Topic 03-04-05:

Basic analysis tools for

comparison and selecting
among alternatives
Engineering Economics (IM1027)
Instructor: Dr. Nguyen Vu Quang

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Quick look
• Invest 100, receive NCF1 60 NCF2 60 NCF3 30
• Invest 90, receive NCF1 20 NCF2 40 NCF3 85

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Introduction
Methods or Tools to analyze and compare projects

• Equivalent worth or equivalent value methods

– Present worth – PW
– Annual worth – AW
– Future worth – FW

• Rate of return method (IRR, ERR)

• Benefit Cost ratio – B/C
• Breakeven analysis

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Introduction
General principles to compare projects

Steps of comparison:
1. Recognize the full set of alternatives
2. Determine the period of analysis
3. Estimate cash flows for each alternative
4. Determine the time value of money, i.e. the discounted rate used to
convert cash flow
5. Select the method of comparison
6. Evaluation and comparison of alternatives
7. Sensitivity Analysis
8. Select the preferred alternative
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Introduction
General principles to compare projects (con’t)

Mutually exclusive alternatives

In engineering economics, to determine investment alternatives it is
important to ensure that: the set of alternatives is mutually exclusive.
Mutually exclusive alternatives: when we choose one, we must
eliminate the remaining alternatives Choose one or the other, cannot
choose two or more alternatives.

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Introduction
General principles to compare projects (con’t)

Analysis time period (Study period)

The time period of analysis is the time frame in which all cash flows
can be counted and analysed
CF occurring outside of that time period are not considered

When to say an alternative is acceptable/valuable or

economically justified?
Minimum Attractive Rate of Return (MARR)

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Topic 03:
Equivalent value methods

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Contents

• Equivalent value methods

– Present worth method (PW)
– Annual worth method (AW)
– Future worth method (FW)

• Relationship between Equivalent value methods

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Present Worth Method
• Convert all CF to present moment, denoted as PW
• The project/alternative is worth to invest, when: PW ≥ 0
• Criteria to select the alternative among mutually exclusive
alternatives: PW  Max

i=8% (MARR)
EOY 0 1 2 PW
NCF(A) -1000 560 610 41.50
NCF(B) -2000 1050 1265 56.76

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Present
Worth
Method
(con’t)

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Future Worth Method &
Annual Worth Method
• Convert all CF to the end of study period, denoted as FW
• Convert all CF to an annuity – uniform series through the study
period, denoted as AW
• The project/alternative is worth to invest, when: FW ≥ 0 or AW ≥ 0
• Criteria to select the alternative among mutually exclusive
alternatives: FW is Max; or AW is max

i=8% (MARR)
EOY 0 1 2 FW AW
NCF(A) -1000 560 610 48.4 23.27
NCF(B) -2000 1050 1265 66.2 31.83

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Relationship between Equivalent value
methods

i=8%
(MARR)
EOY 0 1 2 PW FW AW
NCF(A) -1000 560 610 41.5 48.4 23.27
NCF(B) -2000 1050 1265 56.8 66.2 31.83

PW ( A ) FW ( A ) AW ( A )
= = = Const
PW ( B ) FW ( B ) AW ( B )

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Relationship between Equivalent value
methods (con’t)

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Compare alternatives having different lives
• Useful lives are the same for all alternatives and equal to the study
period.
• Useful lives are unequal among the alternatives, and at least one
does not match the study period.
– Use the study period = a common multiple of the lives of the alternatives
– CF of an alternative’s initial useful life span will also happen in all succeeding life
spans (replacements).
– Use annual worth

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Useful Lives Are Unequal among the
Alternatives
- The repeatability: is appropriate if the study period is infinite (very
long in length) or a common multiple of the useful lives
- Select an appropriate study period (co-terminated assumption)

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Repeatability assumption
Study period=The least common multiple of the useful lives of Alternatives

MARR=10%, which alternative is more desirable?

PW(A) = $1,028

PW(B) = $2,262
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Repeatability assumption (2)
Study period=The least common multiple of the useful lives of Alternatives

MARR=10%, which alternative is more desirable?

AW(A) = $151

AW(B) = $332
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Coterminated assumption
Study period = determined by a responsible manager

MARR=10%, which alternative is more desirable?

FW(A) = $847

FW(B) = $2,561
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Using capitalized worth (CW)
Study period = infinite number

A Large electric utility company is considering two methods for

containing and storing its coal combustion by-products (fly ash). One
method is wet slurry storage, and the second method is dry storage of
the fly ash. The company will adopt one of these methods for all 28 fly
ash impoundments at its seven coal-fired power plants.
Wet storage has an initial capital investment of $2 billion, followed by
annual maintenance expenses of $300 million over the 10-year life of
the method. Dry storage has a $2.5 billion capital investment and $150
million per year annual upkeep expenditures over its 7-year life. If the
utility’s MARR is 10% per year, which method of fly ash storage should
be selected assuming an indefinitely long study period?

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Using capitalized worth (CW)
Study period = indefinite number

Wet storage: P=$2 billion; A=$300 million, N=10 yrs

Dry storage: P=$2.5 billion, A=$150 million, N=7 yrs
Study period is indefinite, MARR = 10%. Which method (wet or dry)
should be selected?

AW(wet) = −$2,000,000,000 (A/P, 10%, 10) − $300,000,000 = −$625,400,000

AW(dry) = −$2,500,000,000 (A/P, 10%, 7) − $150,000,000 = −$663,500,000

CW(wet) = AW/10% = −$6,254,000,000

=
CW(dry) = AW/10% = −$6,635,000,000

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