ENGR 301/4 - Assignment 4 - Solution

Question 4-1
How much would the owner of a building be justified in paying for a sprinkler system that will save $750 a
year in insurance premiums if the system has to be replaced every 20 years and has a salvage value equal to
10% of its initial costs? Assume money is worth 6%.
The best (closest) answer is: * $8888
PW of Cost
P

$7987

$9656

$8410

= PW of Benefits
= $750 (P/A, 6%, 20) + 0.1P (P/F, 6%, 20)
= $750 (11.4699) + 0.1P (0.3118)
= $8602 + 0.03118P
= $8602/(10.03118)
= $8602/0.96882
= $8879
Best (closest) answer is $8888

Question 4-2
A machine costs $980,000 to purchase and will provide $200,000 a year in benefits. The company plans to
use the machine for 13 years, and then will sell the machine for scrap, receiving $20,000. The company
interest rate is 12%. Which one of the following statements is correct:
(a)
(b)
(c)
(d)

NPW
NPW
NPW
NPW

= $980,000 + $200,000 (P/A,12%,13) + $20,000 (P/F,12%,13)

= $980,000 + $200,000 (P/A,12%,13) + $20,000 (P/F,12%,13)
= $980,000 + $200,000 (P/A,12%,13) $20,000 (P/F,12%,13)
= $980,000 $200,000 (P/F,12%,13) $20,000 (P/A,12%,13)

The correct answer is answer (b)

Question 4-3
Company A
NPW
= $15,000 + ($8,000 $1,600)(P/A, 15%, 4) + $3,000 (P/F, 15%, 4)
= $15,000 + $6,400 (2.855) + $3,000 (0.5718) = $4,987
Company B
NPW
= $18,000 + ($9,000 $1,100)(P/A, 15%, 4) + $3,500 (P/F, 15%, 4)
= $18,000 + $7,900 (2.855) + $3,500 (0.5718) = $6,556
Company C
NPW
= $25,000 + ($13,000 $400) (P/A, 15%, 4) + $6,000 (P/F, 15%, 4)
= $25,000 + $12,600 (2.855) + $6,000 (0.5718) = $14,404
Company D
NPW
= $20,000 + ($11,000 $900) (P/A, 15%, 4) + $4,500 (P/F, 15%, 4)
= $20,000 + $10,100 (2.855) + $4,500 (0.5718) = $11,409
Need to maximize NPW, so select Company Cs office equipment.

Question 4-4
The analysis period is chosen to be 10 years and the gasoline option is repeated starting the end of fifth year
for 5 more years.
PWgas = 2400 + (1200(P/A, 10%, 5)) + ((300(P/A, 10%, 5)) + 300(P/F, 10%, 5)
+ (2400(P/F, 10%, 5)) + (1200(P/A, 10%, 5)*(P/F, 10%, 5))
+ ((300(P/A, 10%, 5)*(P/F, 10%, 5)) + 300(P/F, 10%, 10)
= 2400 + (1200*3.791) + (300*3.791) + (300*0.6209)
+ (2400*0.6209) + (1200*3.791*0.6209) + (300*3.791*0.6209)
+ (300*0.3855)
= 12,805
PWelectr = 6000 + (750(P/A, 10%, 10)) + (50(P/A, 10%, 10)) + (600*(P/F, 10%, 10))
= 6000 + (750*6.145) + (50*6.145) + 600(0.3855)
= 10,685
Select the electric pump, because the present worth is highest. So, answer (c).
Questions 4-5and 4-6
Since we are doing calculations in terms of equivalent uniform annual benefits, we do not have to have
equal planning horizons.
EUABA = 500 (A/P,0.08,5) + 130 = 125.23 + 130 = 4.77
EUABB = 600 (A/P,0.08,5) + 115 + 250 (A/F,0.08,5) = 150.27 + 115 + 42.61 = 7.34
EUABC = 700 (A/P,0.08,10) + 100 + 180 (A/F,0.08,10) = 104.32 + 100 + 12.43 = 8.10
5-5:

So, select Company C because it has greatest EUAB.

5-6:

EUABCB = 700 (A/P,i,10) +600 (A/P,i,5) 15 + 180 (A/F,i,10) 250 (A/F,i,5)

For i=0:

EUABCB = 700/10 +600/5 15 + 180/10 250/5 = 3.00

For i=0.2: EUABCB = 700 (A/P,0.2,10) + 600 (A/P,0.2,5) 15 + 180 (A/F,0.2,10) 250 (A/F,0.2,5)
= 700 (0.2385) + 600 (0.3348) 15 + 180 (0.03852) 250 (0.1344) = 8.00
The value of 8.00 is large compared to the + 3.00. So, let us also calculate EUABCB for i=0.1.
For i=0.1: EUABCB = 700 (A/P,0.1,10) + 600 (A/P,0.1,5) 15 + 180 (A/F,0.1,10) 250 (A/F,0.1,5)
= 700 (0.1627) + 600 (0.2638) 15 + 180 (0.06274) 250 (0.1699) = 0.30
Linear interpolation between [0,3] and [0.1, 0.30] gives:
IRR1 = 0 + (0.1*3)/(3+0.30) = 0.091 = 9.1%
Verifying:
Note that

EUABCB(i=0.091) = 0.20.
EUABCB(i=0.1) = 0.30

Linear interpolation between these points gives:

IRR2 = 0.091 + 0.2*(0.10.091)/(0.2+0.30) = 0.091 + 0.0036 = 0.0946 = 9.46%
Verifying:

EUABCB(i=0.0946) = 0.01. Answer is 9.46% and 9.5% is the best answer.

Comment:

Ordinarily, we would use above method to find IRR. However, we are given certain possible
answers for IRR. So, we can substitute our answers in the EUABCB equation and find out
when EUABCB is closest to 0, because EUABCB(IRR) = 0.
EUABCB(i=0.075) = 1.00
EUABCB(i=0.085) = 0.52
EUABCB(i=0.095) = 0.02 This is closest to 0, so IRR = 0.095 = 9.5%
EUABCB(i=0.105) = 0.59

Question 4-7
At Year 0, PW of Cost = PW of Benefits
$412 + $5,000 (P/F, i%, 10) = ($1000/i) (P/F, i%, 10)
Try i = 15%
$412 + $5,000 (0.2472)
$1,648

= ($1,000/0.15) (0.2472)
= $1,648

So, answer: rate of return = 15%

Or at year 10: $5000 + $412 (F/P, i%, 10) = $1000/i
f(i) = 412 i (1+i)10 + 5000 i 1000 = 0
Substituting the answers on the answer sheet in above equation we get:
f(0.18) = 288.14, f(0.21) = 632.06, f(0.15) = 0.02, f(0.12) = 246.45
So the closest answer is i = 0.15 = 15%
Question 4-8
1991 1626 = 365 years = n
F
12 x 109

= P (1 + i)n
= 24 (1 + i)365

(1 + i)365

= 12 x 100/24 = 5.00 x 108

1+i

= (5.00 x 108)1/365 = 1.0564

Or

i = 5.64%

So, 5.6% is best answer

Question 4-9
There is no need to do any calculations; the IRR values for A, B and BA are given. All are investment
schemes, for which we know the following:
Accept A if MARR < IRRA=15%
Accept B if MARR < IRRB=12%
B is better than A if MARR < IRRB-A =9.8%
Since MARR=8%, both alternative A and alternative B are acceptable. Since IRRB-A > MARR, alternative
B is preferred over alternative A, so answer: (c)
Question 4-10
Lets assume that a late twentieth century university graduate got a good job and began a savings account.
She authorized the bank to transfer $75 each month from her checking account to her savings account. The
bank made the first withdrawal 3 July 2007 and is instructed to make the last withdrawal on 3 July 2025.
The bank pays a nominal interest rate of 4.5% and compounds twice a month. What is the future worth of
the account on 3 July 2025?
The monthly deposits to the savings account do not match the twice a month compounding period. To
use the standard formulas we must either
(1) compute an equivalent twice a month savings account deposit, or
(2) compute an equivalent monthly interest rate.
Beware. We have 18 years of withdrawals plus one more because the first withdrawal is made on 3 July
2007 and the last withdrawal on 3 Jul 2025.
Method 1
A

A
n=2
i = 0.045/24 = 0.001875

$75

Equivalent twice a month deposit (A)

Future Sum F

= $75 (A/F, i%, n)

= $75 [0.001875/((1 + 0.001875)2 1)]
= $37.4649

= A (F/A, i%, 18 x 24 + 2)
= $37.4649 [((1 + 0.001875)434 1)/0.001875]
= $25,069

$25,050 is closest

Method 2
Effective i per month (imonth) = (1 + 0.045/24)2 1
Future Sum F

= 0.0037535

= A (F/A, imonth, 18 x 12 + 1)
= $75 [((1 + 0.0037535)217 1)/0.0037535]
= $25,069

$25,050 is closest

Question 4-11
Cost
Uniform Annual Benefit
B/COF X
B/COF Y
B/COF Z

X
$600
$158.3

= $158.3/[$600 (A/P, 10%, 5)]

= $138.7/[$500 (A/P, 10%, 5)]
= $58.3/[$200 (A/P, 10%, 5)]

Y
$500
$138.7

Z
$200
$58.3

= 158.3/158.28 = 1.00
= 138.7/131.90 = 1.05
= 58.3/52.76 = 1.11

All alternatives have a B/C ratio > 1.00. However, a higher B/C ratio does not mean a better
alternative. Proceed with incremental analysis.

Cost
Uniform Annual Benefit

Y-Z
$300
$80.4

X-Y
$100
$19.6

B/COF Y-Z = $80.4/[$300 (A/P, 10%, 5)] = 1.02

Desirable increment. Y is better than Z. Reject Option Z.
B/COF X-Y = $19.6/[$100 (A/P, 10%, 5)] = 0.74
Undesirable increment. Y is better than X. Reject Option X.
Conclusion: Select Option Y.
Alternatively, we can evaluate AW = AWbenefits AWcosts for each alternative.
AWX = 158.3158.28 = 0.02; AWY = 138.7131.9 = 6.8; AWZ = 58.352.76 = 5.54. Option Y is best.
Question 4-12

Cost
Uniform annual benefit
Useful life, in years

A
$800
$230
5

B
$1000
$230
X

EUAC= Cost (A/P, i, time), where i = 12%

(EUAB - EUAC)A = 230 - 800 (A/P, 12%, 5) = 230 - 800 (0.2774) = 230 - 221.92 = 8.08
To make both alternatives desirable, (EUAB - EUAC)A has to be equal to (EUAB - EUAC)B.
(EUAB - EUAC)A = (EUAB - EUAC)B
8.08 = 230 - 1,000 (A/P, 12, X)
221.92 = 1,000 (A/P, 12, X)
So, (A/P, 12, X) = 0.2219
On the 12% discreet compound interest table, the A/P value closest to 0.221 is 0.2191, found at n = 7.
Therefore, X 7 years.