Annual Equivalent Worth

Criterion
Lecture No.19
Chapter 6
Contemporary Engineering Economics
Copyright © 2016

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 Chapter Opening Story: Robots May
Revolutionize China’s Electronics
Manufacturing
o Cost of a robot: $10,000
o Planning horizon: 20 years
o Cost of operating and
owning the robot per
year?

Issue: Replacing people with

robots would reduce the
operating cost at the
expense of increasing capital
cost.

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 Annual Worth Analysis
Principle: Measure an • Annual Equivalent Conversion
investment’s worth on an
annual basis.
Benefits: By knowing
the annual equivalent
worth, we can:
oSeek consistency of
report format.
oDetermine the unit cost
(or unit profit).
oFacilitate the unequal
project life comparison.

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 Fundamental Decision Rules
For Mutually Exclusive
For Single Project: Alternatives:
• If AE(i) > 0, accept the • Service projects: Select
investment. the alternative with the
minimum annual
• If AE(i) = 0, remain equivalent cost (AEC).
indifferent to the
investment. • Revenue projects: Select
the alternative with the
• If AE(i) < 0, reject the maximum AE(i).
investment.

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 Example 6.1: Economics of Installing a
Feed-water Heater
• Install a 150MW unit
• Initial cost = $1,650,000
• Service life = 25 years
• Salvage value = 0
• Expected improvement in fuel efficiency = 1%
• Fuel cost = $0.05kWh
• Load factor = 85%
• Determine the annual worth for installing the unit at
i = 12%.
• If the fuel cost increases at the annual rate of 4%, what
is AE(12%)?
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Solution: Calculation of Annual Fuel Savings
• Required input power before adding the
second unit

150,000kW
= 272,727kW Annual Fuel Savings
0.55
• Required input power after adding the second
unit
150,000kW = Afuel savings (reduction in fuel requirement) × (fuel cost)
= 267,857kW
0.56 :
×(operating hours per year)
• Reduction in energy consumption
. =(4,870kW) × ($0.05/kWh)
272,727kW − 267,857kW =
4,870 kW ×( 7,446 hours/year )
• Annual operating hours
=$1,813,101/year
Operating hours = (365)(24)(0.85)
=7,446 hours/year

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 Solution: Annual Worth Calculations

 (a) with constant fuel price • Cash Flow Diagrams

PW(12%) =
−$1,650,000 + $1,813,101(P / A,12%,25)
= $12,570,403
AE(12%) = $12,573,321(A / P ,12%,25)
= $1,602,726

 (b) with escalating fuel price

A1 =$1,813,101
PW (12%) = −$1,650,000 + $1,813,101(P / A1 ,4%,12%,25)
= $17,459,783
AE(12%) = $17,459,783(A / P ,12%,25)
= $2,226,122

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 Repeating Cash Flow Cycles

• First Cycle

PW(12%) = −$1,000,000
+[($800,000 − $100,000(A G ,12%,4)](P A ,12%,4)
= −$1,000,000 + $2,017,150.
= $1,017,150.

• Repeating Cycles
AE (12% ) = $1,017,150 ( A P , 12%, 4 )
= $334,880.

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Example 6.3: Comparing Alternatives

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 Solution
• Required assumptions
• The service life of the selected alternative is required on a
continuous basis.
• Each alternative will be replaced by an identical asset that has the
same costs and performance.
• Model A
PW (15% ) = −$22,601
AEC (15% ) = $22,601 ( A P , 15%, 3 )
= $9,899.
• Model B
PW (15% ) = −$25,562
AEC (15% ) = $25,562 ( A P , 15%, 4 )
= $8,954.

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 Annual Equivalent Cost (AEC)

When only costs are

involved, the AE method is

Annual Equivalent Costs

called the annual Capital
equivalent cost (AEC). costs
Revenues must cover two +
kinds of costs: operating
Operating
costsand capital costs.
costs

Annual equivalent cost = Capital cost + Operating costs

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 Capital (Ownership) Cost

• Def: Owning equipment

associated with two S
transactions—(1) its initial 0
cost (I), and (2) its salvage N
value (S).
• Capital costs: Taking these
items into consideration, we I
calculate the capital costs as:
0 1 2 3 N
CR(i) I(A / P , i , N) − S(A / F , i , N)
=
(I − S)(A / P , i , N) + iS
= CR(i)

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 Cost of Owning a Vehicle
SEGMENT BEST MODELS ASKING PRICE AFTER 3
PRICE YEARS

Compact car Mini Cooper $19,800 $12,078

Midsize car Volkswagen $28,872 $15,013
Passat
Sports car Porsche 911 $87,500 $48,125
Compact Luxury BMW 3 Series $39,257 $20,806
car
Luxury car Mercedes CLK $51,275 $30,765
Minivan Honda $26,876 $15,051
Odyssey
Subcompact SUV Honda CR-V $20,540 $10,681
Compact SUV Acura MDX $37,500 $21,375
Full size SUV Toyota Sequoia $37,842 $18,921
Compact truck Toyota Tacoma $21,200 $10,812
Full size truck Toyota Tundra $25,653 $13,083
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 Example: Capital Cost (Mini-Cooper)
• Capital Recovery Cost
 Given: $12,078

o I = $19,800 0

o N = 3 years 1 2 3

o S = $12,078
o i = 6% $19,800

 Find: CR(6%) CR(i) = (I -S) (A /P , i , N) + iS

CR(6%) = ($19,800 - $12,078) (A /P , 6%, 3)
+ (0.06)$12,078
= $3,614

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Example 6.4: Required Annual Revenue
• Cost of Owning and Operating
Given: Capital cost $4,000
o I = $20,000
0
o S = $4,000 1 2 3 4 5
o N = 5 years
o i= 10%
$20,000
Find: See if an +
annual revenue of
$5,000 is large 0 1 2 3 4 5

enough to cover both

$500
the capital
. and
operating costs. Operating cost

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 Solution

Need additional revenue in the amount of $120.76 to

justify the investment

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