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Engineering Economics

X-Other Analysis Technique


(Future Worth Analysis, Benefit-Cost Ratio
Analysis and Payback Period)
Date:20/11/2017

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Future Worth Analysis
Benefit-Cost (B/C) Ratio Analysis
Payback Period/Time

Outcome of Today’s Lecture

 Evaluate projects with the Future Woth Analysis, Benefit-


Cost Ratio and Payback Period Analysis

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Part I

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Future Worth Analysis

Future worth analysis is very much like present worth


analysis, dealing with then (future worth) rather than with
now (present worth) situations.

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Example 1

Ron Jamison, a 20-year-old college student, consumes about a


carton of cigarettes a week. He wonders how much money he
could accumulate by age 65 if he quit smoking now and put his
cigarette money into a savings account. Cigarettes cost $35
per carton. Ron expects that a savings account would earn 5%
interest, compounded semi annually. Compute Ron's future
worth at age 65.

Solution:

Semi annual saving $35/carton x 26 weeks = $910


Future worth (FW) = A(F/A, 2.5%, 90) = 910 (329.2) = $299,572

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Example 2

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Example 2

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Benefit-Cost Ratio Analysis

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Benefit-Cost Ratio Analysis

 At a given minimum attractive rate of return (MARR), we would


consider an alternative acceptable, provided:
PW of benefits- PW of costs ≥ 0, or EUAB - EUAC ≥ 0

o or

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Example 3

A firm is trying to decide which of two devices to install to


reduce costs in a particular situation. Both devices cost
$1000 and have useful lives of 5 years and no salvage value.

Device A can be expected to result in $300 savings annually.


Device B will provide cost savings of $400 the first year, but
savings will decline by $50 annually, making the second
year savings $350, the third-year savings $300, and so forth.
With interest at 7%, which device should the firm purchase?

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Recall: Example 1 in PW Analysis
Example 3

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Example 4

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Example 4: Solution

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Example 4: Solution cont.

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Example 4: Solution cont.

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Example 5
Consider six mutually exclusive alternatives A-F. They have
20 year useful lives and no salvage value. If the minimum
attractive rate if return is 6%, which alternatives should be
selected?

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Example 5: Solution

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Example 5: Solution cont.

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Part II

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Payback Period

 Payback period is the period of time required for the


profit or other benefits of an investment to equal the cost
of the investment.

 The criterion in all situations is to minimize the payback


period.

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Example 6

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Example 6: Solution

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Example 7

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Example 7: Solution cont.

Payback Period plots for Example 7:


(a)Atlas Scale; (b) Tom Thumb Scale.
To25 minimize Payback Period, select the Atlas Scale
(However, see next…….)
Note: Disadvantage of Payback Period
Payback period may select the wrong alternative.
When payback period is used, the Atlas scale appears to be
the more attractive alternative. Using present worth
method (Example 5-4 in Newmann's book), the Tom
Thumb scale was the chosen alternative. A review of the
problem reveals the reason for the different conclusions.
The $700 salvage value at the end of 6 years for the Tom
Thumb scale is a significant benefit. The salvage value
occurs after the payback period, so it was ignored in the
payback calculation. It was considered in the present worth
analysis, with the result that the Tom Thumb scale was in
fact more desirable.
Exercise

9-44 a) Future Worth Analysis


b) Benefit-Cost Ratio
c) The Payback Period