Economics

Section (7)

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 Assignment Submission

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 Agenda

ü Capitalized cost

ü Alternative investment

ü Exercise problem

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Capitalized cost
To account for the long-term cost of frequently
replaced equipment, a capitalized cost is used.
This cost reflects the initial purchase price and
the anticipated future replacement cost,
providing a more accurate picture of the
equipment's overall financial impact.

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Capitalized cost
Its aim is to:

a) Accurate financial projections

b) Comparison of different options

c) Understanding the true cost of an asset

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Capitalized cost
Important Definitions:
K Capitalized Cost

P Principal deposited in the bank

VR Replacement Cost = Vo - Vs

i Interest rate

n Service life

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Capitalized cost
K = Vo + P Compound interest is
used since most banks
work with it.
Accumulated sum in the bank should cover VR + P :
If we have 2
S = P + VR alternatives, choose
the one with the
lowest K.
P(1+i)n = P + VR

!!
P= "#$ "%"

VR
K = Vo +
1+i n−1

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Capitalized cost
Exercise:
A heat exchanger has been designed for use in a chemical process. A standard type of heat
exchanger with a negligible scrap value costs $ 5,000 and will have a useful life of 6 years.
Another proposed heat exchanger of equivalent design capacity costs $ 6,500 but will have
a useful life of 10 years and a scrap value of $ 600. Assuming an effective compound
interest rate of 8 percent per year, determine which exchanger is to be recommended based
on the capitalized cost.

K1 = $ 13,591.7 and K2 = $ 11,590.9

Exchanger # 2 would be recommended

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Alternative investment
Choosing the right approach is crucial in
engineering. Often, multiple options exist for
projects and equipment. This chapter equips
you with the tools to evaluate these
alternatives effectively. We'll focus on
economic considerations to ensure you
select the most cost-efficient solution,
ultimately contributing to project success.

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Alternative investment
To be able to compare between alternatives
you must:

• Make sure that all alternatives give the same

function.

• Begin with the cheapest one.

• If the more expensive alternative does not give

any saving so no need to compare.

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Alternative investment
Important Definitions:
ROI Return on investment

ROII Return on increment investment

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Alternative investment
Rate on incremental investment:
ROII ranges from
5 to 30 % and
the typical value
011234 5367189 is 15 %.
x= x 100
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Alternative investment
Sheet - Problem 1:
A company must purchase one reactor to be used in overall operation. Four reactors have
been designed, all of which are equally capable of giving the required service. The following
data apply to four designs. If the company demands a 15% ROII, which of the following should
be accepted.

Design 1 Design 2 Design 3 Design 4

FCI ($) 10,000 12,000 14,000 16,000
OPEX + CAPEX per year ($) 3,000 2,800 2,350 2,100

Design 3 is accepted

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Alternative investment
Sheet - Problem 2:
A heat exchanger has been designed and insulation is being considered for the unit. The insulation can
be obtained in thickness of 1, 2, 3 or 4 inch. The following data have been determined for the different
insulation thickness. What thickness of insulation should be used? The value of heat is 30 cents/106
Btu. An annual return of 15% on the fixed-capital investment is required for any capital put into this
type of investment. The exchanger operates 300 days per year.

1” 2” 3” 4”
BTU/hr saved 300,000 350,000 370,000 380,000
Installation cost ($) 1,200 1,600 1,800 1,870
Annual fixed charges, % 10 10 10 10
2” is accepted

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Alternative investment Don’t forget
taking d into your
considerations !

Sheet - Problem 5:

The owner of a small antifreeze plant has a small canning unit which cost him $5,000 when he purchased it
10 years ago. The unit has been completely depreciated, but the owner estimates that it will still give good
service for 5 more years. At the end of 5 years the unit will be worth a junk value of $100. The owner now
has an opportunity to buy a more efficient canning unit for $6,000 having an estimated service life of 10
years and zero salvage or junk value. The new unit will reduce annual labor and maintenance costs by
$1,000 and increase annual expenses for taxes and insurance by $100. All other expenses except
depreciation would be unchanged. If the old canning unit can be sold for $600, What return on investment
would the owner receive if he decides to make the replacement.
𝑥 = 7.4%

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 Don’t forget taking d into your
considerations !, if the Vo is

Alternative investment
different from the market
value, use the market value and
put your calculations aside !

Sheet - Problem 6:
A chemical company is considering replacing reactor with a modernized continuous reactor. The old unit cost $40,000
when new 5 years ago, and depreciation have been charged on a straight-line basis using an estimated service life of 15
years and final salvage value of $1,000. It is now estimated that the unit has a remaining service life of 10 years and a
final salvage value of $1,000. The new unit would cost now $70,000 and would result on an increase of $5,000 in the
gross annual income. It would permit a labor savings of $7,000 per year.

Additional costs for taxes and insurance would be $1,000 per year. The service life is estimated to be 12 years with a final
salvage value of $1,000. All costs other than those for labor, insurance, taxes and depreciation may be assumed to be the
same for both units. The old unit can now be sold for $5,000. If the minimum required return on investment is 15%,
Should the replacement be made?

NO
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 Thank You

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