İMÜ 376 - ENGINEERING ECONOMICS

2020-2021 FALL SEMESTER

PROBLEM SET 3

Q1. An investment with the initial cost of 100 000 TL will bring a yearly income of 18 000 TL
for 6 years. The investor is willing the accept any option that will provide at least a 10% return
on the invested money (i.e., MARR = 10%). Decide whether this investment is economically
viable using:
a) Present worth method
b) Annual equivalence method
c) Rate of return method

Solution:

18 000 TL 18 000 TL 18 000 TL 18 000 TL 18 000 TL 18 000 TL

1 2 3 4 5 6

100 000 TL

a) PW = -100000 + 18000 (P/A, 10%, 6) = -100000 + 18000 * 4.3553 = -21 604.6 TL

⇒ Not acceptable
b) AE = -100000 (A/P, 10%, 6) + 18000 = -100000 * 0.2296 + 18000 = -4 960 TL
⇒ Not acceptable
c) PW (i*) = 0 = -100000 + 18000 (P/A, i*, 6)
Try i* = 2% ⇒ PW (2%) = -100000 + 18000 * 5.6014 = 825.2 TL
Try i* = 3% ⇒ PW (3%) = -100000 + 18000 * 5.4172 = -2 490.4 TL
825.2
By linear interpolation: i∗ = 2 + = 2.25% < 10%
825.2 + 2490.4
⇒ Not acceptable

Page 1 of 23
Q2. An office building is bought for 500 000 TL to rent it for 5 years. The rental income at the
end of the first year is estimated to be 30 000 TL and it will increase by 10% for five years.
There are also some yearly expenses for the building. The total expense for the first year is
2 500 TL, which will increase by 20% annually.
a) What is the rate of return of this office building if it can be sold by the initial purchase
price at the end of the 5 years?
b) Is this investment reasonable if MARR = 6%?

Solution:

500 000 TL

43 923 TL
39 930 TL
36 300 TL
33 000 TL
30 000 TL

0 1 2 3 4
5

2 500 TL 3 000 TL
3 600 TL 4 320 TL
5184 TL

500 000 TL

a) PW (i*) = 0 = -500000 + 27500 (P/F, i*, 1) + 30000 (P/F, i*, 2) +

32700 (P/F, i*, 3) + 35610 (P/F, i*, 4) + 538739 (P/F, i*, 5)
Try i* = 5% ⇒ PW (5%) = -500000 + 27500 * 0.9524 + 30000 * 0.9070 +
32700 * 0.8638 + 35610 *0.8227 + 538739 * 0.7835 = 33 045.61 TL
Try i* = 6% ⇒ PW (6%) = -500000 + 27500 * 0.9434 + 30000 * 0.8900 +
32700 * 0.8396 + 35610 *0.7921 + 538739 * 0.7473 = 10 904.76 TL
Try i* = 7% ⇒ PW (7%) = -500000 + 27500 * 0.9346 + 30000 * 0.8734 +
32700 * 0.8163 + 35610 *0.7629 + 538739 * 0.7130 = -10 115.71 TL
10904.76
By linear interpolation: i∗ = 6 + = 𝟔. 𝟓𝟐%
10904.76 + 10115.71
b) As i* > MARR, the investment is reasonable.

Page 2 of 23
Q3. In a road construction project, two asphalt materials can be used for surfacing. Cost details
of these materials are tabulated below. Using the present worth comparison method decide
which surfacing material should be selected for the road that has a service life of 20 years. The
interest rate is given as 8% per year.
Cost Item Type A Material Type B Material
Initial Cost 50 000 000 TL 60 000 000 TL
Yearly Maintenance Cost 1 000 000 TL 500 000 TL
Resurfacing Cost 10 000 000 TL 5 000 000 TL
Resurfacing Period 5 years 4 years

Solution:

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
TYPE A

1 000 000 TL 1 000 000 TL

10 000 000 TL 10 000 000 TL 10 000 000 TL

50 000 000 TL

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
TYPE B

500 000 TL 500 000 TL

5 000 000 TL 5 000 000 TL 5 000 000 TL 5 000 000 TL

60 000 000 TL

PWA = -50 000 000 – 1 000 000 (P/A, 8%, 20) – 10 000 000 (P/F, 8%, 5) –
10 000 000 (P/F, 8%, 10) – 10 000 000 (P/F, 8%, 15)
PWA = -50 000 000 – 1 000 000 * 9.8181 – 10 000 000 * 0.6806 –
10 000 000 * 0.4632 – 10 000 000 * 0.3152 = -74 408 100 TL

PWB = -60 000 000 – 500 000 (P/A, 8%, 20) – 5 000 000 (P/F, 8%, 4) –
5 000 000 (P/F, 8%, 8) – 5 000 000 (P/F, 8%, 12) – 5 000 000 (P/F, 8%, 16)
PWB = -60 000 000 – 500 000 * 9.8181 – 5 000 000 * 0.7350 –
5 000 000 * 0.5403 – 5 000 000 * 0.3971 – 5 000 000 * 0.2919 = -74 730 550 TL

PWA < PWB ⇒ Select Type A material

Page 3 of 23
Q4. A construction company can buy 2 different types of a backhoe loader. The first loader has
a useful life of 20 years, whereas the second loader can be used for 15 years. Their cost details
are tabulated below. Using the annual equivalence comparison method decide which backhoe
loader should be selected. The interest rate is given as 15% per year.
Cost Item Backhoe Loader A Backhoe Loader B
Initial Cost 600 000 TL 500 000 TL
Yearly Operational Cost 75 000 TL 80 000 TL
Salvage Value 100 000 TL N/A

Solution:

100 000 TL

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
20 BACKHOE A

75 000 TL

600 000 TL

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
BACKHOE B

80 000 TL

500 000 TL

AEA = -600 000 (A/P, 15%, 20) – 75 000 + 100 000 (A/F, 15%, 20)
AEA = -600 000 * 0.1598 – 75 000 + 100 000 * 0.0098 = -169 900 TL

AEB = -500 000 (A/P, 15%, 15) – 80 000

AEB = -500 000 * 0.1710 – 80 000 = -165 500 TL

AEB < AEA ⇒ Select Backhoe Loader B

Page 4 of 23
Q5. Cash flows of the two investment alternatives are presented below. Find the rate of return
of each alternative and decide which option should be selected using a MARR of 9%.

10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL

0 1 2 3 4
5 OPTION 1

1 000 TL 1 100 TL 1 200 TL 1 300 TL 1 400 TL

30 000 TL

2 500 TL

15 000 TL 14 500 TL 14 000 TL 13 500 TL

13 000 TL 12 500 TL 12 000 TL 11 500 TL
11 000 TL 10 500 TL

0 1 2 3 4 5 6 7 8 9
10 OPTION 2

2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL

5 000 TL

60 000 TL

Solution:

PW (i1*) = 0 = -30000 – [1000 + 100 (A/G, i1*, 5)] (P/A, i1*, 5) + 10000 (P/A, i1*, 5)
Try i1* = 10% ⇒ PW (10%) = -30000 – [1000 + 100 * 1.8101] * 3.7908 + 10000 * 3.7908
PW (10%) = 3 431. 03 TL
Try i1* = 11% ⇒ PW (11%) = -30000 – [1000 + 100 * 1.7923] * 3.6959 + 10000 * 3.6959
PW (11%) = 2 600. 68 TL
Try i1* = 12% ⇒ PW (12%) = -30000 – [1000 + 100 * 1.7746] * 3.6048 + 10000 * 3.6048
PW (12%) = 1 803. 49 TL
Try i1* = 14% ⇒ PW (14%) = -30000 – [1000 + 100 * 1.7399] * 3.4331 + 10000 * 3.4331
PW (14%) = 300. 57 TL
Try i1* = 15% ⇒ PW (15%) = -30000 – [1000 + 100 * 1.7228] * 3.3522 + 10000 * 3.3522
PW (15%) = -407. 72 TL
300.57
By linear interpolation: i1 ∗ = 14 + = 𝟏𝟒. 𝟒𝟐%
300.57 + 407.72

Page 5 of 23
PW (i2*) = 0 = -60000 – 2000 (P/A, i2*, 10) – 5000 (P/F, i2*, 5) +
[15000 – 500 (A/G, i2*, 10)] (P/A, i2*, 10) + 2500 (P/F, i2*, 10)
Try i2* = 10% ⇒ PW (10%) = -60000 – 2000 * 6.1446 – 5000 * 0.6209 +
[15000 – 500 * 3.7255] * 6.1446 + 2500 * 0.3855 = 6 293.20 TL
Try i2* = 11% ⇒ PW (11%) = -60000 – 2000 * 5.8892 – 5000 * 0.5935 +
[15000 – 500 * 3.6544] * 5.8892 + 2500 * 0.3522 = 3 711.85 TL
Try i2* = 12% ⇒ PW (12%) = -60000 – 2000 * 5.6502 – 5000 * 0.5674 +
[15000 – 500 * 3.5847] * 5.6502 + 2500 * 0.3220 = 1 293.46 TL
Try i2* = 14% ⇒ PW (14%) = -60000 – 2000 * 5.2161 – 5000 * 0.5194 +
[15000 – 500 * 3.4490] * 5.2161 + 2500 * 0.2697 = -3 108.61 TL
1293.46
By linear interpolation: i2 ∗ = 12 + 2 ∗ = 𝟏𝟐. 𝟓𝟗%
1293.46 + 3108.61

For both options, the rate of return value is greater than the MARR. It means that they are both
economically viable. However, the best investment option cannot be decided by comparing
their individual rate of return values. In order to determine the best option, any of the annual
equivalence comparison, present worth comparison, or incremental rate of return methods
should be used. Solutions for all methods are provided below:

Annual equivalence comparison method:

AE1 = -30000 (A/P, 9%, 5) – [1000 + 100 (A/G, 9%, 5)] + 10000
AE1 = -30000 * 0.2571 – [1000 + 100 * 1.8282] + 10000 = 1 104.18 TL

AE2 = -60000 (A/P, 9%, 10) – 2000 – 5000 (P/F, 9%, 5) (A/P, 9%, 10) +
[15000 – 500 (A/G, 9%, 10)] + 2500 (A/F, 9%, 10)
AE2 = -60000 * 0.1558 – 2000 – 5000 * 0.6499 * 0.1558 +
[15000 – 500 * 3.7978] + 2500 * 0.0658 = 1 411.33 TL

AE2 > AE1 ⇒ Select Option 2

Page 6 of 23
Present worth comparison method:
For the present worth comparison, alternatives must be evaluated with equal service life. Their
common multiple of lives is 10 years. Accordingly, cash flows are updated as follows:

10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL 10 000 TL

0 1 2 3 4 5 6 7 8 9
10 OPTION 1

1 000 TL 1 100 TL 1 200 TL 1 300 TL 1 400 TL 1 000 TL 1 100 TL 1 200 TL 1 300 TL 1 400 TL

30 000 TL

30 000 TL

2 500 TL

15 000 TL 14 500 TL 14 000 TL 13 500 TL

13 000 TL 12 500 TL 12 000 TL 11 500 TL
11 000 TL 10 500 TL

0 1 2 3 4 5 6 7 8 9
10 OPTION 2

2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL 2 000 TL

5 000 TL

60 000 TL

PW1 = -30000 – 30000 (P/F, 9%, 5) – [1000 + 100 (A/G, 9%, 5)] (P/A, 9%,5) –
[1000 + 100 (A/G, 9%, 5)] (P/A, 9%, 5) (P/F, 9%, 5) + 10000 (P/A, 9%, 10)
PW1 = -30000 – 30000 * 0.6499 – [1000 + 100 * 1.8282] * 3.8897 –
[1000 + 100 * 1.8282] * 3.8897 * 0.6499 + 10000 * 6.4177 = 7 089.12 TL

PW2 = -60000 – 2000 (P/A, 9%, 10) – 5000 (P/F, 9%, 5) +

[15000 – 500 (A/G, 9%, 10)] (P/A, 9%, 10) + 2500 (P/F, 9%, 10)
PW2 = -60000 – 2000 * 6.4177 – 5000 * 0.6499 +
[15000 – 500 * 3.7978] * 6.4177 + 2500 * 0.4224 = 9 050.03 TL

PW2 > PW1 ⇒ Select Option 2

Page 7 of 23
Incremental rate of return method:
The initial cost of Option 2 is greater than Option 1. Therefore, Option 1 is the current best and
Option 2 is the challenger. Cash flow for ‘Challenger – Current Best’ is provided below.

25 000 TL

2 500 TL

5 000 TL 4 500 TL 4 000 TL 3 500 TL 3 000 TL

2 500 TL 2 000 TL 1 500 TL 1 000 TL 500 TL
0 1 2 3 4 5 6 7 8 9
10 OPTION 2 – OPTION 1

1 000 TL 900 TL 800 TL 700 TL 600 TL 1 000 TL 900 TL 800 TL 700 TL 600 TL

30 000 TL

PW2-1 (i2-1*) = 0 = -30000 – [1000 – 100 (A/G, i2-1*, 5)] (P/A, i2-1*,5) –
[1000 – 100 (A/G, i2-1*, 5)] (P/A, i2-1*, 5) (P/F, i2-1*, 5) + 25000 (P/F, i2-1*, 5) +
2500 (P/F, i2-1*, 10) + [5000 – 500 (A/G, i2-1*, 10)] (P/A, i2-1*, 10)
Try i2-1* = 10% ⇒ PW2-1 (10%) = -30000 – [1000 – 100 * 1.8101] * 3.7908 –
[1000 – 100 * 1.8101] * 3.7908 * 0.6209 + 25000 * 0.6209 +
2500 * 0.3855 + [5000 – 500 * 3.7255] * 6.1446 = 731.11 TL
Try i2-1* = 11% ⇒ PW2-1 (11%) = -30000 – [1000 – 100 * 1.7923] * 3.6959 –
[1000 – 100 * 1.7923] * 3.6959 * 0.5935 + 25000 * 0.5935 +
2500 * 0.3522 + [5000 – 500 * 3.6544] * 5.8892 = -430.60 TL
731.11
By linear interpolation: i2−1 ∗ = 10 + = 10.63%
731.11 + 430.60

i2-1* = 10.63% > MARR = 9% ⇒ Current best (Option 1) is eliminated. Select Option 2

Although the individual rate of return value of Option 1 is higher than the that of Option 2,
Option 2 is a better alternative in terms of the economic viability. The individual rate of return
value shows how much of the initial investment returns to the investor. It cannot be used to
compare the alternatives. As a result, according to the three comparison methods shown above,
Option 2 should be selected.

Page 8 of 23
Q6. An investor is evaluating the economical viability of the 3 investment options. Income and
cost details of these alternatives are tabulated below. Assuming a MARR of 16% and using the
present worth comparison method, decide which option should be selected.
Cost-Income Item Option 1 Option 2 Option 3
Service Life 10 years 15 years 6 years
Initial Cost 75 000 000 TL 125 000 000 TL 22 500 000 TL
Yearly Operational Cost 4 000 000 TL 1 000 000 TL 500 000 TL
Yearly Income 25 000 000 TL 27 500 000 TL 12 500 000 TL
Salvage Value 5 000 000 TL 12 500 000 TL N/A

Solution:

The problem can be solved in 3 different ways. All solutions are given below:

Solution 1 (Find PW of each alternative and then use common multiple of lives):
PW1 = -75000000 – 4000000 (P/A, 16%, 10) + 25000000 (P/A, 16%, 10) +
5000000 (P/F, 16%, 10)
PW1 = -75000000 – 4000000 * 4.8332 + 25000000 * 4.8332 +
5000000 * 0.2267 = 27 630 700 TL

PW2 = -125000000 – 1000000 (P/A, 16%, 15) + 27500000 (P/A, 16%, 15) +
12500000 (P/F, 16%, 15)
PW2 = -125000000 – 1000000 * 5.5755 + 27500000 * 5.5755 +
12500000 * 0.1079 = 24 099 500 TL

PW3 = -22500000 – 500000 (P/A, 16%, 6) + 12500000 (P/A, 16%, 6)

PW3 = -22500000 – 500000 * 3.6847 + 12500000 * 3.6847 = 21 716 400 TL

Common multiple of lives: 30 years

Page 9 of 23
 27 630 700 TL 27 630 700 TL 27 630 700 TL

OPTION 1
0 10 20 30

24 099 050 TL 24 099 050 TL

OPTION 2
0 15 30

21 716 400 TL 21 716 400 TL 21 716 400 TL 21 716 400 TL 21 716 400 TL

OPTION 3
0 6 12 18 24 30

For 30 years:

PW1 = 27630700 [1 + (P/F, 16%, 10) + (P/F, 16%, 20)]

PW1 = 27630700 * [1 + 0.2267 + 0.0514] = 35 314 797.67 TL

PW2 = 24099050 [1 + (P/F, 16%, 15)]

PW2 = 24099050 * [1 + 0.1079] = 26 699 337.50 TL

PW3 = 21716400 [1 + (P/F, 16%, 6) + (P/F, 16%, 12) + (P/F, 16%, 18) + (P/F, 16%, 24)]
PW3 = 21716400 * [1 + 0.4104 + 0.1685 + 0.0691 + 0.0284] = 36 405 372.96 TL

PW3 > PW1 > PW2 ⇒ Select Option 3

Solution 2 (Find PW of each alternative with common multiple of lives):

Cash flows of the alternatives for 30 years are given below:

Page 10 of 23
 5 000 000 TL
5 000 000 TL 5 000 000 TL

25 000 000 TL 25 000 000 TL

0 10 20
30 OPTION 1

4 000 000 TL 4 000 000 TL

75 000 000 TL

75 000 000 TL 75 000 000 TL

12 500 000 TL
12 500 000 TL

27 500 000 TL 27 500 000 TL

0 15
30 OPTION 2

1 000 000 TL 1 000 000 TL

125 000 000 TL

125 000 000 TL

12 500 000 TL 12 500 000 TL

0 6 12 18 24
30 OPTION 3

500 000 TL 500 000 TL

22 500 000 TL

22 500 000 TL 22 500 000 TL 22 500 000 TL 22 500 000 TL

PW1 = -75000000 – 75000000 (P/F, 16%, 10) – 75000000 (P/F, 16%, 20) –
4000000 (P/A, 16%, 30) + 25000000 (P/A, 16%, 30) + 5000000 (P/F, 16%, 10) +
5000000 (P/F, 16%, 20) + 5000000 (P/F, 16%, 30)
PW1 = -75000000 – 75000000 * 0.2267 – 75000000 * 0.0514 –
4000000 * 6.1772 + 25000000 * 6.1772 + 5000000 * 0.2267 +
5000000 * 0.0514 + 5000000 * 0.0116 = 35 312 200 TL

Page 11 of 23
PW2 = -125000000 – 125000000 (P/F, 16%, 15) – 1000000 (P/A, 16%, 30) +
27500000 (P/A, 16%, 30) + 12500000 (P/F, 16%, 15) + 12500000 (P/F, 16%, 30)
PW2 = -125000000 – 125000000 * 0.1079 – 1000000 * 6.1772 +
27500000 * 6.1772 + 12500000 * 0.1079 + 12500000 * 0.0116 = 26 702 050 TL

PW3 = -22500000 – 22500000 (P/F, 16%, 6) – 22500000 (P/F, 16%, 12) –

22500000 (P/F, 16%, 18) – 22500000 (P/F, 16%, 24) – 500000 (P/A, 16%, 30) +
12500000 (P/A, 16%, 30)
PW3 = -22500000 – 22500000 * 0.4104 – 22500000 * 0.1685 –
22500000 * 0.0691 – 22500000 * 0.0284 – 500000 * 6.1772 +
12500000 * 6.1772 = 36 407 400 TL

PW3 > PW1 > PW2 ⇒ Select Option 3

Solution 3 (Find AE of each alternative and then convert it to PW with common multiple
of lives):
AE1 = -75000000 (A/P, 16%, 10) – 4000000 + 25000000 + 5000000 (A/F, 16%, 10)
AE1 = -75000000 * 0.2069 – 4000000 + 25000000 + 5000000 * 0.0469 = 5 717 000 TL

AE2 = -125000000 (A/P, 16%, 15) – 1000000 + 27500000 + 12500000 (A/F, 16%, 15)
AE2 = -125000000 * 0.1794 – 1000000 + 27500000 + 12500000 * 0.0194 = 4 317 500 TL

AE3 = -22500000 (A/P, 16%, 6) – 500000 + 12500000

AE3 = -22500000 * 0.2714 – 500000 + 12500000 = 5 893 500 TL

For common multiple of lives (30 years):

PW1 = AE1 (P/A, 16%, 30) = 5717000 * 6.1772 = 35 315 052.40 TL

PW2 = AE2 (P/A, 16%, 30) = 4317500 * 6.1772 = 26 670 061.00 TL

PW3 = AE3 (P/A, 16%, 30) = 5893500 * 6.1772 = 36 405 328.20 TL

PW3 > PW1 > PW2 ⇒ Select Option 3

Page 12 of 23
Q7. A contractor is looking for a car to be used in the construction site for 5 years. There are 3
options available including diesel, gasoline, and hybrid engine cars. Cost details of the cars are
tabulated below. Assuming a MARR of 18% and using the incremental rate of return method
with the present worth approach, decide which car should be purchased.
Cost Item Diesel Gasoline Hybrid
Initial Cost 150 000 TL 100 000 TL 200 000 TL
1st year: 16 000 TL 1st year: 24 000 TL 1st year: 8 000 TL
Yearly Operational
Increases Increases Increases
Cost
2 000 TL/year 3 000 TL/year 1 000 TL/year
1st year: 5 000 TL 1st year: 2 000 TL
Yearly Maintenance
Increases Increases 2 000 TL
Cost
1 500 TL/year 500 TL/year
Salvage Value 140 000 TL 85 000 TL 175 000 TL

Solution:

Current Best: Gasoline engine car

Challenger: Diesel engine car

55 000 TL

5 000 TL 5 000 TL 5 000 TL 5 000 TL 5 000 TL

0
DIESEL – GASOLINE
1 2 3 4 5

50 000 TL

PWD-G (iD-G*) = 0 = -50000 + 5000 (P/A, iD-G*, 5) + 55000 (P/F, iD-G*, 5)

Try iD-G* = 10% ⇒ PWD-G (10%) = -50000 + 5000 * 3.7908 + 55000 * 0.6209 = 3 103.50 TL
Try iD-G* = 11% ⇒ PWD-G (11%) = -50000 + 5000 * 3.6959 + 55000 * 0.5935 = 1 112.00 TL
Try iD-G* = 12% ⇒ PWD-G (12%) = -50000 + 5000 * 3.6048 + 55000 * 0.5674 = -769.00 TL

Page 13 of 23
 1112
By linear interpolation: iD−G ∗ = 11 + = 11.59%
769 + 1112

iD-G* = 11.59% < MARR = 18% ⇒ Current best (Gasoline engine car) remains as the current
best. Challenger (Diesel engine car) is eliminated.

Current Best: Gasoline engine car

Challenger: Hybrid engine car

90 000 TL

23 500 TL 26 000 TL
18 500 TL 21 000 TL
16 000 TL
0
HYBRID – GASOLINE
1 2 3 4 5

100 000 TL

PWH-G (iH-G*) = 0 = -100000 + [16000 + 2500 (A/G, iH-G*, 5)] (P/A, iH-G*, 5) +
90000 (P/F, iH-G*, 5)
Try iH-G* = 16% ⇒ PWH-G (16%) = -100000 + [16000 + 2500 * 1.7060] * 3.2743 +
90000 * 0.4761 = 9 202.69 TL
Try iH-G* = 18% ⇒ PWH-G (18%) = -100000 + [16000 + 2500 * 1.6728] * 3.1272 +
90000 * 0.4371 = 2 452.15 TL
Try iH-G* = 20% ⇒ PWH-G (20%) = -100000 + [16000 + 2500 * 1.6405] * 2.9906 +
90000 * 0.4019 = -3 714.20 TL
2452.15
By linear interpolation: iH−G ∗ = 18 + 2 ∗ = 18.80%
2452.15 + 3714.20

iH-G* = 18.80% > MARR = 18% ⇒ Current best (Gasoline engine car) is eliminated.
Purchase Hybrid engine car.

Page 14 of 23
Q8. In a bridge construction project, two different routes can be used. If the bridge is
constructed on Route 1, it will have 50 km length and can be used for 20 years. The construction
cost of this alternative is 125 000 000 TL and yearly maintenance cost is 10 TL/meter. Number
of cars to use this route is estimated to be 500 000/year and the revenue brought in by each car
will be 58 TL. On the other hand, the bridge to be constructed on Route 2 has the initial
construction cost of 150 000 000 TL and it can serve for 30 years. Yearly maintenance cost
will be 400 000 TL for the first 15 years and 1 000 000 TL for the last 15 years. Number of
cars to use this route is estimated to be 300 000/year and the revenue brought in by each car
will be 110 TL. Assuming a MARR of 20% and using the incremental rate of return method
with the present worth approach, decide which route should be selected for the bridge
construction.

Solution:

Yearly income of Route 1: 500000 * 58 = 29 000 000 TL

Yearly maintenance cost of Route 1: 50 * 1000 * 10 = 500 000 TL
Yearly income of Route 2: 300000 * 110 = 33 000 000 TL
Current best: Route 1
Challenger: Route 2
Common multiple of lives: 60 years

29 000 000 TL

0
20 Route 1

500 000 TL

125 000 000 TL

AE1 (i*) = -125000000 (A/P, i*, 20) + 28500000

PW1 (i*) = [-125000000 (A/P, i*, 20) + 28500000] (P/A, i*, 60)

Page 15 of 23
 33 000 000 TL

0 15
30 Route 2

400 000 TL
1 000 000 TL

150 000 000 TL

AE2 (i*) = -150000000 (A/P, i*, 30) – 400000 (P/A, i*, 15) (A/P, i*, 30)
– 1000000 (F/A, i*, 15) (A/F, i*, 30) + 33000000
PW2 (i*) = [-150000000 (A/P, i*, 30) – 400000 (P/A, i*, 15) (A/P, i*, 30)
– 1000000 (F/A, i*, 15) (A/F, i*, 30) + 33000000] (P/A, i*, 60)

Challenger – current best:

PW2 (i*) - PW1 (i*) = 0 = [-150000000 (A/P, i*, 30) – 400000 (P/A, i*, 15) (A/P, i*, 30) –
– 1000000 (F/A, i*, 15) (A/F, i*, 30) + 125000000 (A/P, i*, 20) + 4500000] (P/A, i*, 60)
Try i* = 16% ⇒ PW2 (16%) - PW1 (16%) = [-150000000 * 0.1619 – 400000 * 5.5755 * 0.1619
– 1000000 * 51.6595 * 0.0019 + 125000000 * 0.1687 + 4500000] * 6.2492
PW2 (16%) - PW1 (16%) = 5 269 810.19 TL
Try i* = 18% ⇒ PW2 (18%) - PW1 (18%) = [-150000000 * 0.1813 – 400000 * 5.0916 * 0.1813
– 1000000 * 60.9653 * 0.0013 + 125000000 * 0.1868 + 4500000] * 5.5553
PW2 (18%) - PW1 (18%) = 1 147 182.10 TL
Try i* = 20% ⇒ PW2 (20%) - PW1 (20%) = [-150000000 * 0.2008 – 400000 * 4.6755 * 0.2008
– 1000000 * 72.0351 * 0.0008 + 125000000 * 0.2054 + 4500000] * 4.9999
PW2 (20%) - PW1 (20%) = -1 890 783.38 TL
1147182.10
By linear interpolation: i∗ = 18 + 2 ∗ = 𝟏𝟖. 𝟕𝟔%
1147182.10 + 1890783.38

i* = 18.76% < MARR = 20% ⇒ Current best remains as the current best. Construct the
bridge on Route 1.

Page 16 of 23
Q9. A power plant, which will be operated for 20 years, can be designed in 3 different ways in
terms of total production capacity. Income and cost details of 500-Megawatt, 1000-Megawatt,
and 1500-Megawatt options are tabulated below. Assuming a MARR of 7% and using the
incremental rate of return method with the annual equivalence approach, decide the most
appropriate capacity of the power plant from an economic point of view. Use the short cut
method.
Cost-Income Item 500-MW 1000-MW 1500-MW
Construction cost $350 000 000 $400 000 000 $500 000 000
Yearly Operational Cost $5 000 000 $5 500 000 $6 000 000
Yearly Maintenance Cost $1 000 000 $1 500 000 $2 500 000
Yearly Income $45 000 000 $50 000 000 $60 000 000
Salvage Value $75 000 000 $120 000 000 $140 000 000

Solution:

Current Best: 500-MW

Challenger: 1000-MW

$ 45 000 000

$ 5 000 000

0
20 1000 MW – MW

$ 1 000 000

$ 50 000 000

AE1000-500 (i1000-500*) = 0 = -50000000 (A/P, i1000-500*, 20) – 1000000 + 5000000 +

45000000 (A/F, i1000-500*, 20)

According to the short cut method i1000-500* = MARR = 7%

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AE1000-500 (7%) = -50000000 (A/P, 7%, 20) – 1000000 + 5000000 + 45000000 (A/F, 7%, 20)
AE1000-500 (7%) = -50000000 * 0.0944 – 1000000 + 5000000 + 45000000 * 0.0244
AE1000-500 (7%) = $ 378 000 > 0 ⇒ Current best (500-MW) is eliminated. Challenger (1000-
MW) becomes the new current best.

Current Best: 1000-MW

Challenger: 1500-MW

$ 20 000 000

$ 10 000 000

0
20 1500 MW – MW

$ 1 500 000

$ 100 000 000

AE1500-1000 (i1500-1000*) = 0 = -100000000 (A/P, i1500-1000*, 20) – 1500000 + 10000000 +

20000000 (A/F, i1500-1000*, 20)

According to the short cut method i1500-1000* = MARR = 7%

AE1500-1000 (7%) = -100000000 (A/P, 7%, 20) – 1500000 + 10000000 + 20000000 (A/F, 7%, 20)
AE1500-1000 (7%) = -100000000 * 0.0944 – 1500000 + 10000000 + 20000000 * 0.0244
AE1500-1000 (7%) = $ -452 000 < 0 ⇒ Current best (1000-MW) remains as the current best.
The most appropriate capacity of the power plant is 1000-MW.

Page 18 of 23
Q10. Cash flows of the three investment options are presented below. Assuming a MARR of
5% and using the incremental rate of return method with the present worth approach, select the
most suitable option.
a) Solve the problem with the short cut method.
b) Solve the problem without the short cut method.

€ 27 500
€ 25 000
€ 22 500
€ 20 000

0 1 2 3
4 OPTION 1

€ 3 000 € 3 000 € 3 000 € 3 000

€ 60 000

€ 17 500
€ 12 500
€ 7 500
0 1 2
3 OPTION 2

€ 25 000

€ 7 500

€ 12 500 € 12 500 € 12 500 € 12 500 € 12 500 € 12 500

0 1 2 3 4 5
6 OPTION 3

€ 5 000

€ 50 000

Page 19 of 23
Solution:

a) With the short cut method:

Current Best: Option 2

Challenger: Option 3
Common multiple of lives: 6 years

€ 15 000

€ 5 000 € 5 000
€ 2 500
0 1 2 3 4 5
6 OPTION 3 – OPTION 2

€ 25 000

PW3-2 (i3-2*) = 0 = -25000 + 5000 (P/F, i3-2*, 1) + 15000 (P/F, i3-2*, 3) + 5000 (P/F, i3-2*, 4) +
2500 (P/F, i3-2*, 6)

According to the short cut method i3-2* = MARR = 5%

PW3-2 (5%) = -25000 + 5000 (P/F, 5%, 1) + 15000 (P/F, 5%, 3) + 5000 (P/F, 5%, 4) +
2500 (P/F, 5%, 6)
PW3-2 (5%) = -25000 + 5000 * 0.9524 + 15000 * 0.8638 + 5000 * 0.8227 +
2500 * 0.7462
PW3-2 (5%) = € - 1 302 < 0 ⇒ Current best (Option 2) remains as the current best. Option 1
becomes the new challenger.

Current Best: Option 2

Challenger: Option 1
Common multiple of lives: 12 years

Page 20 of 23
 € 29 500
€ 27 000
€ 24 500

€ 14 500
€ 12 000
€ 9 500 € 9 500
€ 7 000 € 7 000
€ 4 500

0 1 2 3 4 5 6 7 8 9 10 11
12 OPTION 1 – OPTION 2

€ 35 000

€ 43 000

€ 48 000

PW1-2 (i1-2*) = 0 = -35000 + 9500 (P/F, i1-2*, 1) + 7000 (P/F, i1-2*, 2) + 29500 (P/F, i1-2*, 3) –
43000 (P/F, i1-2*, 4) + 4500 (P/F, i1-2*, 5) + 27000 (P/F, i1-2*, 6) + 14500 (P/F, i1-2*, 7) –
48000 (P/F, i1-2*, 8) + 24500 (P/F, i1-2*, 9) + 12000 (P/F, i1-2*, 10) + 9500 (P/F, i1-2*, 11) +
7000 (P/F, i1-2*, 12)

According to the short cut method i1-2* = MARR = 5%

PW1-2 (5%) = -35000 + 9500 (P/F, 5%, 1) + 7000 (P/F, 5%, 2) + 29500 (P/F, 5%, 3) –
43000 (P/F, 5%, 4) + 4500 (P/F, 5%, 5) + 27000 (P/F, 5%, 6) + 14500 (P/F, 5%, 7) –
48000 (P/F, 5%*, 8) + 24500 (P/F, 5%, 9) + 12000 (P/F, 5%, 10) + 9500 (P/F, 5%, 11) +
7000 (P/F, 5%, 12)
PW1-2 (5%) = -35000 + 9500 * 0.9524 + 7000 * 0.9070 + 29500 * 0.8638 –
43000 * 0.8227 + 4500 * 0.7835 + 27000 * 0.7462 + 14500 * 0.7107 –
48000 * 0.6768 + 24500 * 0.6446 + 12000 * 0.6139 + 9500 * 0.5847 +
7000 * 0.5568
PW1-2 (5%) = € 4 606.45 > 0 ⇒ Current best (Option 2) is eliminated. Option 1 is the most
suitable alternative.

Page 21 of 23
 b) Without the short cut method:

Current Best: Option 2

Challenger: Option 3
Common multiple of lives: 6 years

€ 15 000

€ 5 000 € 5 000
€ 2 500
0 1 2 3 4 5
6 OPTION 3 – OPTION 2

€ 25 000

PW3-2 (i3-2*) = 0 = -25000 + 5000 (P/F, i3-2*, 1) + 15000 (P/F, i3-2*, 3) + 5000 (P/F, i3-2*, 4) +
2500 (P/F, i3-2*, 6)
Try i3-2* = 2% ⇒ PW3-2 (2%) = -25000 + 5000 * 0.9804 + 15000 * 0.9423 + 5000 * 0.9238 +
2500 * 0.8880 = € 875.50
Try i3-2* = 3% ⇒ PW3-2 (3%) = -25000 + 5000 * 0.9709 + 15000 * 0.9151 + 5000 * 0.8885 +
2500 * 0.8375 = € 117.25
Try i3-2* = 4% ⇒ PW3-2 (4%) = -25000 + 5000 * 0. 9615 + 15000 * 0.8890 + 5000 * 0.8548 +
2500 * 0.7903 = € -607.75
117.25
By linear interpolation: i3−2 ∗ = 3 + = 3.16%
117.25 + 607.75

i3-2* = 3.16% < MARR = 5% ⇒ Current best (Option 2) remains as the current best. Option 1
becomes the new challenger.

Current Best: Option 2

Challenger: Option 1
Common multiple of lives: 12 years

Page 22 of 23
 € 29 500
€ 27 000
€ 24 500

€ 14 500
€ 12 000
€ 9 500 € 9 500
€ 7 000 € 7 000
€ 4 500

0 1 2 3 4 5 6 7 8 9 10 11
12 OPTION 1 – OPTION 2

€ 35 000

€ 43 000

€ 48 000

PW1-2 (i1-2*) = 0 = -35000 + 9500 (P/F, i1-2*, 1) + 7000 (P/F, i1-2*, 2) + 29500 (P/F, i1-2*, 3) –
43000 (P/F, i1-2*, 4) + 4500 (P/F, i1-2*, 5) + 27000 (P/F, i1-2*, 6) + 14500 (P/F, i1-2*, 7) –
48000 (P/F, i1-2*, 8) + 24500 (P/F, i1-2*, 9) + 12000 (P/F, i1-2*, 10) + 9500 (P/F, i1-2*, 11)
+ 7000 (P/F, i1-2*, 12)
Try i1-2* = 6% ⇒ PW1-2 (6%) = -35000 + 9500 * 0.9434 + 7000 * 0.8900 + 29500 * 0.8396 –
43000 * 0.7921 + 4500 * 0.7473 + 27000 * 0.7050 + 14500 * 0.6651 –
48000 * 0.6274 + 24500 * 0.5919 + 12000 * 0.5584 + 9500 * 0.5268
+ 7000 * 0.4970 = € 2512.75
Try i1-2* = 7% ⇒ PW1-2 (7%) = -35000 + 9500 * 0.9346 + 7000 * 0.8734 + 29500 * 0.8163 –
43000 * 0.7629 + 4500 * 0.7130 + 27000 * 0.6663 + 14500 * 0.6227 –
48000 * 0.5820 + 24500 * 0.5439 + 12000 * 0.5083 + 9500 * 0.4751
+ 7000 * 0.4440 = € 607.00
Try i1-2* = 8% ⇒ PW1-2 (8%) = -35000 + 9500 * 0.9259 + 7000 * 0.8573 + 29500 * 0.7938 –
43000 * 0.7350 + 4500 * 0.6806 + 27000 * 0.6302 + 14500 * 0.5835 –
48000 * 0.5403 + 24500 * 0.5002 + 12000 * 0.4632 + 9500 * 0.4289
+ 7000 * 0.3971 = € -1118.75
607
By linear interpolation: i1−2 ∗ = 7 + = 7.35%
607 + 1118.75

i1-2* = 7.35% > MARR = 5% ⇒ Current best (Option 2) is eliminated. Option 1 is the most
suitable alternative.

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