5268751

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ENGINEERING ECONOMY Fifth Edition

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CHAPTER VI
Annual Worth Analysis
Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. Don Smith, Texas A&M University.
Learning Objectives:
AW over one project life cycle
AW calculations
Selecting Alternatives by Annual
Worth
AW analysis for a permanent
investment
Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

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CHAPTER VI
6.1 AW over one

project
life cycle
6.1 Advantages and Uses of Annual

Worth
Popular Analysis Technique
Easily understood results are
reported in $/time period
Eliminates the LCM problem
associated with the present worth
method
Only have to evaluate one life
cycle of a project
6.1 AW Calculations
General in nature such that:
AW = PW(A/P,i%,n)
AW = FW(A/F,i%,n)
Convert all cash flows to their

equivalent annual amounts
6.1 Repeatability Assumption
Given alternatives with

unequal lives
The assumptions are:
1. The services so provided are needed
forever
2. The first cycle of cash flows is repeated
for successive cycles
3. All cash flows will have the same
estimated values in every life cycle
6. 1. One or More Cycles
Cycle
1
Cycle
2
Cycle
K
Find the annual

worth of any
given cycle
($/period)
Annualize any one of the cycles
AW assumes repeatability of
CFs
6.1 6-year & 9-year Problem (Ex.

6.1)
See Example 6.1
Location A
First cost,$
-15,000
Annual Lease cost
-3,500
Deposit return,$
1,000
Lease term, years
6
Location B
-18,000
-3,100
2,000
9
Determine which location should be selected,

if
the MARR is 15% per year.
6.1 6-year & 9-year Problem (Ex.

6.1)
Need an 18-year study period for

both
6-year Project
6-year Project 6-year Project
9-year Project
9-year Project
Means a lot of calculation time!
6.1 Example
Consider a project with $3,000
annual operating cost and a $5,000
investment required each 5 years. i
= 10%0
1
2
3
4
5
$5,000
1-5
$3,000
For one cycle

EAC = 3,000 + 5,000 (A|P, 10%, 5) =
$4,319/yr
6.1 Multiple cycle..same result!
0
5
$5,00
0
10
1-10
= $3,000
$5,000
For two cycles

EAC = 3000 + 5000 (1+(P|F, .10, 5))(A|P, .
10, 10)
= 3000 + 1319 = $4319/yr
6.1 AW Requirements
Similar to the Present Worth

Method, AW analysis requires:
A discount rate before the

analysis is started
Estimates of the future cash
flows
Estimate of the time period(s)
involved

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CHAPTER VI
6.2 AW Calculation
13
6.2 Capital Recovery and AW Values
Assume the potential purchase

of any productive asset
One needs to know or estimate:
Initial Investment - P
Estimated Future Salvage Value - S
Estimated life of the asset - N
Estimated operating costs and
timing
Operative interest rate i%
6.2 Capital Recovery Cost

Thus, management is concerned
about the equivalent annual cost of
owing a productive asset.
This cost is termed Capital Recovery
Cost
CR is a function of {P, S, i%, and
n }
6.2 Capital Recovery Cost (CR)

CR = the equivalent annual worth of
the asset given:
FN S
0
1
N
3.
N-1
P0
Capital Recovery (CR) is the annualized
equivalent of the initial investment P 0 and
the annualized amount of the future
salvage value Fn
6.2 Capital Recovery Cost CR

S
FN
Given:
0
N-1
P0
FN
Convert to:
0
1
N
P0
N-1
$A per year
(CRC)
6.2 Capital Recovery Cost

COMPUTING CR FOR INVESTMENTS
WITH SALVAGE VALUES:
Method I - compute EAC of the original
cost and subtract the EAC of the
salvage value
EAC = P(A|P, i, n) - S(A|F, i, n)
6.2 More Traditional CR Approach
Method II Subtract the salvage value

from the original cost and compute the
annual cost of the difference. Add to
the interest that the salvage value
would return each year, SV (i).
CR(i%)= (P - S) (A|P, i, n) + S(i)

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CHAPTER VI
6.3 Selecting
Alternatives
by Annual Worth
20
6.3 Alternatives by Annual Worth

Mutually Exclusive Analysis
If pure cost situation select min. cost

alternative
If mixed costs and revenues select
the max. AW (i%) alternative
Single Alternative
Accept if AW positive, else reject
6.3 Example 6.3

Cash Flow Diagram is:
S = +$1,500
A+ = $1,200/yr
1
5
-$650
-$700
-$750
P=23,000
-$800
-$850
6.3 Example 6.3

The Capital Recovery component
is:
S=+
$1,500
1
CR(10%) = -23,000(A/P,10%,5)
+
P=23,000
1,500(A/F,10%,5) = -$5,822
6.3 Example 6.3

Revenue Op Costs are:
A+ = $1,200/yr
1
5
$650
$700
$750
$800
$850
6.3 Example 6.3

Cost Revenue component is seen to
equal (costs treated as positive
values):
1.810
1
50(A/G,10%,5)
=+550
= 550 90.50
= $459.50
6.3 Example 6.3

Total Annual worth (CR + Cost/Rev)
CR(10%) = -$5,822
Revenue/Cost Annual amount: $459.50
AW(10%) = -$5,822+$459.50
AW(10%) = $5,362.50
This amount would be required to recover the

investment and operating costs at the 10%
rate on a per-year basis

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CHAPTER VI
6.4 AW of a Perpetual
Investment
27
6.4 AW of a Perpetual Investment

EAC of a perpetual investment
If an investment has no finite cycle, it is
called a perpetual investment. If P is
the present worth of the cost of that
investment, then EAC is P times i.
Remember: P = A/i
From the previous
chapter
EAC=A = P* i
6.4 AW of a Perpetual
Investment
Example 6.6
One person received a bonus of
$10,000. If she deposits it now at an
interest rate of 8% per year, how
many years must the money
accumulate before she can
withdraw $2000 per year forever?
End of Chapter 6 Lecture Set

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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

ENGINEERING ECONOMY Fifth Edition

Annual Worth Analysis

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

ENGINEERING ECONOMY Fifth Edition

6.1 AW over one

6.1 Advantages and Uses of Annual

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

General in nature such that:

Convert all cash flows to their

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.1 Repeatability Assumption

Given alternatives with

6. 1. One or More Cycles

Find the annual

6.1 6-year & 9-year Problem (Ex.

Determine which location should be selected,

6.1 6-year & 9-year Problem (Ex.

Need an 18-year study period for

6-year Project 6-year Project

Means a lot of calculation time!

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

For one cycle

6.1 Multiple cycle..same result!

For two cycles

Similar to the Present Worth

A discount rate before the

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

ENGINEERING ECONOMY Fifth Edition

6.2 Capital Recovery and AW Values

Assume the potential purchase

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.2 Capital Recovery Cost

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.2 Capital Recovery Cost (CR)

6.2 Capital Recovery Cost CR

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.2 Capital Recovery Cost

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.2 More Traditional CR Approach

Method II Subtract the salvage value

CR(i%)= (P - S) (A|P, i, n) + S(i)

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

ENGINEERING ECONOMY Fifth Edition

6.3 Alternatives by Annual Worth

If pure cost situation select min. cost

Accept if AW positive, else reject

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.3 Example 6.3

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.3 Example 6.3

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.3 Example 6.3

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.3 Example 6.3

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

6.3 Example 6.3

This amount would be required to recover the

ENGINEERING ECONOMY Fifth Edition

6.4 AW of a Perpetual Investment

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D

End of Chapter 6 Lecture Set

Blank & Tarquin: 5th Edition. Ch. 6 Authored by: Dr. D