2,396
$2,396 $1,198
+0.4Dn
-(0.6)O&M
($10,200) ($10,200) ($10,200) ($10,200) ($10,200) ($10,200)
Net cash flow ($52,000) ($6,040) ($3,544) ($6,206) ($7,804) ($7,804) ($2)

PW (20%) B = $69,985

By letting PW (20%) A = PW (20%) B

$100, 005.29 + 2 X = $69,985

X = $15, 010.14
Required additional annual revenue = $15,010.14
Page | 19

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.15 Let X denote the number of copies to break-even.

A/T annual revenue = (0.6)[$0.05 + ($0.25 $0.05)] X = 0.15X
A/T O&M cost = (0.60)[$300,000(12) + $0.10 X ] = $2,160,000 0.06 X

Depreciation tax credit = (0.40)[$85, 714( P / F ,13%,1) + "

+$26, 775( P / F ,13%,8)]( A / P,13%,10)
= $29, 285
CR(13%) = $600, 000( A / P,13%,10) + $60, 000( A / F ,13%,10)
= $107,316
AE (13%) = 0.15 X $2,160, 000 0.06 X + $29, 285 $107,316
= 0.09 X $2, 238, 031 = 0
X = 24,867, 011 copies per year or 24,867,011/240 =103,613 copies
per day

Probabilistic Analysis
12.16

PW (12%)light = $8, 000, 000 + $1,300, 000( P / A,12%,3)

PW (12%) moderate

= $4,877, 619
= $8, 000, 000 + $2,500, 000( P / A,12%, 4)

PW (12%) high

= $406, 627
= $8, 000, 000 + $4, 000, 000( P / A,12%, 4)
= $4,149,397

E[ PW (12%)] = $4,877, 619(0.20) $406, 627(0.40)

+$4,149,397(0.40)
= $521,584
Since E[ PW ] is positive, it is good to invest.

Page | 20

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.17
(a)
1.

A1 and A2 are mutually independent

200
500
E[ PW (10%)] = 500 +
+
= $95.04
1
2
(1 + 0.1) (1 + 0.1)

Var[ PW (10%)] = 0 +
2.

502

(1 + 0.1)

502

(1 + 0.1)

= 3773.65

A1 and A2 are partially correlated with 12 = 0.3

200
500
E[ PW (10%)] = 500 +
+
= $95.04
1
2
(1 + 0.1) (1 + 0.1)

Var[ PW (10%)] = 0 +

502

(1 + 0.1)

0.3(50)(50)
+ 2
= 4900.62
(1 + 0.1) (1 + 0.1)3
502

(b)

[ PW (10%)] = Var[ PW (10%)]

[ PW (10%)] = 3773.65
= 61.43
0 95.04
=
z=

61.43
= 1.547
P( z < 1.547) = 0.06093 or 6.093%
X

12.18
(a) The PW distribution for project 1:
Event (x,y)
($20,10)
($20,20)
($40,10)
($40,20)

Joint probability
0.24
0.36
0.16
0.24

PW (10%)
$2,000
$3,600
$4,000
$7,200

(b) The mean and variance of the PW for Project 1:

E[ PW (10%)]1 = $2, 000(0.24) + $3, 600(0.36) + $4, 000(0.16)
+$7, 200(0.24)
= $4,144
Var[ PW (10%)]1 = (2, 000 4,144) 2 (0.24) + (3, 600 4,144) 2 (0.36)
+(4, 000 4,144) 2 (0.16) + (7, 200 4,144) 2 (0.24)
= 3, 454, 464
Page | 21

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(c) The mean and variance of the PW for Project 2:

E[ PW (10%)]2 = $0(0.24) + $400(0.20) + $1, 600(0.36)
+$2, 400(0.20)
= $1,136
Var[ PW (10%)]2 = (0 1,136) 2 (0.24) + (400 1,136) 2 (0.20)
+ (1, 600 1,136) 2 (0.36) + (2, 400 1,136) 2 (0.20)
= 815,104

(d) No clear project dominance exists. However, Project 1 may be preferred over
project 2 if we consider the probability of losing money or the possibility of
realizing the worst situation. Project 1: $4,144 3(1,858.62) whereas Project 2:
$1,136 3(902.83).
12.19
(a) Expected value criterion
Option 1:
E[ R ]1 = $2, 450(0.25) + $2, 000(0.45) + $1, 675(0.30)
$150( F / P, 7.5%,1)
= $1,854
Option 2:
E[ R ]2 = $25, 000(0.075) = $1,875

Option 2 is the better choice based on the principle of expected value

maximization.

(b)
Potential return

Prob.

Op.1

Op.2

Optimal
choice

High

0.25

$2,288.75

$1,875

Op.1

$413.75

Medium

0.45

1,838.75

1,875

Op.2

Low

0.3

1,513.75

1,875

Op.2

1,853.75

1,875

Expected value

Opp.
Loss

103.44

Page | 22

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

EPPI = 0.25($2, 288.75) + 0.45($1,875) + 0.30($1,875) = $1,978.44

EMV = $1,875
EVPI = EPPI EMV = $103.44

Note: EPPI (Expected Profit of Perfect Information) is the maximum profit that
can be expected when you have the perfect information as we know what to do in
each situation.
12.20
Let X denote the annual revenue in constant dollars and Y be the general inflation.
(a) NPW as functions of X and Y:
Cash elements
Investment

End of Period
0
-$9,000

Salvage value

4,000(1+Y) 2

Gains tax
(0.4) Dn

1,200

0.4 4,000(1+Y)2 - 4,000

800

(0.6) Rn
working
capital

0.6X(1+Y)

0.6 X (1 + Y ) 2

-2,000

2,000(-Y)

2,000(1+Y)

-$11,000

1,200-2,000Y
+0.6X(1+Y)

2,400 (1+Y) 2 +2,400

Net cash
flow(Actual)
Net cash
flow(Constant)

1, 200(1+Y) -1

-$11,000

2, 000Y (1+Y) 1 + 0.6 X

+0.6X (1+Y) 2 +2,000(1+Y)

2,400 + 2, 400(1+Y) 2
+0.6 X + 2, 000(1+Y)-1

i = i'+ f + i' f
i = 0.1 + Y + 0.1Y = 0.1 + 1.1Y
PW (i) = $11,000 + [1, 200 2,000Y + 0.6 X (1 + Y )]( P / F , i,1)
+[2, 400(1 + Y )2 + 2, 400 + 0.6 X (1 + Y )2 + 2,000(1 + Y )]
( P / F , i, 2)

Page | 23

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

or
PW (10%) = $11, 000 + [1, 200(1+Y) -1 2, 000Y (1+Y) 1 + 0.6 X ]( P / F ,10%,1)
+[2,400 + 2, 400(1+Y) 2 + 0.6 X + 2, 000(1+Y) -1 ]( P / F ,10%, 2)

(b) and (c) Mean and variance calculation:

Note that the market interest rate is a random variable as the general inflation
rate becomes a random variable. There are nine joint events for X and Y.
For example of event No.2, the joint event where X = 10, 000 and Y = 0.05 , we
calculate the market interest rate and then evaluate the PW function with this
market interest rate.
i = i'+ f + i' f = 0.10 + 0.05 + (0.1)(0.05) = 15.5%
PW(15.5%) = $11,000 + [1,200 2,000(0.05) + 0.6(10,000)(1.05)](P / F,15.5%,1)
+[2,400(1.05)2 + 2,400 + 0.6(10,000)(1.05)2 + 2,000(1.05)]
(P / F,15.5%,2)
= $5,722
You repeat the process for the remaining joint events.

Page | 24

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Event No.
1
2
3
4
5
6
7
8
9

X
10,000
10,000
10,000
20,000
20,000
20,000
30,000
30,000
30,000

Y
0.03
0.05
0.07
0.03
0.05
0.07
0.03
0.05
0.07

Event No. PW(i%)

1
$5,877
2
$5,722
3
$5,574
4
$16,290
5
$16,136
6
$15,988
7
$26,704
8
$26,549
9
$26,401

P(x)
0.3
0.3
0.3
0.4
0.4
0.4
0.3
0.3
0.3

P(y)

E[PW]=

$
$
$
$
$
$
$
$
$

$16,137

0.133
0.155
0.177
0.133
0.155
0.177
0.133
0.155
0.177

0.25
0.5
0.25
0.25
0.5
0.25
0.25
0.5
0.25
Var[PW] =
sigma[PW] =

A0
($11,000)
($11,000)
($11,000)
($11,000)
($11,000)
($11,000)
($11,000)
($11,000)
($11,000)

A1
$7,320
$7,400
$7,480
$13,500
$13,700
$13,900
$19,680
$20,000
$20,320

A2
$13,372
$13,761
$14,157
$19,737
$20,376
$21,027
$26,102
$26,991
$27,896

PW(i%)*P(x,y) (PW(i%)-E[PW])^2*P(x,y)
P(x,y)
0.075
$441
7,895,197
0.15
$858
16,270,806
0.075
$418
8,368,000
0.1
$1,629
2,345
0.2
$3,227
1
0.1
$1,599
2,238
0.075
$2,003
8,373,604
0.15
$3,982
16,259,759
0.075
$1,980
7,900,640
65,072,590
1 $16,137
65,072,590
$
8,067

Comparing Risky Projects

12.21
(a)

E[ PW ]1 = ($2, 000)(0.20) + ($3, 000)(0.60) + ($3,500)(0.20) $1, 000

= $1,900
E[ PW ]2 = ($1, 000)(0.30) + ($2,500)(0.40) + ($4,500)(0.30) $800

= $1,850
Project 1 is preferred over Project 2.

Page | 25

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b)
Var[ PW ]1 = (2, 000 1,900) 2 (0.20) + (3, 000 1,900) 2 (0.60)
+ (3,500 1,900) 2 (0.20)
= 1, 240, 000
Var[ PW ]2 = (1, 000 1,850) 2 (0.30) + (2,500 1,850) 2 (0.40)
+(4,500 1,850) 2 (0.30)
= 2, 492,500
Project 1 is still preferred, because of higher E[ PW ] with lower Var[ PW ] .

12.22
(a) Mean and variance calculations:
E[ PW ]A = ($100, 000)(0.20) + ($50, 000)(0.40) + (0)(0.40)
= $40, 000
E[ PW ]B = ($40, 000)(0.30) + ($10, 000)(0.40) + ($10, 000)(0.30)
= $13, 000
Var[ PW ]A = (100, 000 40, 000)2 (0.20) + (50, 000 40, 000) 2 (0.40)
+(0 40, 000) 2 (0.40)
= 1, 400, 000, 000
Var[ PW ]B = (40, 000 13, 000) 2 (0.30) + (10, 000 13, 000) 2 (0.40)
+(10, 000 13, 000) 2 (0.30)
= 381, 000, 000

It is not a clear case, because E A > EB but also VarA > VarB .
If he makes decision solely based on the principle of maximization of expected
value, he may prefer contract A.

Page | 26

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Assuming that both contracts are statistically independent from each other,
Joint event ( PWA > PWB )

Joint Probability

($100,000,$40,000)
($100,000,$10,000)
($100,000,-$10,000)
($50,000,$40,000)
($50,000,$10,000)
($50,000,-$10,000)
($0,-$10,000)

(0.20)(0.30) = 0.06
(0.20)(0.40) = 0.08
(0.20)(0.30) = 0.06
(0.40)(0.30) = 0.12
(0.40)(0.40) = 0.16
(0.40)(0.30) = 0.12
(0.40)(0.30) = 0.12
= 0.72

We could look at this problem from a different angle. That is, project A is certain
not to lose money, and the second best outcome for project A is better than the
best outcome for project B. So it actually doesnt seem like a hard call.
12.23
(a)
Machine A:
CR (10%) A = ($60, 000 $22, 000)( A / P,10%, 6) + (0.10)($22, 000)
= $10,924
E[ AE (10%)]A = ($5, 000)(0.20) + ($8, 000)(0.30)
+ ($10, 000)(0.30) + ($12, 000)(0.20) + $10,924
= $19, 725
Var[ AE (10%)]A = (15,924 19, 725)2 (0.20) + (18,924 19, 725) 2 (0.30)
+ (20,924 19, 725) 2 (0.30) + (22,924 19, 725)2 (0.20)
= 5,560, 000

Machine B:
CR (10%) B = $35, 000( A / P,10%, 4)
= $11, 042
E[ AE (10%)]B = ($8, 000)(0.10) + ($10, 000)(0.30)
+($12, 000)(0.40) + ($14, 000)(0.20) + $11, 042
= $22, 442
Var[ AE (10%)]B = (19, 042 22, 442) 2 (0.10) + (21, 042 22, 442) 2 (0.30)
+(23, 042 22, 442) 2 (0.40) + (25, 042 22, 442) 2 (0.20)
= 3, 240, 000

Page | 27

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Prob[ AE (10%) A > AE (10%) B ] :

Joint event
(O & M A , O & M B ) ( AE A > AEB )

Joint
Probability

($10,000, $8,000)

($20,924, $19,042)

(0.30)(0.10) = 0.03

($12,000, $8,000)

($22,924, $19,042)

(0.20)(0.10) = 0.02

($12,000, $10,000)

($22,924, $21,042)

(0.20)(0.30) = 0.06
= 0.11

12.24
(a) Mean and variance calculation (Note: For a random variable Y, which can be
expressed as a linear function of another random variable X (say, Y = aX ,
where a is a constant) the variance of Y can be calculated as a function of
variance of X, Var[Y ] = a 2Var[ X ] .
E[ PW ]A = $5, 000 + $4, 000( P / A,15%, 2)
= $1,502.84
E[ PW ]B = $10, 000 + $6, 000( P / F ,15%,1) + $8, 000( P / F ,15%, 2)
= $1, 266.54
V [ PW ]A = 1, 0002 + ( P / F ,15%,1) 21, 0002 + ( P / F ,15%, 2)21,5002
= 3, 042,588
V [ PW ]B = 2, 0002 + ( P / F ,15%,1) 21,5002 + ( P / F ,15%, 2) 2 2, 0002
= 7,988,336

(b) Comparing risky projects

E[ PW ]

Project A
$1,503

Project B
$1,267

Var[ PW ]

3,042,588

7,988,336

Project A is preferred because of higher E[ PW ] and lower Var[ PW ] .

Page | 28

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

DecisionTree Analysis
12.25
Joint & Marginal probabilities:

H
L
Marginal probabilities
Actual

H
0.12
0.07
0.19

Survey
M
0.12
0.35
0.47

L
0.06
0.28
0.34

Conditional probabilities:

Actual

(a)

H
L

H
0.632
0.368

Survey
M
0.255
0.745

L
0.176
0.824

EV0 = 0
EVIntro. = (0.3)($4 M ) + (0.7)($2 M ) = $0.2 M
EVDon 't Intro. = 0

(b)

EVPI 0 = EPPI EV0 = 1.2 M

EPPI = (0.3)($4 M ) + (0.7)($0) = $1.2 M
EV0 = 0

Page | 29

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(c) Decision tree

0.3
High
4
introduce

0
0

-0.2

1
No survey

0.7
Low

Event 3

-2
2

-2

0
Do not
0
0

0
0.632
High
4

introduce

0
0

1.792

0.19

0.368
Low

-2

0.14048

-2

1.792
Do not
0
0

0
0.255
High
4

introduce

0
0

-0.47

0.47
Do survey

0.745
Low

-2
2

-0.2

0.34048

-2

0
Do not
0
0

0
0.176
High
4

introduce

0
0

-0.944

0.34

0.824
Low

-2
2
0

-2

0
Do not
0
0

(d)
EVPI e = EPPI EVe = $1.2 M $0.34048M = $0.85952 M

(e) Expected value of sample (survey) information (EVSI)

EVSI = EVPI 0 EVPI e = EVe EV0 = $0.34048M

(f)
Optimal decision: Take the survey. If the survey says high sales (S), then
introduce a new product. Otherwise, do not.
Page | 30

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.26
(a) Lets define the symbols:
P: Party is taking place
NP: No party is planned
TP: Tipster says P
TNP: Tipster says NP
Then, P(TP, NP) = P( NP) P(TP / NP) = (0.4)(0.2) = 0.08

(b)
Optimal decision without sample information:

EMV = (0.6)(100) + (0.4)(50) = 40 points.

Raid the dormitories.

Joint & Marginal probabilities:

P
NP
Marginal Probability

Actual

Tipster says
TP
TNP
0.24
0.36
0.08
0.32
0.32
0.68

Marginal
Probability
0.6
0.4
1

Conditional probabilities:
Tipster says
Actual

P
NP

TP
0.750
0.250

TNP
0.529
0.471

Optimal decision after receiving the tips:

The tipsters information has no value, even though it costs nothing.
Do not reply on the tips.
(c) EVPI = 60 - 40 = 20
EPPI = (0.6)(100) + (0.4)(0) = 60 points
Page | 31

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

* Decision Tree

40

40

NR

Do not take tips

0.4
-6

40
62.5
62.5

Take tips

39.93

0.32

R
NR

TP

-7.5

0.6

29.41
29.41

NR

100

-50
-10

0.4

0.75

100

0.25

-50

0.75
0.25

0.68
TNP

0.6

-10
0
100

0.529
0.471

-5.3

0529
0.471

-50
-10
0

Page | 32

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

12.27
(a)
Demand High case
Income statement
0
Revenue
Depreciation
taxable income
income tax(40%)
Net income
Cash flow statement
Net income
Depreciation
Investment
Salvage
Gain tax
Net cash flow

1
1,000,000
12,821
987,180
394,872
592,308

2
1,000,000
12,821
987,180
394,872
592,308

3 ...14
1,000,000
12,821
987,180
394,872
592,308

592,628
12,287

592,308
12,821

592,308
12,821

592,308
12,821

15
1,000,000
12,287
987,714
395,085
592,628

592,628
12,287

(500,000)
100,000
83,504
(500,000)

PW(15%)=

1,000,000
12,287
987,714
395,085
592,628

604,915

605,128

605,128

605,128

788,419

3,060,763

Demand Medium case

Income statement
0
Revenue
Depreciation
taxable income
income tax(40%)
Net income
Cash flow statement
Net income
Depreciation
Investment
Salvage
Gain tax
Net cash flow

1
500,000
12,821
487,180
194,872
292,308

2
500,000
12,821
487,180
194,872
292,308

3 ...14
500,000
12,821
487,180
194,872
292,308

15
500,000
12,287
487,714
195,085
292,628

292,628
12,287

292,308
12,821

292,308
12,821

292,308
12,821

292,628
12,287

(500,000)
100,000
83,504
(500,000)

PW(15%)=

500,000
12,287
487,714
195,085
292,628

304,915

305,128

305,128

305,128

488,419

1,306,552

Demand Low case

Income statement
0
Revenue
Depreciation
taxable income
income tax(40%)
Net income
Cash flow statement
Net income
Depreciation
Investment
Salvage
Gain tax

(80,000)
12,287
(92,287)
(36,915)
(55,372)

1
(80,000)
12,821
(92,821)
(37,128)
(55,692)

2
(80,000)
12,821
(92,821)
(37,128)
(55,692)

3 ...14
(80,000)
12,821
(92,821)
(37,128)
(55,692)

15
(80,000)
12,287
(92,287)
(36,915)
(55,372)

(55,372)
12,287

(55,692)
12,821

(55,692)
12,821

(55,692)
12,821

(55,372)
12,287

(500,000)
100,000
83,504

Net cash flow

(500,000)

PW(15%)=

(728,333)

(43,085)

(42,872)

(42,872)

(42,872)

140,419

EV0 = (0.3)($3,060,763) + (0.4)($1,306,552) + (0.3)($728,333)

= $1,222,349.8

Open the store

Page | 33

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

EVPI 0 = EPPI EV0 = $1,440,849.7 $1,222,349.8 = $218,499.9

EPPI = $3,060,763 (.3) + $1,306,552 (.4) + $0(.3) = $1,440,849.7

Could pay up to $218,499.9 to know the true state of nature.

(b)
Joint / marginal probabilities:
Survey says

Actual

Marginal
Probability

High

Medium

Low

High

0.21

0.075

0.015

0.3

Medium

0.08

0.24

0.08

0.4

Low

0.015

0.06

0.225

0.3

0.305

0.375

0.320

Marginal Probability

Conditional probabilities:
Survey says

Actual

High

Medium

Low

High

0.689

0.2

0.047

Medium

0.262

0.64

0.25

Low

0.049

0.16

0.703

o Optimal decision: Take a survey. With either High or Medium result

from the survey, open the store. Otherwise, do not open the store.
o Calculating the expected value of perfect information with survey.
EVPI e = EPPI EVe = $1,440,849.7 $1,235,789.12= $205,060.58
EEPI = $3,060,763 (.3) + $1,306,552 (.4) + $0(.3) = $1,440,849.7

EVe = $0(0.32)+ $1,331,812.6 (0.375)+ $2,414,293.1 (0.305)=$1,235,789.12

o Expected Value of Sample Information (EVSI)
Page | 34

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

EVSI = EVPI 0 EVPI e = $218,499.9 $205,060.58= $13,439.32

EVSI = EVe EV0

Decision Tree
0.3
Demand High
3,060,763
0

3060763

0.4
Demand medium

Open

1,306,552
0

1222349.8

1306552

0.3
Demand low

No survey
1
0

(728,333)

1222349.8

-728333

Do not open
0

0
0.68852459
Demand High
3,060,763
0

3060763

0.26229508
Demand medium

Open

1,306,552
0

2414293.09

0.305
Sample info High
#
1234789.12

1306552

0.04918033
Demand low

1
2414293.09

(728,333)
0

-728333

Do not open
0

0
0.2
Demand High
3,060,763
0

3060763

0.64
Demand medium

Open

1,306,552
0

1331812.6

0.375
Sample info Medium

Survey

1306552

0.16
Demand low
1

-1000 1235789.12

(728,333)

1331812.6

-728333

Do not open
0

0
0.046875
Demand High
3,060,763
0

3060763

0.25
Demand medium

Open

1,306,552
0

-41997.875

0.32
Sample info Low

1306552

0.703125
Demand low
2

(728,333)

-728333

Do not open
0

Page | 35

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Short Case Studies

ST 12.1
The EMV of the lottery by assuming that the lotto price is $1:
One ticket each for every possible combination of 6 numbers from 1 to 44:
44!
= 7, 059, 052
6!(44 6)!
Probability
Payoff
0.0000001416
$27,007,364 - $1
0.0000323
$899 - $1
0.00149
$51 - $1
0.02381
$1 - $1
0.974668
$0 - $1
Total:
C (44, 6) =

Prize
First
Second
Third
Fourth
Fail

EMV
$3.81
$0.03
$0.07
$0
-$0.97
$2.94

It is worth trying because of the positive EMV.

The probability is increased by 1/ 7, 059, 052 when you purchase one more
ticket.
ST 12.2
(a) Project cash flows:
(a) Project cash flows based on most-likely estimates:
0
1
Income Statement
Revenue:
Steam Sales
$1,550,520
Tipping Fee
976,114
Expenses:
O&M
832,000
Depreciation
Interest(11.5%)
805,000

8-19

$1,550,520 $1,550,520
208,585
0

20

$1,550,520
895,723

$1,550,520
800,275

$1,550,520
687,153

$1,550,520
553,301

$1,550,520
395,161

$1,550,520
0

832,000

832,000

832,000

832,000

832,000

832,000

832,000

832,000

805,000

805,000

805,000

805,000

805,000

805,000

805,000

805,000

Taxable Income
Income Tax (0%)

$889,634
0

$809,243
0

$713,795
0

$600,673
0

$466,821
0

$308,681
0

$122,105
0

($86,480)
0

($86,480)
0

Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage
Gains Tax
Loan Repayment

$889,634

$809,243

$713,795

$600,673

$466,821

$308,681

$122,105

($86,480)

($86,480)

889,634
0

809,243
0

713,795
0

600,673
0

466,821
0

308,681
0

122,105
0

(86,480)
0

(6,688,800)

(86,480)
0
300,000

6,688,800

(7,000,000)

Net Cash Flow

PW (10%) =

0
$1,639,723

889,634

809,243

713,795

600,673

466,821

308,681

122,105

(86,480)

(6,786,480)

Yes, enough revenue.

Note: There are no tax payments by the City of Opelika, as a municipal

government.
Page | 36

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Let X denote the steam charge per pound. Then, annual steam
charge = 1, 061,962(0.001X )(365) = 387, 616 X
n
1
2
3
4
5
6
7
8-19
20

Revenue
$387,616X
$387,616X
$387,616X
$387,616X
$387,616X
$387,616X
$387,616X
$387,616X
$387,616X

Expenses
-$660,886
-$741,277
-$836,725
-$949,847
-$1,083,699
-$1,241,839
-$1,428,415
-$1,637,000
-$8,337,000

AE (10%) = $387, 616 X [$660,886( P / F ,10%,1) + "

+$8,337, 000( P / F ,10%, 20)]( A / P,10%, 20)
= $387, 616 X $1,357,918
=0
X = $3.503 per lb

or $3,503 per thousand lbs

(c) Sensitivity graph is not provided.

Page | 37

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

ST 12.3
(a) Project cash flows based on most-likely estimates:
0
Income Statement
Revenue:
Bill savings
Mile Savings
Expenses:
Depreciation

$3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000 $3,000,000

Taxable Income
Income Tax (38%)
Net Income
Cash Flow Statement
Cash From Operation:
Net Income
Depreciation
Investment&Salvage

-10,000,000

Net Cash Flow

-10,000,000

1,250,000

1,250,000

1,250,000

1,250,000

1,250,000

1,250,000

2,000,000

3,200,000

1,920,000

1,152,000

1,152,000

576,000

2,250,000

1,050,000

2,330,000

3,098,000

3,098,000

855,000

399,000

885,400

1,177,240

1,177,240

$1,395,000

1,250,000

1,250,000

3,674,000

4,250,000

4,250,000

1,396,120

1,615,000

1,615,000

$651,000 $1,444,600 $1,920,760 $1,920,760 $2,277,880 $2,635,000 $2,635,000

1,395,000

651,000

1,444,600

1,920,760

1,920,760

2,277,880

2,635,000

2,635,000

2,000,000

3,200,000

1,920,000

1,152,000

1,152,000

576,000

3,395,000

3,851,000

3,364,600

3,072,760

3,072,760

2,853,880

2,635,000

2,635,000

PW (18%) = $3,204,044

(b) Sensitivity analysis:

Percentage
deviation
-30%
-20%
-10%
0 (base)
+10%
+20%
+30%

Savings In
T.B.
$2,100,000
2,400,000
2,700,000
3,000,000
3,300,000
3,600,000
3,900,000

PW(18%)
$928,762
1,687,189
2,445,616
3,204,044
3,962,471
4,720,898
5,479,325

Savings In
D.M.
$875,000
1,000,000
1,125,000
1,250,000
1,375,000
1,500,000
1,625,000

PW(18%)
$2,256,010
2,572,021
2,888,032
3,204,044
3,520,055
3,836,066
4,152,078

(c) Sensitivity graphs are not provided.

Page | 38

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

ST 12.4
(a), (b), and (c).
Random Variables

Low

Most

High

Likely
Annual Market size (units)

5,000

8,000

10,000

Growth rate (annual)

3%

5%

8%

Unit price

$80,000

$84,000

$86,000

Unit variable cost

$56,000

$60,000

$65,000

Fixed cost (annual)

$5,000,000 $8,000,000 $9,000,000

excluding depreciation
Salvage value

$6,000,000 $7,000,000 $8,000,000

Depreciated on a 7-year MACRS

Depreciation:
%
14.29
24.49
17.49
12.49
8.93
8.92
8.93
4.46

n
0
1
2
3
4
5
6
7
8

Dn
$7,859,500
$13,469,500
$9,619,500
$6,869,500
$4,911,500
$4,906,000
$4,911,500
$2,453,000

Bn
$55,000,000
$47,140,500
$33,671,000
$24,051,500
$17,182,000
$12,270,500
$7,364,500
$2,453,000
$0

Net cash flow (Low case)

Page | 39

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Income statement
0

1
400,000,000
285,000,000
7,859,500
107,140,500
37,499,175
69,641,325

Revenue
Expense
Depreciation
Taxable income
Income taxes(35%)
Net income

2
3
412,000,000 424,360,000
293,400,000 302,052,000
13,469,500
9,619,500
105,130,500 112,688,500
36,795,675 39,440,975
68,334,825 73,247,525

4
437,090,800
310,963,560
6,869,500
119,257,740
41,740,209
77,517,531

5
450,203,524
320,142,467
4,911,500
125,149,557
43,802,345
81,347,212

6
463,709,630
329,596,741
4,906,000
129,206,889
45,222,411
83,984,478

7
477,620,919
339,334,643
4,911,500
133,374,776
46,681,171
86,693,604

8
491,949,546
349,364,682
2,453,000
140,131,864
49,046,152
91,085,712

Cash flow statement

Operating activities
Net income
Depreciation
Investment activities
Investment
-$55,000,000
Salvage
Gains tax
Net cash flow
-$55,000,000
PW(15%)=

69,641,325
7,859,500

2
68,334,825
13,469,500

3
73,247,525
9,619,500

4
77,517,531
6,869,500

5
81,347,212
4,911,500

6
83,984,478
4,906,000

86,693,604
4,911,500

91,085,712
2,453,000

91,605,104

6,000,000
2,100,000
97,438,712

77,500,825

81,804,325

82,867,025

84,387,031

86,258,712

88,890,478

$324,589,088

Page | 40

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Result of simulation (with random variables)

o Mean: $534,575,300
o Standard deviation: $97,630,260
o Estimate the probability that the NPV will be negative: 0%

Page | 41