HU-300 ENGINEERING ECONOMICS

END SEMESTER QUESTIONS AND ANSWERS

1. Each of the three alternatives shown has a 5 year useful life. If the MARR is 10%
which alternative should be selected? Answer the question using benefit-cost analysis.
Particulars A B C
Cost (Rs.) : 600 500 200
Uniform annual benefit : 158.3 138.7 58.3

ANSWER: A B/C = AW of Benefits = 158.3 = 158.3 = 1.14

AW of Cost 600 (A/P 10% 5) 138.6

B B/C = AW of Benefits = 138.7 = 138.7 = 1.20

AW of Cost 500 (A/P 10% 5) 115.5

C B/C = AW of Benefits = 58.3 = 58.3 = 1.26

AW of Cost 200 (A/P 10% 5) 46.2

Alternative C OR Alternative B

2. A mine is for sale. A mining engineer estimates that, at current production levels, the
mine will yield an annual net income of Rs 80,000 for 15 years, after which the
mineral will be exhausted. If an investor’s MARR is 15%, what is the maximum
amount he can bid on this property?
ANSWER:
P = 8000 (P/A i n)
P = Rs 4,67,760/-

3. While in college Barbie received Rs 10,000 in student loans at 5% interest. She will
graduate in June and is expected to begin repaying the loans in either 5 or 10 equal
payments. Compute her yearly payments for both repayment plans.

ANSWER:
5 years 10 years
A = P (A/P, i, n) A = P (A/P, i, n)
A = Rs 2,310/- A = Rs 1295/-

4. A project requires an initial investment of Rs 10,000 and returns benefits of Rs 6,000

at the end of every 5th year thereafter. If the minimum attractive rate of return
(MARR) is 10%, should the project be undertaken? Show supporting calculations.

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ANSWER:

6000

0----------5------------10---------15---------20------------25---------- ~

10,000 i = 10%

EUAW = 6,000 (A/F, 10% 5) – 10,000 (A/P, 10% ~)

= Rs – 17.20 The project should not be undertaken.

5. A grateful college graduate makes a donation of Rs 2,000 now and will pay Rs 37.50
per month for 10 years to establish a scholarship. If interest in the fund is computed at
9%, what annual scholarship may be established? Assume the first scholarship will be
paid at the end of the first year.

ANSWER:
P= 2000 + 37.50 (P/A, ¾%, 120) = Rs 4,960.33
A = Pi = 4960.33 (.09) = Rs 446.43
Scholarship Rs : 450/- or 446/-

6. Two machines are being considered for purchase. If interest is 7%, which machine
should be bought? Show that the annual cost of machine B for the 6 year analysis period
is the same as the annual cost for the 12 year analysis period.
Machine A Machine B
Initial cost Rs 7000 Rs 5000
End-of-useful-life salvage value Rs 1500 Rs 1000
Useful life, in years 12 6

ANSWER:

The annual cost for 12 years of Machine A can be found by using the following Equation:
EUAC = (P – SV) (A/P, i, n) + SVi
= (7000 – 1500) (A/P, 7%, 12) + 1500(0.07)
= 5500(0.1259) + 105 = Rs 797
Now compute the annual cost for 6 years of Machine B:
EUAC = (5000 - 1000) (A/P, 7%, 6) + 1000(0.07)
= 4000(0.2098) + 70 = Rs 909

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For a common analysis period of 12 years, we need to replace Machine B at the end of its
6-year useful life. If we assume that another Machine B’ can be obtained, having the
same Rs 5000 initial cost, Rs 1000 salvage value, and 6-year life, the cash flow Diagram
will be as follows:
For the 12-year analysis period, the annual cost for Machine B is
EUAC = [(5000 - 1000) (P/F, 7%, 6) + 5000(P/F, 7%, 6)
-1000(P/F, 7%, 12)] x (A/P, 7%, 12)
= [5000 – 1000(0.6663) +5000(0.6663)-1000(0.4440)] x (0.1259)
= (5000-666+3331-444) (0.1259)
= (7211) (0.1259) = Rs 909
The annual cost of B for the 6-year analysis period is the same as the annual cost for the
12-year analysis period. This is not a surprising conclusion when one recognizes that the
annual cost of the first 6-year period is repeated in the second 6-year period. Thus the
lengthy calculation of EUAC for 12 years of Machine B and B’ was not needed. By
assuming that the shorter-life equipment is replaced by equipment with identical
economic consequences, we can avoid a lot of calculations.
Select Machine A.

7. A certain GOI Treasury bond that matures in eight years has a face value of Rs
10,000. This means that the bondholder will receive Rs 10,000 cash when the bond’s
maturity date is reached. The bond stipulates a fixed nominal interest rate of 8% per year,
but interest payments are made to the bondholder every three months; therefore each
payment amounts to 2% of the face value. A prospective buyer of this bond would like to
earn 10% nominal interest (compounded quarterly) per year on his or her investment
because interest rates in the economy has risen since the bond was issued. How much
should this buyer be willing to pay for the bond?

ANSWER: To establish the value of this bond in view of stated conditions, the PW of
future cash flows during the next eight years (the study period) must be evaluated.
Interest payments are quarterly. Because the prospective buyer desires to obtain 10%
nominal interest per year on the investment, the PW is computed at i = 10%/ 4 = 2.5%
per quarter for the remaining 8x4 = 32 quarters of the bond’s life.

V N = 10000(0.02) (P/A, 2.5%, 32) + 10,000(P/F, 2.5%, 32)

= 4,369.84+ 4,537.71
= Rs 8,907.55
Thus, the buyer should pay not more than Rs 8,907.55 when 10% nominal interest per
year is desired

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9. The XYZ Chemical Company installed a heat exchanger in its plant for Rs 10,000, ten
years ago. The company is considering replacing the heat exchanger because
maintenance costs have been increasing. The estimated maintenance costs for the next 5
years are as follows:
Year 1 2 3 4 5
Maintenance (Rs.) 1,000 1,200 1,400 1,600 1,800
Whenever the heat exchanger is replaced, the cost of removal will be Rs 1,500 more
than the heat exchanger is worth as scrap metal. The replacement the company is
considering has an equivalent annual cost of Rs 900 at its most economic life. Should
the heat exchanger be replaced now if the company’s minimum attractive rate of
return (MARR) is 20%?

ANSWER:
Since the current value (Rs -1,500) is not changing but maintenance costs are increasing,
the most economic life is one year.

Year Cash Flow

0 +1,500 (Forgone Salvage)
1 -1,000 (Maintenance)
S -1,500 (Negative Salvage)

Equivalent annual cost of the defender:

EACD = 1,000 + 1,500(A/F, 20%, 1) – 1,599(A/P, 20%, 1) = Rs700

Since EACD < EACC i.e., 700< 900, keep the old exchange for now.

10. A business organisation having its branches nation-wide has purchased machines for
its 100 branches at a cost of Rs.4000/-per branch. The estimated salvage value for each
machine is estimated to be 5% of the first cost after 3 years. Assume that the owner
wants to compare the depreciation for 3 year MACRS model with that for a 3 year DDB
model. The owner is curious about the total depreciation over the next 2 years.
a) Determine which model offers the larger total depreciation after 2 years?
b) Determine the book value for each model after 2 years and at the end of the
recovery period.

ANSWER:

B = Rs 400,000
SV = 0.05 (400,000) = Rs 20,000

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 MACRS
Year rate Depreciation Book Value
0 Rs 0 400,000
1 0.3333 133,320 266,680
2 0.4445 177,800 88,880
3 0.1481 59,240 29,640
4 0.0741 29,640 0
DDB

Year Depreciation Book Value

0 - Rs 400,000
1 266,667 133,333
2 88,889 44,444
3 24,444 20,000

a) The 2 year total accumulated depreciation

MACRS = 133,320 + 177,880 = Rs 3,11,120
DDB = 266,667 + 88,889 = Rs 3,55,656

b) After 2 years book value for DDB at Rs 44,444 is 50% of the MACRS book value
of Rs 88.880,. At the end of recovery, which is 4 years for MACRS and 3 years for
DDB, the MACRS value is BV4 =0 and the DDB value is BV3 = Rs 20,000

12. Consider the following investment in a piece of land.

Purchase price Rs 10,000

Annual maintenance: Rs 100
Expected sale price after 5 years: RS 20,000
Determine: a) The rate of return. b) What is the lowest sale price the
investor should accept if he/she wishes to earn a return of 10% after keeping the land for
10 years?

(a) NPW = -10,000 -100(P/A, i%,5) + 20,000(P/F, i%, 5) = 0

Try i = 15%: = -391.2

Try i = 12%: = +987.5

15% < i < 12% interpolating

i = 14.15%

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(b) NFW = 0 = -10,000(F/P, 10%, 10) – 100 (F/A, 10%, 10) + Sale Price
Sale Price = Rs 27,534

13. Two machines are being considered for purchase. If interest is 7%, which machine
should be bought? Show that the annual cost of machine B for the 6 year analysis period
is the same as the annual cost for the 12 year analysis period.
Machine A Machine B
Initial cost Rs 7000 Rs 5000
End-of-useful-life salvage value Rs 1500 Rs 1000
Useful life, in years 12 6

ANSWER:
The annual cost for 12 years of Machine A can be found by using the following Equation:

EUAC = (P – SV) (A/P, i, n) + SVi

= (7000 – 1500) (A/P, 7%, 12) + 1500(0.07)
= 5500(0.1259) + 105 = Rs 797

Now compute the annual cost for 6 years of Machine B:

EUAC = (5000 - 1000) (A/P, 7%, 6) + 1000(0.07)
= 4000(0.2098) + 70 = Rs 909

For a common analysis period of 12 years, we need to replace Machine B at the end of its
6-year useful life. If we assume that another Machine B’ can be obtained, having the
same Rs 5000 initial cost, Rs 1000 salvage value, and 6-year life, the cash flow Diagram
will be as follows:
For the 12-year analysis period, the annual cost for Machine B is

EUAC = [(5000 - 1000) (P/F, 7%, 6) + 5000(P/F, 7%, 6)

-1000(P/F, 7%, 12)] x (A/P, 7%, 12)
= [5000 – 1000(0.6663) +5000(0.6663)-1000(0.4440)] x (0.1259)
= (5000-666+3331-444) (0.1259)
= (7211) (0.1259) = Rs 909

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The annual cost of B for the 6-year analysis period is the same as the annual cost for the
12-year analysis period. This is not a surprising conclusion when one recognizes that the
annual cost of the first 6-year period is repeated in the second 6-year period. Thus the
lengthy calculation of EUAC for 12 years of Machine B and B’ was not needed. By
assuming that the shorter-life equipment is replaced by equipment with identical
economic consequences, we can avoid a lot of calculations.
Select Machine A.
14.XYZ Inc. manufacturers a certain product. Its current financial and production figures
are as follows:
Unit selling price = Rs. 45
Unit variable cost = Rs. 20
Fixed costs = Rs. 4,00,000
Output = 24,000 units
a) What is XYZ’s current level of profit?
b) What will be the percentage change in profit for the following changes: (i) a
10 percent increase in out put, (ii) a 12 percent increase in units selling price,
(iii) a 5 percent decrease in unit variable cost.
ANSWER:
PROFIT = Q (P - V) – F

a) Rs 2,00,000

b) i) 30 %

ii) 64.8 %

iii) 12 %

15. An Rs.8,200 investments returned Rs.2,000 per year over a 5 year useful life. What
was the ROR on the investment? From interest tables we find
i 6% 7% 8%
(P/A, i, 5) 4.212 4.100 3.993
ANSWER:

PW of Benefits = 1 2000 (P/A, i, 5) = 1

PW of Costs 8200

Rewriting, we get
(P/A, i, 5) = 8200 = 4.1
2000
The IRR is exactly 7%

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 16 Consider the following alternatives:
Particulars A B
First cost Rs.5,000 Rs.10,000
Annual maintenance Rs.500 Rs. 200
Salvage value Rs.600 Rs.1,000
Useful life 5 years 15 years
Based on an 8% interest rate, which alternative should be selected?
ANSWER:

EUAC = -5000 (A/P 8% 5) -500+ 600 (A/F 8% 5)

= -5000 (0.2505) – 500 + 600 (0.1705)
= -1252.5-500+102.3= -1650.2
EUAC = -1650

EUAC = -10000 (A/P 8% 15) -200+ 1000 (A/F 8% 15)

= -10000 (0.1168) – 200 + 1000 (0.0368)
= -1168-200+36.8
= -1331.20
EUAC = -1331

17. A firm is trying to decide which of two weighing scales it should install to check a
package filling operation in the plant. The ideal scale would allow better control of
the filling operation and result in less overfilling. If both scales have lives equal to the
6-year analysis period, which one should be selected? Assume an 8% interest rate.
Alternatives Cost Uniform End-of-Useful-Life
Rs Annual Benefit Rs Salvage Value Rs
Atlas scale 2000 450 100
Comp scale 3000 600 700
ANSWER:
PW OF Benefits – PW of Cost

Atlas Scale = 450 (P/A 8% 6) +100 (P/F 8% 6) – 2000

= 450 (4.623) + 100 (0.6302) – 2000
NPW = 2080 + 63 – 2000 = Rs. 143

Comp Scale = 600 (P/A 8% 6) + 700 (P/F 8% 6) – 3000

= 600 (4.623) + 700 (0.6302) – 3000
NPW = 2774 + 441 – 3000 = Rs.215

Comp Scale is preferred alternative.

18. A company has decided to replace the existing computer which had a book value of
Rs.25,000 at that time. A new faster computer acquired having a market value of Rs.

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 4,00,000 and a class life of 6 years. The vendor has accepted the older computer as a
trade in. A deal was agreed to whereby the company would pay Rs.3,25,000 (cash for
the new computer system)
a) What is the cost basis of new computer? b) What is the GDS property class of the
new system? c) How much depreciation can be deducted each year under MACRS-
GDS on this class life?

ANSWER:

a) Rs. 3,50,000
b) 5 years
c) Year Percentage Amount (Rs.)
1 0.2 x 3,50,000 70,000
2 0.32 x 3,50,000 1,12,000
3 0.192 x 3,50,000 67,200
4 0.1152 x 3,50,000 40,320
5 0.1152 x 3,50,000 40,320
6 0.0576 x 3,50,000 20,160
3,50,000

19. A non-profit government corporation is considering two alternatives for generating

power. Benefits and costs are as follows:

Alternative A: Alternative B:
Coal powered generating facility Hydro electric powered generating facility
First Cost - Rs 20,000,000 First Cost - Rs 30,000,000
Annual Power Sales - Rs 1,000,000 Power Sales - Rs 800,000
Annual O&M Costs - Rs 200,000 O&M Costs - Rs 100,000
Induced investment - Rs 500,000 Annual Benefits
(i.e. investment attracted by alternative A Flood Control - Rs 600,000
every year) Irrigation - Rs 200,000
Recreation - 100,000
Ability to attract new industry - 400,000

The useful life of both alternatives is 50 years. Using an interest rate of 5%, which
alternative should be selected according to the B/C ratio method?

ANSWER:

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 Project A.
First Cost: Rs. 20,000,000 (A/P 5%, 50)
Rs. 10,95,600 Modified B/C
O&M Cost: Rs. 2,00,000 B-D- O&M
Initial Investment
Benefits: Rs. 100,000
Rs. 500,000 1500000- 200000
Rs. 1,500,000 1095600

Conventional B/C = B-D = 1.186

C
= 1500000
1295600
= 1.1577

Project B :
First Cost = Rs.30,000,000 (A/P 5%, 50)
= 1,643,400

O&M Cost = Rs. 100,000

Benefits = $ 800000
600000
200000
100000
400000
Rs.2,100,000

Conventional B/C ratio = B-D

C
= 2100000
1643400 + 100000
= 1.21
Modified B/C
= 2100000 – 100000
1643400

= 1.217

20. East Publishing Company is doing an analysis of a proposed new finance text. The
following data have been obtained.

Fixed costs (per edition):

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 Development (reviews, class testing, etc.) Rs 15,000
Copy editing 4,000
Selling and promotion 7,500
Typesetting 23,500
Total Rs 50,000
Variable costs (per copy):
Printing and binding Rs 6.65
Administrative costs 1.50
Salespeople’s commission (2% of selling price) .55
Author’s royalties (12% of selling price) 3.30
Bookstore discounts (20% of selling price) 5.50
Total Rs 17.50
Project selling price Rs 27.50

Using the data presented above:

a) Determine the company’s break-even volume for this book in i) Units ii) Rupee
Sales
b) Determine the number of copies East must sell to earn an (operating) profit of
Rs 30,000 on this text.
c) Suppose East feels that Rs 27.50 is too high a price to charge for the new
finance text. It has examined the competitive market and determined that Rs
25 would be a better selling price. What would the break-even volume be at
this new selling price?

ANSWER:

(a) (i) TFC = 50000 = 5000 units

SP-AVC 27.50 - 17.50

(ii) TFC = 50000 = Rs. 1,37,476/-

1-AVC 1 - 17.50
SP 27.50
= Rs. 1,37,500/-

(b) Target Sales = лT + TFC

SP-AVC

Target Sales = 30000 + 50000 = 80000 = 8000 Units

27.50 – 17.50 10

(c) BEQ = TFC = 50000 = 50000 = 6,666

SP-AVC 25- 17.5 7.5

6,667 Units or Rs. 1,66,675.

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