3

Engineering Economics
Tutorial Sheet 2

1 Payback Period
1.1 Consider the given cash flows:
a. Calculate the payback period for each project.
b. Determine whether it is meaningful to calculate a payback
period for project D.
c. Assuming that calculate the discounted payback period for each
project.

2 NPW Criterion
2.1 Consider the given sets of investment projects, all of which
have a three-year investment life:
a. Compute the net present worth of each project ati= 10%.
b. Plot the present worth as a function of the interest rate
(from 0% to 30%) for project B.
2.2 Your firm is considering purchasing an old office building with an estimated remaining service life of
25 years. Recently, the tenants signed long
long-term
term leases, which leads you to believe that the current
rental income of $150,000 per year will remain constant for the first 5 years. Then the rental income
will increase by 10% for every 5-year
year interval over the remaining life of the asset. For example, the
annual rental income would be $165,000 for years 6 through 10, $181,500 for years 11 through 15,
$199,650 for years 16 through 20, and $219,615 for years 21 through 25. You estimate that operating
expenses, including income taxes, will be $45,000 for the first year and that they will increase by
$3,000 each year thereafter. You also estimate that razing the building and selling the lot on which it
stands will realize a net amount of $50,000 at the end of the 25
25-year
year period. If you had the opportunity
to invest your money elsewhere and thereby earn interest at the rate of 12% per annum, what would be
the maximum amount you would be willing to pay for the building and lot at the present time?
2.3 A large food-processing
processing corporation is considering using laser technology to speed up and eliminate
waste in the potato-peelingg process. To implement the system, the company anticipates needing $3.5
million to purchase the industrial strength lasers. The system will save $1,550,000 per year in labor
and materials. However, it will require an additional operating and maintenance costcost of $350,000.
Annual income taxes will also increase by $150,000. The system is expected to have a 10-year
10 service
life and will have a salvage value of about $200,000. If the company’s MARR is 18%, use the NPW
method to justify the economics of the pro
project.

3 Future Worth and Project Balance

3.1 Consider the following sets of investment projects, all of
which have a three-year
year investment life:
a. Compute the net present worth of each project at i=15%
b. Compute the net future worth of each project at i=15%
c. Which project
roject or projects are acceptable?
3.2 Your R&D group has developed and tested a computer software package that assists engineers to
control the proper chemical mix for the various process manufacturing industries. If you decide to
market the software, your first-year operating net cash flow is estimated to be $1,000,000. Because of
market competition, product life will be about 4 years, and the product’s market share will decrease by
25% each year over the previous year’s share. You are approached by a big software house which
wants to purchase the right to manufacture and distribute the product. Assuming that your interest rate
is 15%, for what minimum price would you be willing to sell the software?

4 Capitalized Equivalent Worth

4.1 Maintenance money for a new building has been sought. Mr. Kendall would like to make a donation to
cover all future expected maintenance costs for the building. These maintenance costs are expected to
be $50,000 each year for the first 5 years, $70,000 each year for years 6 through 10, and $90,000 each
year after that. (The building has an indefinite service life.)
a. If the money is placed in an account that will pay 13% interest compounded annually, how large
should the gift be?
b. What is the equivalent annual maintenance cost over the infinite service life of the building?
4.2 To decrease the costs of operating a lock in a large river, a new system of operation is proposed. The
system will cost $650,000 to design and build. It is estimated that it will have to be reworked every 10
years at a cost of $100,000. In addition, an expenditure of $50,000 will have to be made at the end of
the fifth year for a new type of gear that will not be available until then. Annual operating costs are
expected to be $30,000 for the first 15 years and $35,000 a year thereafter. Compute the capitalized
cost of perpetual service at i= 8%.

5 Mutually Exclusive Alternative

5.1 Two methods of carrying away surface runoff water from a new subdivision are being evaluated:
Method A. Dig a ditch. The first cost would be $60,000, and $25,000 of redigging and shaping would
be required at five-year intervals forever.
Method B. Lay concrete pipe. The first cost would be $150,000, and a replacement would be required
at 50-year intervals at a net cost of $180,000 forever.
At i=12% which method is the better one?
5.2 A local car dealer is advertising a standard 24-month lease of $1,150 per month for its new XT 3000
series sports car. The standard lease requires a down payment of $4,500, plus a $1,000 refundable
initial deposit now. The first lease payment is due at the end of month 1. In addition, the company
offers a 24-month lease plan that has a single up-front payment of $30,500, plus a refundable initial
deposit of $1,000. Under both options, the initial deposit will be refunded at the end of month 24.
Assume an interest rate of 6% compounded monthly. With the present worth criterion, which option is
preferred?
5.3 Two machines are being considered for a manufacturing process. Machine A has a first cost of
$75,200, and its salvage value at the end of six years of estimated service life is $21,000. The
operating costs of this machine are estimated to be $6,800 per year. Extra income taxes are estimated
at $2,400 per year. Machine B has a first cost of $44,000, and its salvage value at the end of six
years’service is estimated to be negligible. The annual operating costs will be $11,500. Compare these
two mutually exclusive alternatives by the present-worth method at i= 13%.
5.4 An electric motor is rated at 10 horsepower (HP) and costs $800. Its full load efficiency is specified to
be 85%. A newly designed high-efficiency motor of the same size has an efficiency of 90%, but costs
$1,200. It is estimated that the motors will operate at a rated 10 HP output for 1,500 hours a year, and
the cost of energy will be $0.07 per kilowatt-hour. Each motor is expected to have a 15-year life. At
the end of 15 years, the first motor will have a salvage value of $50 and the second motor will have a
salvage value of $100. Consider the MARR to be 8%.
a. Use the NPW criterion to determine which motor should be installed.
 b. In (a), what if the motors operated 2,500 hours a year instead of 1,500 hours ayear? Would the motor
you chose in (a) still be the choice?
5.5 A largerefinery–petrochemical complex is to manufacture caustic soda, which will use feed water of
10,000 gallons per day. Two types of feed water storage installation are being considered over the 40
years of their useful life.
Option 1. Build a 20,000-gallon tank on a tower. The cost of installing the tank and tower is estimated
to be $164,000. The salvage value is estimated to be negligible.
Option 2. Place a tank of 20,000-gallon capacity on a hill, which is 150 yards away from the refinery.
The cost of installing the tank on the hill, including the extra length of service lines, is estimated to be
$120,000, with negligible salvage value. Because of the tank’s location on the hill, an additional
investment of $12,000 in pumping equipment is required. The pumping equipment is expected to have
a service life of 20 years, with a salvage value of $1,000 at the end of that time. The annual operating
and maintenance cost (including any income tax effects) for the pumping operation is estimated at
$1,000. If the firm’s MARR is known to be 12%, which option is better, on the basis of the present-
worth criterion?
5.6 A mall with two levels is under construction. The plan is to install only 9 escalators at the start,
although the ultimate design calls for 16. The question arises as to whether to provide necessary
facilities (stair supports, wiring conduits, motor foundations, etc.) that would permit the installation of
the additional escalators at the mere cost of their purchase and installation or to defer investment in
these facilities until the escalators need to be installed.
• Option 1. Provide these facilities now for all 7 future escalators at $200,000.
• Option 2. Defer the investment in the facility as needed. Install 2 more escalators in two years, 3
more in five years, and the last 2 in eight years.
The installation of these facilities at the time they are required is estimated to cost $100,000 in year 2,
$160,000 in year 5, and $140,000 in year 8. Additional annual expenses are estimated at $3,000 for
each escalator facility installed. At an interest rate of 12%, compare the net present worth of each
option over eight years.
5.7 An electrical utility is experiencing a sharp power demand that continues to grow at a high rate in a
certain local area. Two alternatives are under consideration. Each is designed to provide enough
capacity during the next 25 years, and both will consume the same amount of fuel, so fuel cost is not
considered in the analysis.
Alternative A. Increase the generating capacity now so that the ultimate demand can be met with
additional expenditures later. An initial investment of $30 million would be required, and it is
estimated that this plant facility would be in service for 25 years and have a salvage value of $0.85
million. The annual operating and maintenance costs (including income taxes) would be $0.4 million.
• Alternative B.Spend $10 million now and follow this expenditure with future additions during the
10th year and the 15th year. These additions would cost $18 million and $12 million, respectively. The
facility would be sold 25 years from now, with a salvage value of $1.5 million. The annual operating
and maintenance costs (including income taxes) initially will be $250,000 and will increase to $0.35
million after the second addition (from the 11th year to the 15th year)and to $0.45 million during the
final 10 years. (Assume that these costs begin 1 year subsequent to the actual addition.)
On the basis of the present-worth criterion, if the firm uses 15% as a MARR, which alternative should
be undertaken?