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# 6-1

## Mutually Exclusive Alternatives: PW Method

6.1
PW (12%) A \$800 \$1,500( P / F ,12%,1)
L \$660( P / F ,12%,10)
\$988.91
PW (12%) B \$2, 635 \$565( P / F ,12%,1)
L \$840( P / F ,12%,10)
\$1, 696.01

Select Project B.

6.2
(a)

## PW (15%) A \$1,500 \$1,350( P / F ,15%,1) L

\$100( P / F ,15%, 4)
\$467.52
PW (15%) B \$1,500 \$1, 000( P / F ,15%,1) L
\$150( P / F ,15%, 4)
\$586.26

Select Project B.

(b)
NFW (15%) D \$1,500( F / P,15%,4) \$450( F / A,15%, 4)
\$376.49
NFW (15%) E \$1,800( F / P,15%, 4) \$600( F / A,15%, 4)
\$152.18

Select Project D.

(c)
PW (15%)C \$3, 000 \$1, 000( P / F ,15%,1)
X ( P / F ,15%, 2)
\$1,500( P / F ,15%,3) X ( P / F ,15%, 4)
1.3279 X \$1,144.16

6-2

## To be acceptable, it must satisfy the following condition:

PW (15%)C 0
1.3279 X \$1,144.16 0
X \$861.63

(d)
PW (18%) D \$1,500 \$450( P / A,18%, 4)
\$289.47 0
Yes, Project D is acceptable.

## (e) If MARR < 10.40%, Project E is better. Otherwise, Project D is better.

6.3

(a)
PW (12%) A \$14,500 \$12,610( P / F ,12%,1) \$12,930( P / F ,12%,2)
\$12,300( P / F ,15%,3) \$15,821.54
PW (12%) B \$12,900 \$11,210( P / F ,12%,1) \$11,720( P / F ,12%,2)
\$11,500( P / F ,12%,3) \$14,637.51

Select Project A.

(b)
FW (12%) A \$15,821.54( F / P,12%,3) \$22,228.13
FW (12%) B \$14,637.51( F / P,12%,3) \$20,564.65

Select Project A.

6.4

(a)
PW (15%) A \$6,000 \$800( P / F ,15%,1) \$14,000( P / F ,15%,2)
\$5,281.66
PW (15%) B \$8,000 \$11,500( P / F ,15%,1) \$400( P / F ,15%,2)
\$2,302.46

Select Project A.

6-3

(b) PW(i) function for each alterative on the same chart between 0% and 50%:

6.5

Method A:

## \$25, 000( A / F ,12%,5)

CE (12%) A \$60, 000 \$92, 791.67
0.12

Method B:

## \$180, 000( A / F ,12%,50)

CE (12%) B \$150, 000 \$150, 625.5
0.12

6.6

6-4

## PW (0.5%)SL \$5,500 \$1,150( P / A, 0.5%, 24)

\$1, 000( P / F , 0.5%, 24)
\$30,560.10

## PW (0.5%)SU \$31,500 \$1, 000( P / F , 0.5%, 24)

\$30, 612.82

Select the standard lease option as you will save \$52.72 in present worth.

6.7
Machine A:

## PW (13%) \$75, 200 (\$6,800 \$2, 400)( P / A,13%, 6)

\$21, 000( P / F ,13%, 6)
\$101,891

Machine B:

## PW (13%) \$44, 000 \$11,500( P / A,13%, 6)

\$89,971
Machine B is a better choice.

*
6.8

(a)
Required HP to produce 10 HP:

## Motor A: X 1 10 / 0.85 11.765 HP

Motor B: X 2 10 / 0.90 11.111 HP

## Motor A: 11.765(0.7457)(1,500)(0.07) \$921.18

Motor B: 11.111(0.7457)(1,500)(0.07) \$869.97

Present Worth:
*
An asterisk next to a problem number indicates that the solution is available to students
on the Companion Website.

6-5

## PW (8%) A \$800 \$921.18( P / A,8%,15)

\$50( P / F ,8%,15)
\$8, 669
PW (8%) B \$1, 200 \$869.97( P / A,8%,15)
\$100( P / F ,8%,15)
\$8, 614

Motor B is preferred.

## PW (8%) A \$800 \$1,535.26( P / A,8%,15)

\$50( P / F ,8%,15)
\$13,925
PW (8%) B \$1, 200 \$1, 449.97( P / A,8%,15)
\$100( P / F ,8%,15)
\$13,579
Motor B is still preferred.

6.9 Given: Required service period = infinite, analysis period = least common
multiple service periods (six years)

Project A:

## PW (12%)cycle \$20, 000 \$17,500( P / F ,12%,1) \$17, 000( P / F ,12%, 2)

\$15, 000( P / F ,12%,3)
\$19,854.00
PW (12%) total \$19,854[1 ( P / F ,12%,3)]
\$33,985.69

Project B:

## PW (12%)cycle \$25, 000 \$25,500( P / F ,12%,1) \$18, 000( P / F ,12%, 2)

\$12,117.35
PW (12%) total \$12,117.35[1 ( P / F ,12%, 2) ( P / F ,12%, 4)]
\$29, 478.02
Project A is preferred.

6-6

6.10

(a) Without knowing the future replacement opportunities, we may assume that
both alternatives will be available in the future with the identical investments
and expenses. We further assume that the required service period will be
indefinite.

Project A1:

## PW (10%)cycle \$900 \$400( P / A,10%,3)

\$200( P / F ,10%,3)
\$1, 744.48
PW (10%) total \$1, 744.48[1 ( P / A,33.10%, 7)]
\$6,302.63

(1.10)3 1 33.10%

Project A2:

## PW (10%)cycle \$1,800 \$300( P / A,10%,8)

\$500( P / F ,10%,8)
\$3,167.22
PW (10%) total \$3,167.22[1 ( P / F ,10%,8)
( P / F ,10%,16)]
\$5,334.03
Project A2 is preferred.

(c)
PW (10%) A1 \$1,744.48
PW (10%) A 2 \$1,800 \$300( P / A,10%,3) S ( P / F ,10%,3)
\$2,546.06 0.7513S

S \$1, 067

6-7

6.11

Project B1:

## PW (12%)cycle \$18, 000 \$2, 000( P / A,12%,5) \$2, 000( P / F ,12%,5)

\$24, 075
PW (12%) total \$24, 075[1 ( P / A, 76.23%, 2)]
\$45, 487
Note: (1.12) 5 1 76.23%

Project B2:

## PW (12%) cycle \$15,000 \$2,100( P / A,12%,3) \$1,000( P / F ,12%,3)

\$19,332
PW (12%) total \$19,332[1 ( P / A,40.49%,4)]
\$54,826
Note: (1.12) 3 1 40.49%

## Select Project B1.

(b)
Project B1 with two replacement cycles:

## PW (12%) \$24, 075 \$24, 075( P / F ,12%,5)

\$37, 736

Project B2 with four replacement cycles where the fourth replacement ends
at the end of the first operating year:

## PW (12%) \$19,332[1 ( P / F ,12%,3) ( P / F ,12%, 6)]

[\$15, 000 (\$2,100 \$6, 000)( P / F ,12%,1)]( P / F ,12%,9)
\$47, 040

## Project B1 is still a better choice

6.12 Since only Model A is repeated in the future, we may have the following
sequence of replacement cycles:

6-8

## Option 1: Purchase Model A now and repeat Model A forever.

Option 2: Purchase Model B now and replace it at the end of year 2 by
Model A. Then repeat Model A forever.

## PW (15%) Model A \$6, 000 \$3,500( P / A,15%,3)

\$1,991.29
A \$1,991.29( A / P,15%,3)
\$872.14
PW (15%)Model B \$15, 000 \$10, 000( P / A,15%, 2)
\$1, 257.09
A \$1, 257.09( A / P,15%, 2)
\$773.26
(a)
Option 1:
\$872.14
PW (15%) AAAL
0.15
\$5,814.27
Option 2:
\$872.14
PW (15%) BAAL \$1, 257.09 ( P / F ,15%, 2)
0.15
\$5, 653.51
Option 1 is a better choice.

## Solving for S yields

S \$2, 072.50

6.13

Since either tower will have zero salvage value after 20 years, we may select
the analysis period of 35 years:

## PW (11%) Bid A \$137, 000 \$2, 000( P / A,11%,35)

\$154, 710
PW (11%)Bid B \$128, 000 \$3,300( P / A,11%,35)
\$157, 222

6-9

## Bid A is a better choice.

If you assume an infinite analysis period, the present worth of each bid will
be:
[\$137, 000 \$2, 000( P / A,11%, 40)]( A / P,11%, 40)
PW (11%) Bid A
0.11
\$157, 296
[\$128, 000 \$3,300( P / A,11%,35)]( A / P,11%,35)
PW (11%) Bid B
0.11
\$161,367

## Bid A is still preferred.

6.14

(a)
PW (15%) A1 \$15, 000 \$9,500( P / F ,15%,1)
\$12,500( P / F ,15%, 2) \$7,500( P / F ,15%,3)
\$7, 644.04

(b)
PW (15%) A 2 \$25, 000 X ( P / F ,15%, 2)( P / F ,15%,1)
\$9,300
X \$24, 263

(c) Note that the net future worth of the project is equivalent to its terminal
project balance.

\$11, 625.63

## (d) Select Project A2.

6.15
(a) Project balances as a function of time are as follows:

Project Balances
n A D
0 \$2,500 \$5,000
1 2,100 6,000
2 1,660 7,100

6-10

3 1,176 3,810
4 694 1,191
5 163 1,690
6 421 3,859
7 763 7,245
8 1,139

## (b) Knowing the relationship FW (i ) PB (i ) N ,

FW (10%) A \$1,139
FW (10%) D \$7, 245

## PW (10%) B \$7, 000 \$1,500( P / A,10%,8)

\$1, 000( P / F ,10%,1) \$500( P / F ,10%, 2)
\$1,500( P / F ,10%, 7) \$1,500( P / F ,10%,8)
\$17, 794
PW (10%)C \$5, 000 \$2, 000( P / A,10%, 7)
\$3, 000( P / F ,10%,8)
\$16,136
Select Project C.

6.16

\$304,320

## PW (12%)2 \$100, 000( P / F ,12%, 2) \$6, 000( P / A,12%,3)( P / F ,12%, 2)

\$160, 000( P / F ,12%,5) \$15, 000( P / A,12%,3)( P / F ,12%,5)
\$140, 000( P / F ,12%,8)
\$258,982
Option 2 is a better choice.

6-11

*
6.17

## PW (15%) A \$30M \$0.40M ( P / A,15%, 25)

\$0.85M ( P / F ,15%, 25)
\$32,559,839

## PW (15%) B \$10M \$18M ( P / F ,15%,10)

\$12 M ( P / F ,15%,15) \$1.5M ( P / F ,15%, 25)
\$0.25M ( P / A,15%, 25)
\$0.10M ( P / A,15%,15)( P / F ,15%,10)
\$0.10 M ( P / A,15%,10)( P / F ,15%,15)
\$17, 700, 745

Select Alternative B.

6.18

## Option 2: Tank/hill installation with the pumping equipment replaced at the

end of 20 years at the same cost

## PW (12%)2 (\$120, 000 \$12, 000)

(\$12, 000 \$1, 000)( P / F ,12%, 20)
\$1, 000( P / F ,12%, 40) \$1, 000( P / A,12%, 40)
\$141,373

## Unit-Cost Profit Calculation

6-12

*
6.19
Let T denote the total operating hours in full load.

Motor I (Expensive)

## Annual power cost:

150
(0.746) (0.05) T \$6.741T
0.83
Equivalent annual cost of operating the motor:

## AEC (6%) I \$4,500( A / P, 6%,10) \$675 6.741T

\$1, 286.41 \$6.741T

## Annual power cost:

150
(0.746) (0.05) T \$6.9938T
0.80

## AEC (6%) II \$3, 600( A / P, 6%,10) \$540 6.9938T

\$1, 026.11 6.9938T

## T 1, 017.8 hours per year

6.20
Option 1: Purchase units from John Holland

## PW (15%)dm \$63, 000( P / A1 ,5%,15%,5) \$230, 241

PW (15%)dl \$190,800( P / A1 , 6%,15%,5) \$709, 491
PW (15%) vo \$139, 050( P / A1 ,3%,15%,5) \$490,888
AEC (15%) (\$230, 241 \$709, 491 \$490,888)( A / P,15%,5) \$70, 000
\$496, 776

6-13

## Option 1 is a better choice.

6.21

(a) Determine the unit profit of air sample test by the TEM (in-house).

Subcontract Option:

## AEC (15%) (\$415, 000 \$9,500)( A / P,15%,8) (\$50, 000

\$6, 000 \$18, 000 \$20, 000)
\$188, 600

## Unit cost \$188, 600 /1, 000 \$188.60

Unit profit \$300 \$188.60 \$111.40

(b) Let X denote the break-even number of air samples per year.

## \$1,500 \$188, 600

\$400 (\$300 \$0.50 ) \$300
X X

## X 933.17 934 air samples per year

Note: If SECs goal is simply to minimize per unit cost of sampling, then the
break-even point would be calculated without including the revenue:

6.22

(a)

6-14

## AE (15%) A \$12, 000( A / P,15%, 4) [\$9,120 \$2, 280( A / G,15%, 4)]

\$1,892.95
AE (15%) B \$12, 000( A / P,15%, 4) \$6,350
\$2,146.82

## (b) Process A: \$1,892.95 / 2, 000 \$0.9465 / hour

Process B: \$2,146.82 / 2, 000 \$1.0734 / hour

*
6.23

## Capital recovery cost for both motors:

CR (13%)CV \$13, 000( A / P,13%, 20) \$1,851
CR(13%)PE \$15, 600( A / P,13%, 20) \$2, 221

## 18.650 kW \$0.07 3,120 hrs

CV : \$4,551
0.895 kWh year
18.650 kW \$0.07 3,120 hrs
PE : \$4,380
0.93 kWh year

## AEC (13%)CV \$1,851 \$4,551 \$6, 402

AEC (13%) PE \$2, 221 \$4,380 \$6, 601

## Comments: At 3,120 annual operating hours, it will cost the company an

additional \$370, but energy savings are only \$171, which results in a \$199
loss from each motor. The total output power is 58,188 kWh per year (25
HP 0.746 kW/HP 3120 hrs/year). Therefore, the savings (losses) per
operating hour from switching from conventional motor to the PE is

(\$199 / yr)
(\$0.034) / kWh
58,188 kWh/yr

(b)

6-15

## \$1,851 1.4587T \$2, 221 1.4038T

0.0549T 370
T 6, 737 hours

6.24
New Lighting System Cost:

AEC (12%) \$50, 000( A / P,12%, 20) (\$8, 000 \$3, 000)
\$17, 694

## AEC (12%) \$20, 000

Annual savings from installing the new lighting system \$2,306

## 6.25 Given: i 6% interest compounded monthly, the effective annual

interest (1.005)12 1 6.17% per year, effective semiannual
interest (1.005)6 1 3.04% per semiannual

## AE (3.04%)1 \$2, 000( A / P,3.04%, 6) \$100 \$2, 000( A / F ,3.04%, 6)

\$39.20 per semiannual
AE (6.17%) \$39.20( F / A,3.04%, 2)
\$79.59 per year

\$107.17

\$126.60

## Making the personal loan is the best option.

6.26
Equivalent Annual Cost:

6-16

## AEC (13%) A (\$1, 200, 000 \$60, 000)( A / P,13%, 20)

(0.13)(\$60, 000) \$50, 000 \$40, 000
\$260, 083
AEC (13%) B (\$750, 000 \$30, 000)( A / P,13%,10)
(0.13)(\$30, 000) \$80, 000 \$30, 000
\$216,395

## C A \$260, 083 /(20)(365) \$35.63 per tonne

CB \$216,395 /(20)(365) \$29.64 per tonne
Incinerator B is a better choice.

6.27

(a)
AE (15%) A [\$2,500 \$1, 000( P / F ,15%,1)
\$400( P / F ,15%, 4)]( A / P,15%, 4)
\$216.06
AE (15%) B [\$4, 000 \$100( P / F ,15%,1)]( A / P,15%, 4) \$1,500
\$129.40
Project A is a better choice.

(b)
AE (15%) B \$129.40

## AE (15%)C [\$5, 000 \$200( P / A,15%, 2)]( A / P,15%, 4) \$2, 000

\$134.79
Project C is a better choice.

6-17

## Life-Cycle Cost Analysis

6.28 Assumption: Jet Fuel Cost = \$1.50/L

## System A : Equivalent annual fuel cost: A1 = (\$1.5/L)(160kL/1,000

hours)(2,000 hours) \$480, 000 (assuming an end of-year convention)

## AEC (10%)fuel [\$480, 000( P / A1 , 6%,10%,3)]( A / P,10%,3)

\$507, 494
AEC (10%) A (\$100, 000 \$10, 000)( A / P,10%,3)
(0.10)(\$10, 000) \$507, 494
\$544, 684

## System B : Equivalent annual fuel cost: A1 = (\$1.50/L)(128kL/1,000

hours)(2,000 hours = \$384,400

## AEC (10%)fuel [\$384, 000( P / A1 , 6%,10%,3)]( A / P,10%,3)

\$405,995
AEC (10%) B (\$200, 000 \$20, 000)( A / P,10%,3)
(0.10)(\$20, 000) \$405,995
\$480,376

## System A \$544, 684 / 2, 000 \$272.34 per hour

System B \$480,376 / 2, 000 \$240.19 per hour

## System B is a better choice.

6.29 Since the required service period is 12 years and the future replacement cost
for each truck remains unchanged, we can easily determine the equivalent
annual cost over a 12-year period by simply finding the annual equivalent cost
of the first replacement cycle for each truck.

## AEC (12%) A (\$15, 000 \$5, 000)( A / P,12%,3)

(0.12)(\$5, 000) \$3, 000
\$7, 763.50

6-18

## AEC (12%) B (\$20, 000 \$8, 000)( A / P,12%, 4)

(0.12)(\$8, 000) \$2, 000
\$6,910.80

6.30

## (a) Number of decision alternatives (required service period = five years):

Alternative Description

## Buy Machine A and use it for four years.

A1
Then lease the machine for one year.

## Buy Machine A and use it for four years.

A4 Then buy another Machine A and use it
for just one year.

## Buy Machine A and use it for four years.

A5
Then buy Machine B and use it for one year.

## Both A4 and A5 are feasible but may not be practical alternatives. To

consider these alternatives, we need to know the salvage values of the
machines after one-year use.

(b) With lease, the O&M costs will be paid by the leasing company:

For A1:

6-19

## PW (10%)1 \$6,500 (\$600 \$100)( P / F ,10%, 4)

\$800( P / A,10%, 4) \$200( P / F ,10%,3)
\$100( P / F ,10%, 2) (\$3, 000 \$100)( P / F ,10%,5)
\$10,976
AEC (10%)1 \$10,976( A / P,10%,5)
\$2,895.44

For A2:

## PW (10%) 2 \$8,500 \$1, 000( P / F ,10%,5)

\$520( P / A,10%,5) \$280( P / F ,10%, 4)
\$10, 042
AEC (10%) 2 \$10, 042( A / P,10%,5)
\$2, 649

For A3:

## AEC (10%)3 [\$3, 000 \$3, 000( P / A,10%, 4)]( A / P,10%,5)

\$3,300

A2 is a better choice.

*
6.31

Option 1:

## AEC (18%)1 \$125,000(300)( A / P,18%, 20)

\$(0.08)(125,000)(300)( A / F ,18%, 20)
(0.01 0.473)(80,000,000)
\$52,824,600
cost/kg \$52,824,600 / 80,000,000
\$66.0 cents/kg

Option 2:

## AEC (18%) 2 (\$0.10 0.473)(80,000,000)

\$45,840,000
cost/kg \$45.84 / 80
57.34 cents/kg

6-20

## Plan A: Incremental Investment Strategy:

Capital Investment :

## AEC (10%)1 [\$400, 000 \$400, 000( P / F ,10%,15)]( A / P,10%, )

\$49,576

Supporting Equipment:

( A / P,10%, )
\$565

## Note that the effective interest rate for 15-year period is

(1 0.1)15 1 3.1772

Operating Cost:

## AEC (10%)3 [\$31, 000( P / A,10%,15)

\$62, 000( P / A,10%,5)( P / F ,10%,15)]
\$63, 000
[ \$1, 000( P / G,10%, )]
0.10
( P / F ,10%, 20)]( A / P,10%, )
\$40, 056

## Plan B: One-Time Investment Strategy:

Capital Investment:

6-21

## AEC (10%)1 \$550, 000( A / P,10%, )

\$55, 000

Supporting Equipment:

\$150, 000
AEC (10%) 2 ( A / P,10%, )
16.4494
\$912

## Note that the effective interest rate for 30-year period is

(1 0.1)30 1 16.4494

Operating Cost:

## AEC (10%)3 [\$35, 000( P / A,10%,15)

\$55, 000( P / A,10%, )( P / F ,10%,15)]
( A / P,10%, )
\$39, 788

Design Economics
*
6.33

(a)
Energy Loss:

## 0.0042059 \$3, 038.13

(24 365)(\$0.0825)
A A

Material Weight:

(60)(8894) A 533640 A

6-22

## CR (11%) [\$6937 320 A \$2 533640 A]( A / P,11%, 25) \$2 533640 A 0.11

5870040 A A / P,11%, 25 117400.8 A
814175 A

## Total Equivalent Annual Cost:

3.03813
AEC (11%) \$814175 A
A

## dAEC (11%) 3.03813

\$814175 0
dA A2
A 0.00193172m 2 19.3172 cm 2

## (b) Minimum Annual Equivalent Total Cost:

AEC (11%)
2 3.03813 \$3,145.52
0.00193172

(c) Graphs of the capital cost, energy-loss cost, and the total cost as a function of
the cross-sectional area A:

6-23

Mixed Investments
6.34

## n Net Cash Flow

Project A Project B B-A
0 \$300 \$800 \$500
1 0 \$1,150 \$1,150
2 \$690 \$40 \$650

i* B A 0% or 30%

6-24

Since this is a mixed incremental investment, we need to find the RIC using an
external interest rate of 15%.

## RICB-A IRRB-A 16.95% 15%

Project B is preferred.

6-25

6.35

## (a) Project A: IRR 11.71%

Project B: IRR 19.15%

## Net Cash Flow

n Option 1 Option 2 Option 1 Option 2
0 -\$10,000 -\$10,000 0
1 0 1,000 -1,000
2 0 1,000 -1,000
3 0 1,000 -1,000
4 0 1,000 -1,000
5 16,105 11,000 5,105

i*1 2 10% 9%

## Net Cash Flow

n Project A Project B B-A
0 -\$2,000 -\$3,000 -\$1,000
1 1,400 2,400 1,000
2 1,640 2,000 360

i* B A 28.11% 15%

Select Project B.

6-26

6.38

## Net Cash Flow

n Project A1 Project A2 A2 A1
0 10,000 12,000 \$2,000
1 5,000 6,100 1,100
2 5,000 6,100 1,100
3 5,000 6,100 1,100

i* A 2 A1 29.92%

## (b) Since it is a simple incremental investment, IRR A2-A1 29.92% 10% .

Therefore, select Project A2.

6.39

## Net Cash Flow

n
A1 A2 A2 A1
0 -\$15,000 -\$20,000 -\$5,000
1 7,500 8,000 500
2 7,500 15,000 7,500
3 7,500 5,000 -2,500

## Since the incremental cash flow series portrays a nonsimple investment, we

need to find the RIC at 10%, which is RIC A 2 A1 7.36% 10% . So, select A1.

(b) We can verify the same result by applying the NPW criterion.

## PW (10%) A1 15, 000 \$7,500( P / A,10%,3)

\$3, 651
PW (10%) A 2 20, 000 \$8, 000( P / F ,10%,1) \$15, 000( P / F ,10%2)
\$5, 000( P / F ,10%,3)
\$3, 426

6-27

n AB
0 \$2,376
1 0
2 0
3 0
4 2,500

IRR A B 1.28%

*
6.41

## The best decision is do-nothing.

6.42

(a) The least common multiple project lives = six years analysis period six
years

## Net Cash Flow

n
Project A Project B BA
0 \$100 \$200 100
1 60 120 60
2 50 150-200 100
3 50100 120 170
4 60 150-200 110
5 50 120 70
6 50 150 100

Since the incremental cash flow series indicates a nonsimple investment, but it
is a pure incremental investment.

6-28

## Net Cash Flow

n
Project C Project D CD
0 \$4,000 \$2,000 \$2,000
1 2,410 1,400 1,010
2 2,930 1,720 1,210

## Net Cash Flow

n
Project E Project F F E
0 \$2,000 \$3,000 \$1,000
1 3,700 2,500 1,200
2 1,640 1,500 140

system.

## Comparison Between A0 and A1:

n A0 A1 A1 A0
0 0 -\$2,500,000 -\$2,500,000
1-8 -5,000,000 -2,900,000 2,100,000

## i* A1 A0 IRR A1 A0 83.34% 10%

A1 is a better choice.

## Comparison Between A1 and A2:

n A2 A1 A2 A1
0 -\$5,000,000 -\$2,500,000 -\$2,500,000
1-8 -1,400,000 -2,900,000 1,500,000

6-29

## i* A 2 A1 IRR A 2 A1 58.49% 10%

A2 is a better choice. That means that the stockless supply system is the final
choice.

6.44

(a)
Project A vs. Project B

## Net Cash Flow

n
Project A Project B BA
0 \$1,000 \$1,000 0
1 900 600 -\$300
2 500 500 0
3 100 500 400
4 50 100 50

## Net Cash Flow

n
Project B Project C CB
0 \$1,000 \$2,000 \$1,000
1 600 900 300
2 500 900 400
3 500 900 400
4 100 900 800

## i*C B IRR C B 26.32% 12% , select C.

(b)
\$1, 000 \$300( P / A, i, 4)
i 7.71%

(c) Since borrowing rate of return (BRR) is less than MARR, Project D is
acceptable.

(d)

## Net Cash Flow

n
Project C Project E CE

6-30

1 900 400 500
2 900 400 500
3 900 400 500
4 900 400 500

## i*C E IRR C E 50.23% 12% , select C.

6.45

(a)
i1* 85.08%, i2* 48.11%, and i3* 44.31%

(b)
Project 1 vs. Project 2:

n Project 1 Project 2 21
0 \$1,000 \$5,000 \$4,000
1 500 7,500 7,000
2 2,500 600 1,900

15%.

## RIC21 33.69% 15%

Select Project 2.

## Project 2 vs. Project 3:

n Project 2 Project 3 23
0 -\$5,000 -\$2,000 -\$3,000
1 7,500 1,500 6,000
2 600 2,000 -1,400

## This is another nonsimple incremental investment, so we need to calculate

RIC on the incremental investment.

## RIC23 59.42% 15%

Again, select Project 2.

6.46

6-31

## Net Cash Flow

n Project A Project B BA
0 \$10,000 \$20,000 \$10,000
1 5,500 0 5,500
2 5,500 0 5,500
3 5,500 40,000 34,500

## Since IRR B A 24.24% 15%, select Project B.

6.47 Select Model C. Note that all three projects would be acceptable individually,
as each projects IRR exceeds the MARR. The incremental IRR of Model (C
B) is 40%, indicating that Model C is preferred over Model B at MARR = 12%.
Similarly, the incremental IRR of Model (C A) is 15%, which exceeds the
MARR. Therefore, Model C is again preferred.

6.48 All projects would be acceptable because individual ROR exceed the MARR.
Based on the incremental analysis, we observe the following relationships:

## IRR A 2 A1 10% 15% (Select A1)

IRR A3 A1 18% 15% (Select A3)
IRR A3 A 2 23% 15% (Select A3)
Therefore, A3 is the best alternative.

6.49 From the incremental rate of return table, we can deduce the following
relationships:

## IRR A 2 A1 9% 15% (Select A1)

IRR A3 A 2 42.8% 15% (Select A3)
IRR A 4 A3 0% 15% (Select A3)
IRR A5 A 4 20.2% 15% (Select A5)
IRR A6 A5 36.3% 15% (Select A6)

It is necessary to determine the preference relationship among A1, A3, and A6.

6-32

## IRR A6 A3 20.18% 15% (Select A6)

IRR A6 A1 18.24% 15% (Select A6)
A6 is the best alternative.

6.50 For each power saw model, we need to determine the incremental cash flows
over the by-hand operation that will result over a 20-year service life.

Power Saw
Category Model A Model B Model C
Investment cost \$4,000 \$6,000 \$7,000
Salvage value \$400 \$600 \$700
Annual labour savings \$1,296 \$1,725 \$1,944
Annual power cost \$400 \$420 \$480
Net annual savings \$896 \$1,305 \$1,464

## Net Cash Flow

n Model A Model B Model C
0 -\$4,000 -\$6,000 -\$7,000
1 896 1,305 1,464
2 896 1,305 1,464

20 400+896 600+1,305 700+1,464
IRR 22.03% 21.35% 20.46%
PW(10%) \$3,688 \$5,199 \$5,568

## PW (i ) B A \$2, 000 \$409( P / A, i, 20) \$200( P / F , i, 20)

0
IRR B A 19.97% 10%

Select Model B.

## PW (i )C B \$1, 000 \$159( P / A, i, 20) \$100( P / F , i, 20)

0
IRR C B 15.03% 10%

Select Model C.

6-33

## Net Cash Flow

n Project A Project B BA
0 -\$100 -\$200 -\$100
1 60 120 60
2 50 150-200 -100
3 50-100 120 170
4 60 150-200 -110
5 50 120 70
6 50 150 100

## Since the incremental cash flow series is a nonsimple investment, we may

abandon the IRR analysis and use the PW decision rule.

## PW (15%) B A \$100 \$60( P / F ,15%,1)

\$100( P / F ,15%, 6)
\$3.48

## Since PW (15%) B A 0, or PW (15%) B PW (15%) A , select Project B.

Comments: Even though the incremental flow is a nonsimple, it has a unique rate
of return. As shown in Problem 7.39, this incremental cash flow series will pass the
net investment test, indicating that the incremental cash flow is a pure investment.

## IRR B A 15.98% 15%

6.52

(a) Since there is not much information given regarding the future replacement
options and the required service period, we may assume that the required
service period is indefinite and both projects can be repeated at the same cost
in the future.

(b) The analysis period may be chosen as the least common multiple of project
lives, which is three years.

n A2 A1
0 -\$5,000
1 0
2 0

6-34

3 15,000

IRR A 2 A1 44.195%
The MARR must be less than 44.195% for Project A1 to be preferred.

## Short Case Studies

ST6.1

Option 1: Process device A lasts only four years. You have a required
service period of six years. If you take this option, you must consider how you
will satisfy the rest of the required service period at the end of the project life.
One option would subcontract the remaining work for the duration of the
remaining required service period. If you select this subcontracting option
along with Device A, the equivalent net present worth would be

## PW (12%)1 \$100, 000 \$60, 000( P / A,12%, 4)

\$10, 000( P / F ,12%, 4)
\$100, 000( P / A,12%, 2)( P / F ,12%, 4)
\$383, 292

Option 2: This option creates no problem because its service life coincides
with the required service period.

## PW (12%) 2 \$150, 000 \$50, 000( P / A,12%, 6)

\$30, 000( P / F ,12%, 6)
\$340,371

## Option 3: With the assumption that the subcontracting option would be

available over the next six years at the same cost, the equivalent present worth
would be

\$411,141

alternative.

## Notes to Instructors: This problem is deceptively simple. However, it can make

the problem interesting with the following embellishments.

6-35

If the required service period is changed from six years to five years, what would
be the best course of action?
If there are price differentials in the subcontracting option (say, \$55,000 a year for
a six-year contract, \$60,000 for a five-year contract, \$70,000 a year for a four-
year contract, and \$75,000 a year for any contract lasting less than four years),
what would be the best option?
If both Processes A and B would be available in the subsequent years, but the
required investment and salvage value would be increasing at the annual rate of
10%, what would be the best course of action?
If both Device A and B will be available in the subsequent years, but the required
investment and salvage value (as well as the O & M costs) would be decreasing at
the annual rate of 10%, what would be the best course of action?

ST6.2

Note to Instructors: This case problem requires several pieces of information. (1)
No minimum attractive rate return figure is given for Northern Electric. (2) What
would be a typical number of accidents in line construction work? (3) How does a
typical electric utility handle the nesting problems? If there is some cleaning cost,
how much and how often?

First, we may calculate the equivalent present value (cost) for each option
without considering the accident costs and nesting problems.

Design Options
Factors Option 1 Option 2 Option 3 Option 4
Cross Arm Triangular Horizontal Stand Off
Line
Investment:
Construction cost \$495,243 \$396,813 \$402,016 \$398,000
Accident cost
Annual cost:
Flashover repair \$6,000 \$3,000 \$3,000 \$3,000
Cleaning nest
Annual savings:
Inventory 0 \$4,521 \$4,521 \$4,521

Assume that Northern Electrics required rate of return would be 12%. The
equivalent present value cost for each option is as follows:

6-36

## PW (12%)1 \$495, 243 \$6, 000( P / A,12%, 20)

\$540, 060
PW (12%)2 \$396,813 \$3, 000( P / A,12%, 20)
\$4,521( P / A,12%, 20)
\$385, 452
PW (12%)3 \$402, 016 \$3, 000( P / A,12%, 20)
\$4,521( P / A,12%, 20)
\$398, 654
PW (12%)4 \$398, 000 \$3, 000( P / A,12%, 20)
\$4,521( P / A,12%, 20)
\$386, 639

## It appears that the triangular design configuration be the most

economical.

If we consider the potential accident costs (\$65,000 per accident) during line
construction work, it is likely to change the outcome. If we expect only a
couple of accidents, Option 2 still appears to be the best. However, if you
expect more than three accidents, the conventional cross-arm design appears
to be more economical. If the nest cleaning cost were factored into the
analysis, the accident cost would be reduced to the extent of the annual
cleaning cost, indicating the preference of the triangular design.

ST6.3

## This case problem appears to be a trivial decision problem as one alternative

(laser blanking method) dominates the other (conventional method). The
problem of this nature (from an engineers point of view) involves more
strategic planning issues than comparing the accounting data. We will first
calculate the unit cost under each production method. Since all operating costs
are already given in dollars per part, we need to convert the capital expenditure
into the required capital recovery cost per unit.

Conventional method:

## CR (16%) \$106, 480( A / P,16%,10)

\$22, 031 per year
\$22, 031
Unit capital recovery cost
3, 000
\$7.34 per year

6-37

## CR(16%) \$83, 000( A / P,16%,10)

\$17,173 per year
\$17,173
Unit capital recovery cost
3, 000
\$5.72 per part

Blanking Method
Description Conventional Laser
Steel cost/part \$14.98 \$8.19
Transportation cost/part \$0.67 \$0.42
Blanking cost/part \$0.50 \$0.40
Capital cost/part \$7.34 \$5.72
Total unit cost \$23.49 \$14.73

## It appears that the window frame production by the laser blanking

technique would save about \$8.76 for each part produced. If Ford decides
to make the window frame in house, the part cost would range between
\$14.73 and \$23.49, depending upon the blanking method adopted. If Ford
relies on an outside supplier, the subcontracting work should be in this
cost range. If Ford were producing the window frames by the conventional
important issues is to address if it is worth switching to the laser blanking
this time or later. If Ford decides to go with the laser blanking, it will take
six months to reach the required production volume. What option should
Ford exercise to meet the production need during this start-up period?

ST6.4

## Given: annual energy requirement 66 Gg of steam, net proceeds from

demolishing the old boiler unit \$1, 000
Annual Energy Requirement 66 2.32 153.12 TJ

## (a) Annual fuel costs for each alternative:

Alternative 1:
153,12 TJ
Weight of dry coal
(0.75)(33.24 MJ/kg)
6,142 tonnes

## Annual fuel cost 6,142 125

= \$7,67,750

Alternative 2:

6-38

153.12 TJ(0.94)
Natural Gas cost 40 / m3 3
(0.78)(39 MJ/m )
= \$1,892,608

153.12 TJ(0.06)
Heating Oil cost \$864 / L
(0.81)(38.6 MJ/L)
= \$252,702

= \$2,145,310

## AEC (10%) (\$1, 770,300 \$100, 000

\$1, 000)( A / P,10%, 20)
\$767, 750
\$10, 71,970

\$10, 71,970
Unit cost \$1.62 /kg
66106 kg

Alternative 2:
AEC (10%) (\$889, 200 \$1, 000)( A / P,10%, 20)
\$2,145,310
\$2, 249, 638

## \$2, 249, 638

Unit cost 3.41 /kg
66106 kg
(c) Select Alternative 1.

ST6.5

## (a) Assumptions Required:

There is no information regarding the analysis period; we will assume that the
firm will be in business for an indefinite period.
There is no information regarding the future plastics technology options; we
will assume that the best one available will be the technology introduced n
months from now.

6-39

We will assume that the annual revenue/costs are spread evenly throughout
the year.

## (b) Investment Decision:

Present Worth Analysis: First we will determine the equivalent present worth for
each option, and its value at MARR = 15%

Option 1:

Option 2:

## PW(i)2 = {(0.1n 10) + [(15/12 0.15n) (6/12 + 0.05n)](P/A,i,96-n) +

[1+0.05n](P/F,i,96-n)}(P/F,i,n) + [15/12 6/12](P/A,i,n)

## PW(i)2 = {(0.1n 10) + [0.75 0.2n](P/A,i,96-n) + [1+0.05n](P/F,i,96-

n)}(P/F,i,n)) + 0.75(P/A,i,n)

Although Option 1 (switching now) bestows a great present worth (\$36.53 M), it
can be seen that the best time to retrofit would be to wait the full 96 months,
which would yield a PW of \$48.22 M. The worst time to retrofit would be after
41 months (\$186.43 M).

6-40

n PW n PW n PW n PW n PW n PW
1 \$24.64 17 -\$116.43 33 -\$179.01 49 -\$180.47 65 -\$134.77 81 -\$53.08
2 \$13.14 18 -\$122.44 34 -\$180.73 50 -\$178.86 66 -\$130.61 82 -\$47.00
3 \$2.02 19 -\$128.16 35 -\$182.22 51 -\$177.08 67 -\$126.32 83 -\$40.81
4 -\$8.72 20 -\$133.57 36 -\$183.48 52 -\$175.12 68 -\$121.90 84 -\$34.52
5 -\$19.09 21 -\$138.69 37 -\$184.51 53 -\$172.98 69 -\$117.34 85 -\$28.13
6 -\$29.09 22 -\$143.53 38 -\$185.31 54 -\$170.68 70 -\$112.65 86 -\$21.64
7 -\$38.73 23 -\$148.08 39 -\$185.90 55 -\$168.20 71 -\$107.83 87 -\$15.06
8 -\$48.01 24 -\$152.36 40 -\$186.27 56 -\$165.56 72 -\$102.89 88 -\$8.38
9 -\$56.95 25 -\$156.36 41 -\$186.43 57 -\$162.75 73 -\$97.82 89 -\$1.61
10 -\$65.54 26 -\$160.09 42 -\$186.39 58 -\$159.79 74 -\$92.63 90 \$5.25
11 -\$73.79 27 -\$163.56 43 -\$186.13 59 -\$156.67 75 -\$87.32 91 \$12.20
12 -\$81.70 28 -\$166.76 44 -\$185.67 60 -\$153.39 76 -\$81.90 92 \$19.24
13 -\$89.29 29 -\$169.71 45 -\$185.02 61 -\$149.96 77 -\$76.36 93 \$26.36
14 -\$96.55 30 -\$172.41 46 -\$184.17 62 -\$146.38 78 -\$70.70 94 \$33.57
15 -\$103.49 31 -\$174.85 47 -\$183.12 63 -\$142.65 79 -\$64.94 95 \$40.85
16 -\$110.12 32 -\$177.05 48 -\$181.89 64 -\$138.78 80 -\$59.06 96 \$48.22

6-41

ST6.6

## (a) Assumptions Required:

There is no information regarding the expected cash flows from the current
operation if Chiller Cooling decides to defer the introduction of the
absorption technology for three years. Therefore, we need to make an
explicit assumption of the expected cash flows for the first three years if
Chiller Cooling decides to defer the decision. Assume that the annual cash
flow during this period would be X.
Another assumption we have to make is about the analysis period.
Assuming that the firm will be in business for an indefinite period, we also
need to make an explicit assumption regarding the future cooling technology.
Since there is no information about the future cooling technology options,
we may assume that the best cooling technology will be the absorption
technology that will be introduced three years from now. Therefore, if
Chiller Cooling decides to select Option 1, we could assume that, at the end
of eight years, Option 2 (the best cooling technology at that time) will be

## Present Worth Analysis: First, we will determine the equivalent present

worth for each option:

## PW (i )1 \$6 \$9( P / A, i,8) \$1( P / F , i,8)

[\$5 \$4( P / A, i,8) \$2( P / F , i,8)]( A / P, i,8)

i
( P / F , i,8)
PW (i ) 2 X ( P / A, i,3)
[\$5 \$4( P / A, i,8) \$2( P / F , i,8)]( A / P, i,8)

i
( P / F , i,3)

Now we can determine the value X that makes the two options economically
equivalent at an interest rate of 15%. In other words, if we evaluate the two
present worth functions at i 15% , we have

PW (15%)1 \$41.31
PW (15%)2 2.2832 X \$13.28

6-42

X \$12.28

## As long as the current operation continues to generate annual net revenue of

\$12.28 millions for three years, Option 2 is a better choice.

Rate of return analysis: The present worth analysis above indicates that, if
X \$12.28 , the break-even rate of return on incremental investment is
i*1 2 15%

Therefore, the ultimate choice will depend on the level of annual revenues
generated during the first three years when the advanced cooling technology is
deferred. Clearly, if

ST6.7

## n Current Pump(A) Larger Pump(B) B-A

0 \$0 -\$1,600,000 -\$1,600,000
1 \$10,000,000 \$20,000,000 \$10,000,000
2 \$10,000,000 \$0 -\$10,000,000

IRR = 25%
400%

The incremental cash flows result in multiple rates of return (25% and 400%), so
we may abandon the rate of return analysis. Using the PW analysis,

## PW (20%) \$1.6 M \$10 M ( P / F , 20%,1) \$10 M ( P / F , 20%, 2)

\$0.21 0
Reject the larger pump.

## PB (i, 20%)0 \$1, 600, 000

PB(i, 20%)1 \$1, 600, 000(1 i ) \$10, 000, 000
8, 400, 000 1, 600, 000i

## If i 525%, then PB(i, 20%)1 0 .

6-43

PB (i, 20%) 2 (8, 400, 000 1, 600, 000i)(1 0.20) \$10, 000, 000
80, 000 1,920, 000i
0
i 4.17% 20%

If i 525%, then PB(i, 20%)1 0 , no RIC exists. So the RIC on the incremental
cash flows should be 4.17%, which indicates Select a smaller pump.

ST6.8

(a) Whenever you need to compare a set of mutually exclusive projects based
on the rate of return criterion, you should perform an incremental analysis.
In our example, the incremental cash flows would look like the following:

n B-A
0 -\$10,000
1 +23,000
2 -13,200

## This is a nonsimple investment with two rates of return.

i* B A 10% or 20%

We could abandon the IRR analysis and use the PW analysis to rank the
projects.

(b) If we plot the present worth as a function of interest rate, we will observe
the following:

6-44

## If MARR < 10% select Project A.

If 10% MARR 18.1%, select Project B.
If MARR > 18.1%, do nothing.

Return on Invested Capital: The true rate of return can be found as a function of
MARR.

## PB (i, MARR)0 \$10, 000

PB(i, MARR)1 \$10, 000(1 i ) \$23, 000
\$13, 000 10, 000i
PB(i, MARR) 2 (\$13, 000 10, 000i)(1 MARR)
\$13, 200
0

(Note that, if, i 1.3, there will be no feasible solution.) Rearranging the terms
in PB(i, MARR) 2 gives an expression of IRR as a function of MARR.

1.32
IRR 1.3
1 MARR