Abu Dhabi University

GEN 200 Engineering Economy

Fall 2016
TERM PROJECT
Due: Wed November 23, 2016

Instructions
1. Please select one of the case studies given below.
2. You can use spreadsheet solutions IF required or you are free to choose hand method
instead of spreadsheet, if both solutions are possible.
3. Prepare a 15-minutes PowerPoint presentation

CASE STUDY 1
THE CHANGING SCENE OF AN ANNUAL WORTH ANALYSIS

Background and Information

Harry, owner of an automobile battery distributorship in
Atlanta, Georgia, performed an economic analysis 3 years ago when he decided to place
surge protectors in-line for all his major pieces of testing equipment. The estimates used and
the annual worth analysis at MARR = 15% are summarized below. Two different
manufacturers’ protectors were compared.

The spreadsheet in Figure 6–9 is the one Harry used to make the decision. Lloyd’s was the
clear choice due to its substantially larger AW value. The Lloyd’s protectors were installed.
During a quick review this last year (year 3 of operation), it was obvious that the
maintenance costs and repair savings have not followed (and will not follow) the estimates
made 3 years ago. In fact, the maintenance contract cost (which includes quarterly inspection)
is going from $300 to $1200 per year next year and will then increase 10% per year for the
next 10 years. Also, the repair savings for the last 3 years were $35,000, $32,000, and
$28,000, as best as Harry can determine. He believes savings will decrease by $2000 per year
hereafter. Finally, these 3-year-old protectors are worth nothing on the market now, so the
salvage in 7 years is zero, not $3000.

Case Study Exercises

1. Plot a graph of the newly estimated maintenance costs and repair savings projections,
assuming the protectors last for 7 more years.
2. With these new estimates, what is the recalculated AW for the Lloyd’s protectors? Use the
old first cost and maintenance cost estimates for the first 3 years. If these estimates had
been made 3 years ago, would Lloyd’s still have been the economic choice?
3. How has the capital recovery amount changed for the Lloyd’s protectors with these new
estimates?
CASE STUDY 2
ROR ANALYSIS WITH ESTIMATED LIVES THAT VARY

Background
Make-to-Specs is a software system under development by ABC Corporation. It will be able
to translate digital versions of three-dimensional computer models, containing a wide variety
of part shapes with machined and highly finished (ultra smooth) surfaces. The product of the
system is the numerically controlled (NC) machine code for the part’s manufacturing.
Additionally, Make-to-Specs will build the code for superfine finishing of surfaces with
continuous control of the finishing machines.

Information
There are two alternative computers that can provide the server function for the software
interfaces and shared database updates on the manufacturing floor while Make-to- Specs is
operating in parallel mode. The server first cost and estimated contribution to annual net cash
flow are summarized below.

Server 1 Server 2
First cost, $ 100,000 200,000
Net cash flow, $/year 35,000 50,000 year 1, plus 5000 per years 2, 3, and 4
(gradient)
70,000 maximum for years 5 on, even if the
server is replaced
Life, years 3 or 4 5 or 8

The life estimates were developed by two different individuals: a design engineer and a
manufacturing manager. They have asked that, at this stage of the project, all analyses be
performed using both life estimates for each system.

Case Study Exercises

Use spreadsheet analysis to determine the following:
(a) If the MARR = 12%, which server should be selected? Use the PW or AW method to
make the selection.
(b) Use incremental ROR analysis to decide between the servers at MARR = 12%.
(c) Use any method of economic analysis to display on the spreadsheet the value of the
incremental ROR between server 2 with a life estimate of 5 years and a life estimate of 8
years.
CASE STUDY 3
COMPARING B/C ANALYSIS OF TRAFFIC ACCIDENT REDUCTION

Background
This case study compares benefit/cost analysis and cost effectiveness analysis on the same
information about highway lighting and its role in accident reduction. Poor highway lighting
may be one reason that proportionately more traffic accidents occur at night. Traffic accidents
are categorized into six types by severity and value. For example, an accident with a fatality
is valued at approximately $4 million, while an accident in which there is property damage
(to the car and contents) is valued at $6000. One method by which the impact of lighting is
measured compares day and night accident rates for lighted and unlighted highway sections
with similar characteristics. Observed reductions in accidents seemingly caused by too low
lighting can be translated into either monetary estimates of the benefits B of lighting or used
as the effectiveness measure E of lighting.

Information
Freeway accident data were collected in a 5-year study. The property damage category is
commonly the largest based on the accident rate. The number of accidents recorded on a
section of highway is presented here.

Number of Accidents Recorded

Unlighted Lighted
Accident Type Day Night Day Night
Property damage 379 199 2069 839

The ratios of night to day accidents involving property damage for the unlighted and lighted
freeway sections are 199/379 = 0.525 and 839/2069 = 0.406, respectively. These results
indicate that the lighting was beneficial. To quantify the benefit, the accident rate ratio from
the unlighted section will be applied to the lighted section. This will yield the number of
accidents that were prevented. Thus, there would have been
 2069   0.525   1086 accidents
instead of 839 if there had not been lights on the freeway. This is a difference of 247
accidents.
At a cost of $6000 per accident, this results in a net annual benefit of

B   247   $6000   $1, 482, 000

For an effectiveness measure of number of accidents prevented, this results in E = 247.

To determine the cost of the lighting, it will be assumed that the light poles are center poles
67 meters apart with 2 bulbs each. The bulb size is 400 watts, and the installation cost is
$3500 per pole. Since these data were collected over 87.8 kilometers of lighted freeway, the
installed cost of the lighting is (with number of poles rounded off):

Installation cost = $3500 (87.8/ 0.067)

=3500(1310)
= $4,585,000

There are a total of 87.8/0.067=1310 poles, and electricity costs $0.10 per kWh.
Therefore, the annual power cost is:
Annual power cost
 =1310 poles  2 bulbs/pole   0.4 kilowatt/bulb 
   x  12 hours/day   365 days/year 
x  $0.10/kilowatt-hour 
= $459,024 per year
The data were collected over a 5-year period. Therefore, the annualized cost C at i = 6% per
year is
Total annual cost =$4,585,000 (A/P, 6%, 5)
+459,024
= $1,547,503

If a benefit/cost analysis is the basis for a decision on additional lighting, the B/C ratio is
1, 482, 000
B/C   0.96
1,547,503
Since B/C< 1.0, the lighting is not justified. Consideration of other categories of accidents is
necessary to obtain a better basis for decisions. If a cost-effectiveness analysis (CEA) is
applied, due to a judgment that the monetary estimates for lighting’s benefit is not accurate,
the C/E ratio is
1,547, 503
C/E   6265
247
This can serve as a base ratio for comparison when an incremental CEA is performed for
additional accident reduction proposals.
These preliminary B/C and C/E analyses prompted the development of four lighting options:

W) Implement the plan as detailed above; light poles every 67 meters at a cost of $3500 per
pole.
X) Install poles at twice the distance apart (134 meters). This is estimated to cause the
accident prevention benefit to decrease by 40%.
Y) Install cheaper poles and surrounding safety guards, plus slightly lowered lumen bulbs
(350 watts) at a cost of $2500 per pole; place the poles 67 meters apart. This is estimated
to reduce the benefit by 25%.
Z) Install cheaper equipment for $2500 per pole with 350-watt light bulbs and place them 134
meters apart.
This plan is estimated to reduce the accident prevention measure by 50% from 247 to 124.

Case Study Exercises

Determine if a definitive decision on lighting can be determined by doing the following:
1. Use a benefit/cost analysis to compare the four alternatives to determine if any are
economically justified.
2. Use a cost-effectiveness analysis to compare the four alternatives.

From an understanding viewpoint, consider the following:

3. How many property-damage accidents could be prevented on the unlighted portion if it
were lighted?
4. What would the lighted, night-to-day accident ratio have to be to make alternative Z
economically justified by the B/C ratio?
5. Discuss the analysis approaches of B/C and C/E. Does one seem more appropriate in this
type of situation than the other? Why? Can you think of other bases that might be better
for decisions for public projects such as this one?
CASE STUDY 4
DEVELOPING AND SELLING AN INNOVATIVE IDEA

Background
Three engineers who worked for Mitchell Engineering, a company specializing in public
housing development, went to lunch together several times a week. Over time they decided to
work on solar energy production ideas. After a lot of weekend time over several years, they
had designed and developed a prototype of a low-cost, scalable solar energy plant for use in
multifamily dwellings on the low end and medium sized manufacturing facilities on the upper
end. For residential applications, the collector could be mounted alongside a TV dish and be
programmed to track the sun. The generator and additional equipment are installed in a
closet-sized area in an apartment or on a floor for multiple-apartment supply. The system
serves as a supplement to the electricity provided by the local power company. After some 6
months of testing, it was agreed that the system was ready to market and reliably state that an
electricity bill in high-rises could be reduced by approximately 40% per month. This was
great news for low income dwellers on government subsidy that are required to pay their own
utility bills.

Information
With a hefty bank loan and $200,000 of their own capital, they were able to install
demonstration sites in three cities in the sunbelt. Net cash flow after all expenses, loan
repayment, and taxes for the first 4 years was acceptable; $55,000 at the end of the first year,
increasing by 5% each year thereafter. A business acquaintance introduced them to a
potential buyer of the patent rights and current subscriber base with estimated $500,000 net
cash out after only these 4 years of ownership. However, after serious discussion replaced the
initial excitement of the sales offer, the trio decided to not sell at this time. They wanted to
stay in the business for a while longer to develop some enhancement ideas and to see how
much revenue may increase over the next few years.
During the next year, the fifth year of the partnership, the engineer who had received
the patents upon which the collector and generator designs were based became very
displeased with the partnering arrangements and left the trio to go into partnership with an
international firm in the energy business. With new research and development funds and the
patent rights, a competing design was soon on the market and took much of the business
away from the original two developers. Net cash flow dropped to $40,000 in year 5 and
continued to decrease by $5000 per year. Another offer to sell in year 8 was presented, but it
was only for $100,000 net cash. This was considered too much of a loss, so the two owners
did not accept. Instead, they decided to put $200,000 more of their own savings into the
company to develop additional applications in the housing market.
It is now 12 years since the system was publicly launched. With increased advertising
and development, net cash flow has been positive the last 4 years, starting at $5000 in year 9
and increasing by $5000 each year until now.

Case Study Exercises

It is now 12 years after the products were developed, and the engineers invested most of their
savings in an innovative idea. However, the question of “When do we sell?” is always present
in these situations. To help with the analysis, determine the following:
1. The rate of return at the end of year 4 for two situations: (a) The business is sold for the net
cash amount of $500,000 and (b) No sale.
2. The rate of return at the end of year 8 for two situations: (a) The business is sold for the net
cash amount of$100,000 and (b) No sale.
3. The rate of return now at the end of year 12.
4. Consider the cash flow series over the 12 years. Is there any indication that multiple rates
of return may be present?
If so, use the spreadsheet already developed to search for ROR values in the range _100%
other than the one determined in exercise 3 above.
5. Assume you are an investor with a large amount of ready cash, looking for an innovative
solar energy product.
What amount would you be willing to offer for the business at this point (end of year 12) if
you require a 12% per year return on all your investments and, if purchased, you plan to
own the business for 12 additional years? To help make the decision, assume the current
NCF series continues increasing at $5000 per year for the years you would own it. Explain
your logic for offering this amount.