ENGINEERING ECONOMY

Most engineering and business projects can be accomplished by more

than one method or alternatives. This topic will deal with problems
involving more than one alterative.
The fundamental principle on which alternative should be used is
stated as follows:

The alternative that requires the minimum investment of

capital and will produce satisfactory functional result will
always be used unless there are definite reasons why an
alternative requiring a larger investment should be adopted.
 ENGINEERING ECONOMY
METHODS/PATTERN IN COMPARING ALTERNATIVES:
THE RoR ON ADDITIONAL INVESTMENT METHOD
The formula for the rate of return on additional investment is:
net annual savings
Rate of return on additional investment =
additional investment
THE ANNUAL COST (AC) METHOD
To apply this method, the annual cost of the alternatives including
interest on investment is determined. The alternative with the least
annual cost is chosen. This pattern like the rate of return on
additional investment pattern, applies only to alternatives which has a
uniform cost data for each year and a single investment of capital t
the beginning of the first year of the project life.
 ENGINEERING ECONOMY
THE EQUIVALENT UNIFORM ANNUAL COST (EUAC)
METHOD
In this method, all cash flows (irregular or uniform) must be
converted to an equivalent uniform annual cost, that is, a year-end
amount which is the same each year. The alternative with the least
EUAC is preferred. When the EUAC method is used, the equivalent
uniform annual cost of the alternatives must be calculated for one life
cycle only.
THE PRESENT WORTH COST (PWC) METHOD
In comparing alternatives by this method, determine the present
worth of the net cash flows for each alternative for the same period
of time. The alternative with the least present worth of cost is
selected.
 ENGINEERING ECONOMY
THE CAPITALIZED METHOD
The capitalized cost method is a variation of the present worth cost
pattern. This method is used for alternatives having long lives. To use
the method, determine the capitalized of all the alternatives and
choose that one with the least capitalized cost.

THE PAYBACK (PAYOUT) PERIOD METHOD

The use this method, the payback period of each alternative is
computed. The alterative with the shortest payback period I adopted.
This method is seldom used.
 ENGINEERING ECONOMY
Sample Problem:
A company is considering two types of equipment for its
manufacturing plant. Pertinent data are as follows:
Type A Type B
First cost ₱300,000 ₱400,000
Annual operating cost 40,000 30,000
Annual labor cost 60,000 40,000
Insurance and property taxes 3% 3%
Payroll taxes 4% 4%
Estimated life 10 10
If the minimum required rate of return is 15%, which
equipment should be selected?
 ENGINEERING ECONOMY
Solution:
By the rate of return on additional investment method:
Type A
Annual costs:
P 300 ,000
=
(300 ,000 )(0.15 ) = P 14 ,775.62
Depreciation =
F / A , 15%, 10 (1 + 0.15 )10 − 1
Operation = 40 ,000
Labor = 60 ,000
Payroll taxes = P 300 ,000 (0.04 ) = 12 ,000
Taxes and insurance = P 300 ,000 (0.03 ) = 9 ,000

Total annual cost = P 135 ,775.62

 ENGINEERING ECONOMY
Type B
Annual costs:
P 400 ,000 (400 ,000 )(0.15 ) = P 16 ,364.54
Depreciation = =
F / A , 15%, 10 (1 + 0.15 )10 − 1
Operation = 30 ,000
Labor = 40 ,000
Payroll taxes = P 400 ,000 (0.04 ) = 16 ,000
Taxes and insurance = P 400 ,000 (0.03 ) = 12 ,000
Total annual cost = P 114 ,364.54
Annual Savings = P 135 ,775.62 − P 114 ,364.54 = P 21 ,411.08
Additional investment = P 400 ,000 − P 300 ,000 = P 100 ,000
P 21 ,411.08
Rate of return on additional investment = x 100% = 21.41%
P 100 ,000
Type B should be selected.
 ENGINEERING ECONOMY
By the annual cost method:
Type A
Annual costs:
P 300 ,000
=
(300 ,000 )(0.15 )
= P 14 ,775.62
Depreciation =
F / A , 15%, 10 (1 + 0.15 )10 − 1
Operation = 40 ,000
Labor = 60 ,000
Payroll taxes = P 300 ,000 (0.04 ) = 12 ,000
Taxes and insurance = P 300 ,000 (0.03 ) = 9 ,000
Interest on capital = P 300 ,000 (0.15 ) = 45 ,000
Total annual cost = P 180 ,775.62
 ENGINEERING ECONOMY
Type B
Annual costs:
P 400 ,000 (400 ,000 )(0.15 ) = P 16 ,364.54
Depreciation = =
F / A , 15%, 10 (1 + 0.15 )10 − 1
Operation = 30 ,000
Labor = 40 ,000
Payroll taxes = P 400 ,000 (0.04 ) = 16 ,000
Taxes and insurance = P 400 ,000 (0.03 ) = 12 ,000
Interest on capital = P 400 ,000 (0.15 ) = 60 ,000
Total annual cost = P 174 ,364.54

Since ACB < ACA , Type B should be selected.

 ENGINEERING ECONOMY
By the present worth cost method:
Type A
Annual costs (excluding depreciation) = P40,000 + P60,000 + P12,000 + P9,000 = P121,000

0 1 2 3 9 10

121,000 121,000 121,000 121,000 121,000

300,000

1 − (1 + 0.15 ) −10 
PWCA = P 121 ,000   + P 300 ,000
 0.15 
= P 907 ,271.00
 ENGINEERING ECONOMY
Type B
Annual costs (excluding depreciation) = P30,000 + P40,000 + P16,000 + P12,000 = P98,000

0 1 2 3 9 10

98,000 98,000 98,000 98,000 98,000

400,000

1 − (1 + 0.15 ) −10 
PWCA = P 98 ,000   + P 400 ,000
 0.15 
= P 891 ,839.32

Since ACB < ACA for the same period of time, Type B should be selected.
 ENGINEERING ECONOMY
By the EUAC method:
Type A
Annual costs (excluding depreciation) = P40,000 + P60,000 + P12,000 + P9,000 = P121,000
0 1 2 3 9 10 0 1 2 3 9 10

121,000 121,000 121,000 121,000 121,000 EUAC EUAC EUAC EUAC EUAC

300,000

 0.15 
EUACA = P 300 ,000   + P 121 ,000
1 − (1 + 0 .15 ) −10

= P 180 ,775.62
 ENGINEERING ECONOMY
Type B
Annual costs (excluding depreciation) = P30,000 + P40,000 + P16,000 + P12,000 = P98,000
0 1 2 3 9 10 0 1 2 3 9 10

98,000 98,000 98,000 98,000 98,000 EUAC EUAC EUAC EUAC EUAC

400,000

 0.15 
EUACA = P 400 ,000   + P 98 ,000
1 − (1 + 0 .15 ) −10

= P 177 ,700.82

Since EUACB < EUACA , Type B should be selected.