Module 5: Annual Worth

Analysis
Outline Module 5

• Selection of Alternatives with Different Lives

• Salvage Sinking-Fund Method
• Salvage Present Worth Method
• Capital-Recovery-Plus-Interest Method
• AW of a Perpetual Investment
Selection of Alternatives with Different Lives

1. Selection of investment alternatives can commonly evaluated by comparing their

equivalence-uniform-annual-worth (over the life of the investment)
2. Unlike other method, for evaluating
SV alternatives with different
SV lives, EUAW doesSVnot
require comparison over the least common multiple periods.
O&M
R R R R R R R R R
A
0 1 2 3
I I I

I R R R I = Rp. 240 millions

O&M
B O&M = Rp. 25 millions/month
R = Rp. 190 millions/4 months
0 1 SV = Rp 75 millions
SV

EUAWA = EUAWB
Example

• Consider a project with $3000 annual operating

cost and a $5000 investment required each 5 years.
i = 10%

0 1 2 3 4 5

A 1-5 = $3,000
$5,000

For one cycle

EAC = 3000 + 5000(A/P,10%,5) = $4319/yr
 Multiple cycle..same result!

0 1 2 3 4 5 6 7 8 9 10

A 1-10 = $3,000
$5,000

$5,000

For two cycles

EAC = 3000 + 5000 (1+(P|F, .10, 5))(A|P, .10, 10)
= 3000 + 1319 = $4319/yr
(A) Salvage Sinking-Fund Method

1. Initial investment and salvage value are to be

converted into an equivalent uniform annual value
2. Any other cash flows are to be converted first to
present value (P) or future value (F), then
converted into equivalent uniform annual value
3. Combine all equivalent uniform annual values
P O1
I1 SV

A1

0 1 2 3
EUAW = – P(A/P, i, 36) +SV(A/F, i, 36) – A1 – O1(P/F, i, 9)(A/P, i, 36) + I1(F/P, i, 14)(A/F, i, 36)
(B) Salvage Present Worth Method

1. Calculate the present worth of salvage value using (P/F)

factor, and subtract that value from the initial cost, P
2. Convert that value (2) into equivalent uniform worth
3. Any other cash flows are to be converted first to present
value (P) or future value (F), then converted into equivalent
uniform annual value
4. Combine
P all equivalent uniform annualI1values SV
O1
A1

0 1 2 3
EUAW = – [P-SV(P/F, i, 36)](A/P, i, 36) – A1 – O1(P/F, i, 9)(A/P, i, 36) + I1(F/P, i, 14)(A/F, i, 36)
(C) Capital-Recovery-Plus-Interest Method

1. Subtract the salvage value from initial cost, then convert that value into
equivalent uniform worth
2. Multiply the salvage value by the interest rate
3. Add value obtained from (1) and (2)
4. Any other cash flows are to be converted first to present value (P) or
future value (F), then converted into equivalent uniform annual value
5. Combine all equivalent uniform annual values
P O1
I1 SV

A1

0 1 2 3
EUAW = – (P-SV)(A/P, i, 36) - SV(i) – A1 – O1(P/F, i, 9)(A/P, i, 36) + I1(F/P, i, 14)(A/F, i, 36)
 Example:
S = +$1500
• Cash Flow Diagram is:
A = +$1200/yr

1 2 3 4 5

-$650
-$700
-$750
P=-23,000 -$800
-$850
Example:

• The Capital Recovery component is:

S = +$1500

1 2 3 4 5

CR(10%) = -23,000(A/P,10%,5) +
1500(A/F,10%,5) = -$5822

P=-23,000
Example:

• (Revenue – Operating Costs) are:

A = +$1200/yr

1 2 3 4 5

$650
$700
$750
$800
$850
Example:

• Cost/Revenue component
1.8101 is seen to equal:

=+550 –50(A/G,10%,5)
= 550 – 90.50
= $459.50
 Example

• Total Annual worth (CR + Cost/Rev)

• CR(10%) = -$5822
• Revenue/Cost Annual amount: $459.50
• AW(10%) = -$5822+$459.50
• AW(10%) = $5,362.50

This amount would be required to recover the investment and operating costs at the
10% rate on a per year basis
AW of a Perpetual Investment

• EAC of a perpetual investment

• If an investment has no finite cycle it is called a

perpetual investment. If “P” is the present worth of
the cost of that investment, then EAC is P times i,
the interest P would have earned each year.

Remember: P = A/i EAC=A = P(i)

From the previous chapter
Example: Perpetual Investment

• EXAMPLE
Two alternatives are considered for covering a
football field.
The first is to plant natural grass and the second is
to install AstroTurf. Interest rate is 10%/year.
Assume the field is to last a “long time”.
Example: Continued

Alternative A:
Natural Grass - Replanting will be required each 10
years at a cost of $10,000. Annual cost for
maintenance is $5,000. Equipment must be
purchased for $50,000 which will be replaced after
5 years with a salvage value of $5,000
Example: Natural Grass
Since cost is predominate, let (+) = cost and (-)
= salvage values

Alternative A: F5 = $5,000 F5 = $5,000

0 1 2 3 4 5 6 7 8 9 10

A = $5,000

$10,000
F5=$50,000
P = $50,000+ $10,000
Example: Natural Grass: Analysis

• (+) $60,000(A/P,10%,10)
• (+) $5,000 (already an annual cost)
• (+) $50,000(P/F,10%,5)(A/P,10%,10)
• (-) $5,000(P/F,10%,5)(A/P,10%,10)
• (+) $10,000(A/F,10%,10)
• (-) $5,000(A/F,10%,10)
• = $ 19,046/year
Example: Artificial Carpet (Surface)

• A = P(i) for a perpetual life project

• Annual Cost of Installation:
• =$150,000 (.10) = $15,000/ year
• Annual Maintenance = $5,000/year

• Total: $15,000 + $5,000 = $20,000/Yr

•Choose A, cost less per year!