Present Worth Analysis

Goal

To convert a series of costs and benefits over a period of time

into one equivalent Present Time Value.
Definition

Present Worth Analysis is an equivalence method of analysis in

which a project’s cash flows are discounted to a single present
value.
Formula

Net Present Worth =

Present Worth of Benefits - Present Worth of Costs

NPW = PW of benefits - PW of costs

Cash Inflows (+ve)

Cash Outflows (-ve)
Functional Notation Version of Formula

Total Present Worth =

- P + A1 (P/A, i, n) - A2 (P/A, i, n) + F (P/F, i, n)

Initial Savings Maintenance Salvage
Cost Cost Value

Uniform Payments
Example 1 (Equal Life Alternatives)
Alternative X has first cost of $20,000, an operating cost of $9,000 per year, and
$5000 salvage value after 5 years. Alternative Y will cost $35,000 with an operating
cost of $4000 per year and a salvage value of $7,000 after 5 years. At MARR of 12%
per year, which should be selected?

X Y
Initial Cost 20,000 35,000
Operating Cost per year 9,000 4,000
Salvage Value 5000 7,000
Life span 5 5
i=12%
Example 1 (Equal Life Alternatives)
X Y
Initial Cost 20,000 35,000
Operating Cost per year 9,000 4,000
Salvage Value 5000 7,000
Life span 5 5
i=12%

PW of X = - 20,000 - 9000(P/A, 12%, 5) + 5000(P/F, 12%, 5)

= - 49,606 $
PW of Y = - 35,000 - 4000(P/A, 12%, 5) + 7000(P/F, 12%, 5)
= - 45,447 $
Example 2 (Different Life Alternatives)
Compare the machines below using present worth analysis a i=10% per year.

X Y
Initial Cost 20,000 30,000
Operating Cost per year 9,000 4,000
Salvage Value 4000 6,000
Life span 3 6
i=10%
 Example 2 (Different Life Alternatives)
X Y
Initial Cost 20,000 30,000
Operating Cost per year 9,000 4,000
Salvage Value 4000 6,000
Life span 3 6
i=10%

PW of X = - 20,000 - 9000(P/A, 10%, 6) - 16000(P/F, 10%, 3) +4000 (P/F, 10%, 6)

= - 68,961 $
PW of Y = - 30,000 - 4000(P/A, 10%, 6) + 6000(P/F, 10%, 6)
= - 57,100 $
Merits
➔ Good measure of profitability
➔ Accepts conventional cash flow pattern
➔ Consideration of all cash flows
➔ Considers time value of money
Demerits
➔ Not useful for comparing projects of different sizes
➔ Might be inaccurate sometimes because it does not account
hidden costs
Thank You!