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Module 5 Notes
Module 5 Notes
In the real world, the majority of engineering economic analysis problems is alternative
comparisons. In these problems, two or more mutually exclusive investments compete
for limited funds. A variety of methods exists for selecting the superior alternative from
a group of proposals. Each method has its own merits and applications
The objective of chapter 7 is to evaluate correctly capital investment alternatives in
making decisions.
Making decisions means comparing alternatives. There are two basic types of
alternatives.
Investment Alternatives-Those with initial capital investment that produces positive cash
flows from increased revenue, savings through reduced costs, or both.
Cost Alternatives -Those with all negative cash flows, except for a possible positive cash
flow from disposal of assets at the end of the project’s useful life.
The alternative that requires the minimum investment of capital and will produce
satisfactory functional results will always be used unless there are definite reasons why
an alternative requiring a larger investment should be adopted.
The annual worth method assumes that each alternative will be replaced by an
identical twin at the end of its useful life (i.e., infinite renewal). This method, which may
also be used to rank alternatives according to their desirability, is also called the annual
return method or capital recovery method.
To apply this method, the annual cost of the alternatives including interest on
investment is determined. The alternative with the least annual cost is chosen. This
pattern, like the rate of return on additional investment pattern, applies only to
alternatives which has a uniform cost data each year and a single investment of capital
at the beginning of the first year of the project life.
The major advantage of this method is that it is not necessary to make the comparison
over the same number of years when the alternatives have different lives. The reason
for that, it is an equivalent annual cost over the life of the project.
In this method , all cash flows must be converted to an equivalent uniform annual cost,
that is, a year- end amount which is the same each year. The alternative with the least
equivalent uniform cost is preferred. When EUAC method is used, the equivalent
uniform annual cost of the alternatives must be calculated for one life cycle only. This
method is flexible and can be used for any type of alternative selection problem.
ENGINEERING ECONOMY
When two or more alternatives are capable of performing the same functions, the
economically superior alternative will have the largest present worth. The present worth
method is restricted to evaluating alternatives that are mutually exclusive and that have
the same lives. This method is suitable for ranking the desirability of alternatives.
In comparing alternatives by this method, determine the present worth of the net cash
outflows for each alternative for the same period of time. The alternative with the least
present worth of cost is selected.
Problems
1. A company is considering two types of equipment for its plant. Pertinent data are
as follows:
TYPE A TYPE B
Payroll Taxes 8% 8%
400,000 600,000
Dep’n= 10 (0. 15) 19,700.83 Dep’n= 10 (0. 15) 29,551.24
(1+0.15) −1 (1+0.15) −1
Total = 182,671.24
Total = 215,700.825
215,700.825−182,671.24
𝑅𝑂𝑅 = 600,000−400,000
(100%) =16.51%
2. The following data have been estimated for two feasible investment A and B , for
which revenues as well as costs are known and which have different lives. If the
Minimum attractive rate of return is 10% show which feasible alternative is more
desirable?
A B
Salvage Value 0 0