The homework 2, sets 1 through 4, is due as a single submission, on Monday, 10/28/13.

The solutions to all sets of HW 2 will uploaded on Moodle on the same day after the class.
Late submission will not be accepted. Early submission may be arranged.
Show your work for full credit.
1. Two different alternatives shown in the table below are being considered by Kal Tech
Engineering systems. Assume that alternatives X and Y are replaced at the end of their lives.
Data
Initial Cost
Uniform Annual Benefits
Useful Life in Years
MARR

Alternative X Alternative Y
$6,000
$1,500
$810
$ 230
20
10
12%

The Net Present Worth (NPW) of alternative

The NPW for alternative

is ____$49.89_____. (Use the CF function)

is ___$41.67 ___________. (Use the CF function)

2. An engineering freshman wants to purchase a laptop computer for use during the 4 years
that she plans to study engineering at Texas Tech. After looking around a bit, she finds that
a well-equipped laptop with software can be purchased for $1,800 and that it should have a
market value of at least $300 if she wants to sell it when she graduates after 4 years.
Assume that maintenance and supplies will cost $100 each
. Use an interest rate
of 12%
with monthly compounding, and determine the present cost of owning and
operating the computer.

Hint:

i = 12% per year.

So, the six month interest rate becomes: i6

Answer: Initial cost = $1,800 Salvage value = $300

= 4.5 x 2 = 9 (semi-annual periods)

= (1 + 0.12/12)6 1 = 6.152%

M&O = $100/ every 6 months

Use the CF register of the calculator to find the

$2,300.40.
(You may find it a negative value depending on how you enter the cash flows)
3. A person buys a $1,000 face value bond 2 years after its issue. He intends to keep it until its
maturity date, which is 18 years from now. This bond pays 6% annually. What price can he
pay now for the bond so that his investment earns 8%? The investor gets the face value back
at the maturity.

Answer: Face value = $1,000 (In the last period, the face value is returned). The annual cash
flow=Interest per year = 0.06 (1,000) = $60. Use the CF register of the calculator to
find the
$812.52.

4. The construction of a dam will cost $1,000 at time 0, $500 in year 1, $500 in year 2. It will be
completed at the end of year 2. Beginning in year 3, maintenance costs will be $100 per year
through year 10. From years 11 on, maintenance costs will be $150 per year forever. Find
the present worth of all the costs if = 10%.

Answer: PW of costs = Use the CF function

= (150/0.10) (P/F, 10%10) + 100 (P/A, 10%, 8) (P/F, 10%, 2) + 500 (P/A, 10%, 2) + 1,000
= (150/0.10) (0.3855) + 100(5.335) (0.8264) + 500(1.736) + 1,000 = $2,887.13

1. John Davis, a recent IE graduate from Tennessee Technological University, bought an

SUV for $30,000 with a down payment of $10,000. John had a little business on the side
and did not have a girlfriend when he was at school and hence he was able to save the
$10,000 for his dream car. He expects to take good care of the car and the dealership,
owned by John's uncle, agrees to take the car back for $8,000 at the end of 4 years.
If the monthly payment is $400, what is the nominal interest rate on this loan?
What is the effective interest rate?
Consider this: (30,000 10,000) 400(P/ A, i, 48) 8,000(P/F, i, 48). Interest rate is
unknown. N=48
Use the CF register of the calculator to find the IRR=1.027. This is monthly
rate. Annual nominal interest rate = 1.027 x 12 = 12.33%.
Effective interest rate
= (1 + 0.01027)12 1= 0.1305 or 13.05%. The effective rate can be found using the
ICONV function on the calculator.
2. Fancy Gadgets, Inc. has developed a new Thing-A-May-Jig at a cost of $2,000,000.
Projected profits from the sale of Thing-A-May-Jigs for the next five years are:
$300,000, $400,000, $500,000, $600,000, and $250,000. At the end of the fifth year,
the production equipment associated with the Thing-A-May-Jig project will be disposed
of for $750,000. Determine the rate of return for the Thing-A-May-Jig project.
Year
0
Cash Flow, $ 2M

1
300K

2
400K

3
500K

4
600K

5
1,000K

This one is straightforward. Use the CF register of the calculator to find the
IRR=10. 17%

3.

Barry, a Texas Crude Company engineer who did not take Engineering Economy while
studying at Tech, recommended that Texas Crude purchase a special tool to reduce the
cost of pumping oil out of the bayous of St. Martin Parish. As a result of Barry's
recommendation, Texas Crude purchased the tool for $30,000 on January 1, 2005. By
January 1, 2006, the tool had saved a total of $5,000 and went on line full time. After
going on line full time, the tool saved Texas Crude $9,000 each year for the next three
years and Barry was happy. However, Barry recommended the "el-cheapo" model (Barry
is a tightwad), and it started breaking down during the early part of year five, and ended
up by saving only $4,000 during year five. It was scrapped as being unusable at the
end of year five, and had a zero salvage value. Barry told his boss that his
recommendation had been correct, as it had saved Texas Crude $6,000 and that is a
savings of 20%.
Use a MARR of 10% and evaluate the effectiveness of the tool and the correctness of
Barry's recommendation.
Answer:

Use the CF register of the calculator to find the

So, Barry was wrong on his recommendation.

IRR=6.50%.

4. A 10-year, 12%, $1,000 bond that pays dividends quarterly can be purchased for $900.
If the bond is purchased and pays as scheduled, what effective rate of return will the
purchaser receive?
N = 10 years
Dividend rate = 12%
Dividends paid quarterly: Dividend
Amount = 1000 (0.12/4) = $30 (regular cash inflow). Number of quarterly periods,
N = 40 Face Value = $1000 (the final cash inflow). Purchase Price = $900 (this is
the PV or the initial cash outflow).
Use the CF register of the calculator to find the IRR=3.47%. This is the quarterly
rate of return. Nominal interest rate per year = 4 (3.47%) = 13.88%. Find the
effective interest rate using the ICONV function=14.61%.

1. Stephen Zehnder, an enterprising engineer, wants to get into business. He is looking at

the following two alternatives. He has compiled the cost data for both alternatives as
shown in table below. If Stephen wants to have at least a rate of return of 12% on this
business investment, which one should he choose?
Data
Convenience Store with Gas (A)
Ice Cream Store (B)
Initial Cost
$80,000
$120,000
Net Income
$12,000
$ 20,000
After 20 years, he plans to sell the business at double the initial cost.
:
This problem requires an incremental IRR analysis.
(120,00080,000) = (20,00012,000) (P/A, i, 20) + {(240,000160,000) (P/F, i, 20)}
Or, 40,000 = 8,000(P/A, i, 20) + 80,000(P/F, i, 20)
First, find the incremental cash flow (B A). Then, using the CF function, find the
IRR=20.50%. Since IRR=20.50% > (MARR=12%), choose to invest in the ice cream
store, the initial higher-cost alternative.
2. Two hazardous environment facilities are being evaluated, with the projected life of
each facility being 10 years. The cash flows for each facility are shown in the table
below. The company uses a MARR of 14%. Based on the rate of return, which is the
most desirable alternative?
Cash Flows
First Cost
M & O Costs
Annual Benefit
Salvage Value

A
-$450,000
-$15,000
$85,000
$45,000

Alternatives
B
-$615,000
-$10,000
$158,000
$65,000

Ans: Require an incremental ROR or IRR analysis to choose a better alternative between
the two given alternatives. The incremental cash flow is given below:
Year
Alt. BAlt. A
0
-$165,000
1 to 10
$78,000
10
$20,000 (Salvage Value)
First, find the incremental cash flow (B A). Then, using the CF function, find the
IRR=46.34%. Since IRR= 46.34%> MARR of 14%, choose the higher cost alternative,
i.e. Alt. B.

1.Two mutually exclusive projects are under consideration.

Year
Project A
Project B
0
-$5,000
-$9,000
1
$2,750
$1,000
2
$2,750
$3,000
3
$2,750
$5,000
4
$2,750
$7,000
5
$2,750
$9,000
(a) Which project should be selected if the simple payback method is used to make the
determination?
(b) Which project should be selected if NPV were used?
(c) Explain any differences in results.
Part (a): Simple payback or Payback period = Initial cost/Annual benefit = the
number of years required to recover the initial investment.
Project A: 5,000/ 2,750 = 1.8 Years.
Project B: By inspection, 3 years are required. Choose project A.
Part (b): NPW/NPV (A) = using the CF function, find NPV=$4,218
NPW/NPV (B) = using the CF function, find NPV = $5,902.
Since NPW (B) is greater than NPW (A), choose B.
Part (c): Explain differences:
Payback method does not consider time value of money and does not consider
cash flows beyond payback period. In this problem, large cash flows in years 4
and 5 for Project B are ignored and true value of the project is not considered if
payback analysis is used.

2. A construction company is considering procuring one of two types of heavy

construction equipment (A and B).
Each type of equipment is expected to have a
5-year useful life with zero salvage value. Equipment A can be purchased at a cost of
$30,000, while Equipment B would cost $55,000. The net cash flows for each type of
equipment are given below.

(a) Using the conventional payback period approach, determine which type of
equipment (A or B) the company should purchase.
(b) Consider the time value of money to be 12%. Use the benefit cost ratio approach
and determine which type of equipment (A or B) the company should procure.
The conventional payback period is the period of time it will take to recover the
initial investment out-lay.
Data
Year
Net Cash Flow
Cumulative

0
-$30,000
-$30,000

1
+$6,000
-$24,000

Equipment A
2
3
+$6,000
+$12,000
-$18,000
-$6,000

4
+$6,000
$0

5
+$25,564
-$25,564

4
-$7,000
-$7,000

5
+$26,610
+$19,610

Payback Period = 4 years.

Data
Year
Net Cash Flow
Cumulative

0
-$55,000
-$55,000

1
+$24,000
+$31,000

Equipment B
2
3
+$10,000
+$21,000
+$21,000
$0

Payback Period = 3 years.

Select Equipment B with a payback period of 3 years and reject
Equipment A with a longer period of 4 years.
Benefit Cost ratio analysis.
First, compute the PW of benefits and PW of costs for each alternative.
Alt. A
PW of benefits = $36,999.73 (Use the CF function. Start from year 1. First year
benefit is zero)
PW of cost
= $30,000
Alt. B
PW of benefits = $54,999.41 (Use the CF function. Start from year 1. First year
benefit is zero)
PW of cost
= $55,000
Then, find the Alt. B Alt. A Increment
B /C = (54,999.41 36,999.73) / (55,000 30,000) = 17,999.68/25,000 = 0.72
Choose Alt. A, the lower-cost alternative since the B /C ratio is < 1.