AACE INTERNATIONAL APPLIED ENGINEERING ECONOMICS

Chapter 28

Applied Engineering Economics

Dr. Scott J. Amos, PE

INTRODUCTION
In the previous chapter, the basic tools for economic analysis
were developed. These tools allow us to manipulate cash
flows in many ways and give us the power to compare and
evaluate cash flow against specified criteria. Application of
these tools is the subject of this chapter. In general, econom-
ic selection criterion will be either maximization of benefits,
minimization of costs, or maximization of the net profits.
Techniques will be presented for evaluation of single as well
as multiple alternative type problems.
LEARNING OBJECTIVES
which benefits are equivalent to costs. Thus the cash flow is
solved for the unknown value, i. This technique is also
known as internal rate of return and can be used with either
present worth or annual worth equivalents.
Example 28.1—
A $10,000 investment returned $2,342 per year over a 5-
year period. What was the rate of return on this invest-
ment?
Solution—Set the present worth of benefits equal to the
present worth of costs, then algebraically isolate the dis-
count factor and treat it as an unknown.

After completing this chapter, readers should be able to
• evaluate and select the best alternative using present
value, future value, equivalent uniform annual value,
and discounted rate of return; and
• compare alternatives using the benefit-cost ratio.
CASH FLOW ANALYSIS
$2,342 (P/A, i, 5) = $10,000
(P/A, i, 5) = $10,000 = 4.27
$2,342
Now look at the compound interest factors in the tables
27.2 and 27.3 for the value of i where (P/A, i, 5) = 4.270;
since no tabulated value is given, find the values on
either side of the desired value and interpolate to find
the rate of return i.

There are two fundamental approaches to the analysis of a From the tables find
given cash flow, equivalent worth, and rate-of-return.
i (P/A, i, 5)
Equivalent Worth—The equivalent worth method simply
5.0 % 4.379
converts to one of the basic forms, i.e., the equivalent present
? 4.270
worth, or annual worth, using previously-developed tech-
6.0 % 4.212
niques and the required MARR. A negative result means the
proposed cash flow is unacceptable because it does not pro-
vide the required return-on-investment. Positive results are
desirable and indicate an investment that will meet the pre-
scribed criteria. This technique has been previously illustrat- In this example, the rate of return for the investment was
ed in examples 27.5 through 27.7. found to be 5.5 percent.

Rate-of-Return—The fundamental concept behind rate-of-

return (ROR) analysis is that the ROR is the interest rate at

28.1