Engineering

Economics
Module No. 008
Future Worth Method
 Future Worth Criterion
 In this type of comparison of alternatives, future worth of
various alternatives will be computed. Then, the alternative
with the maximum future worth of net revenue and with the
minimum future worth of net cost will be selected as the
alternative for implementation.
 Revenue-dominated cash flow analysis is given as:
FW = - P(1 + i)n + R1(1 + i)n-1 + R2(1 + i)n-2 + ………+ Rn + S

 Cost-dominated cash flow analysis is given as:

FW = P(I + i)n + C1(1 +i)n-1 + C2(1 +i)n-2 + …….…+ Cn - S
 Future Worth Criterion
 Example: Consider the following mutually exclusive
alternatives, at i = 12%, select the best alternative based on
future worth method.
 Future Worth Criterion
Practice Questions
 The family-operated Foothills Ranching Company (FRC) owns the
mineral rights to land used for growing grain and grazing cattle.
Recently, oil was discovered on this property. The family has decided
to extract the oil, sell the land, and retire. The company can lease the
necessary equipment and extract and sell the oil itself, or it can lease
the land to an oil-drilling company.
 Drill option. In this option, it will require $300,000 up front, but the
net annual cash flow after taxes from drilling operations will be
$600,000 each year for the next five years. The company can sell the
land for a net cash flow of $1,000,000 after five years, when the oil is
depleted.
 Lease option. In this option, the drilling company can extract all the oil
in only three years, and FRC can sell the land for a net cash flow of
$800,000 at that time. The net cash flow from the lease payments to
FRC will be $630,000 at the beginning of each of the next three years.
 Select best option using FW method of comparison at i=15%?
 Future Worth Criterion
Practice Questions

PW(15%)Drill = - 300,000 + 600,000(P/A, 15%, 4) +

1,600,000( P/F, 15%, 5) = 2,208,470.
PW(15%)Lease = 630,000 + 630,000(P/A, 15%, 2) + 800,000(P/F, 15%, 3)
= 2,180,210
Note that these are revenue projects; therefore, the drill option appears to be the
marginally better option
 Future Worth Criterion
Practice Questions
Consider the following two mutually exclusive alternatives

End of the year

Alternativ 0 1 2 3 4
e
A -5000 2000 2000 2000 2000

B -4500 1800 1800 1800 1800

at i = 18%, select the best alternative based on future worth

method of comparison.
 Future Worth Criterion
Practice Questions
 A man owns a corner plot. He must decide which of the several
alternatives to select in trying to obtain a desirable return on his
investment. After much study and calculation, he decides that
the two best alternatives are given in the following table:
Build Gas Station Soft Ice Cream
Stand
First cost 20,00,000 36,00,000
Ann. Property Tax 80,000 1,50,000
Annual Income 8,00,000 9,80,000
Life of building 20 20
Salvage value 0 0

 Evaluate the alternatives based on the future worth method

at i = 12%
 Future Worth Criterion
Practice Questions
 The cash flows of two mutually exclusive alternatives
are given as: all figures in (000)

0 1 2 3 4 5 6

Option -500 50 100 150 200 250 300

A
Option -700 70 140 210 280 350 420
B

 Select the best alternative based on future worth method

at i = 8%
 Future Worth Criterion
Practice Questions
M/S Krishna Castings Ltd. is planning to replace its annealing furnace.
It has received tenders from three different original manufacturers of
annealing furnace. The details are as follows:

1 2 3
Initial cost 80,00,000 70,00,000 90,00,000
Life (years) 12 12 12
Annual Operation & 8,00,000 9,00,000 8,50,000
Maintenance cost
Salvage value after 12 5,00,000 4,00,000 7,00,000
years

Which is the best alternative based on future worth method at i = 20%

 Future Worth Criterion
Practice Questions
 A company must decide whether to buy machine A or
machine B:

Machine A Machine B
Initial cost 4,00,000 8,00,000
Life (years) 4 4
Annual Operation & 40,000 0
Maintenance cost
Salvage value 2,00,000 5,50,000

 At 12% interest rate, which machine should be selected?