ENGR 390 Lecture 12: Present Worth Analysis Winter 2007

- Problems

Reviewing…
Net Present Worth:
• Used to select among alternative
projects.
• Used to compare mutually exclusive
alternatives.
• If all expenses and revenues are
included, select the largest NPW that is
greater than zero.
• If some or none of the revenues are
included, select the largest NPW.

Reviewing…
Salvage Value – – the amount of
money you can expect to receive
by selling an asset when you are
done with it. What value does it
have when you are done with it?

MARR – Minimum Attractive Rate

of Return– I expect or need this
return in order to be willing to
invest my money.

S.V. Atre 1
ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
- Problems

Problem 2
Project #1 costs $10,000 and has annual, end of
the year revenues of $10,000 over its 5 year
life. There is no salvage value.

Project #2 costs $20,000 and has annual end of

year revenues of $10,000 over its 10 year life.
There is no salvage value.

Conduct an economic analysis to select the

preferred project using a MARR of 15% per
year, compounded annually.

Problem 2
DIAGRAM: GIVEN: PROJECT 1 PROJECT 2
LIFETIME 5 YRS 10 YRS
ANN. REV. 1ST COST $10,000 $20,000
ANN. REV. $10,000 $10,000
0 1 2 3 N ANN. COST - -
SALVAGE - -
MARR 15%/YR CPD. ANNUALLY
1st COST

NPW1 = - $10,000 + $10,000(P|A,15%,5) NPW2 = - $20,000 + $10,000(P|A,15%,10)

= - $10,000 + $10,000(3.3522) = - $20,000 + $10,000(5.0188)
= - $10,000 + $33,522 = - $20,000 + $50,188
NPW1 = $23,522 NPW2 = $30,188

Worth investing in ???

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
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Calculating NPWs…
NPW1 = $23,522 NPW2 = $30,188

Why is it wrong to select #2

based on this analysis???

Project life is not the same

So… How do we handle comparing

projects with unequal durations?

(Net) Present Worth Analysis

One possible approaches when project
lives are different:

Common Multiple Period: Projects are

assumed to be repeated until a
common multiple point in time is
established.

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
- Problems

Problem 2
Common Multiple Period: Projects are assumed
to be repeated until a common multiple point
in time is established:
Reinvest $10,000 in project again after
Year 5 for 5 years (with similar revenue)
NPW1’ = $NPW1 + NPW1(P|F,15%,5)
= $23,522 + $23,522(0.4972)
= $23,522 + $11,695
NPW1’ = $35,217
NPW2 = $30,188
Pick Project 1 (for similar life time)

Problem 3
A firm is considering the purchase of one of two
new machines. The data on each are as below:

Machine A B
Service Life 3 years 6 years
Initial Cost $3,400 $6,500
Annual Net
Operating Expense: $2,000 $1,800
Salvage Value $100 $500
Use a MARR of 12% compounded annually and
the lowest common multiple assumption to
determine the alternative to be selected.

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
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Problem 3
DIAGRAM: MACHINE A GIVEN: MACHINE A MACHINE B
LIFETIME 3 YRS 6 YRS
$100 $100
1ST COST $3,400 $6,500
0 1 2 3 4 5 6 ANN. REV. None Given None Given
ANN. COST $2,000 $1,800
$2K $2K (NET EXP.) (NET EXP.)
CYCLE 1 CYCLE 2
SALVAGE $100 $500
$3,400 $3,400
MARR 12%/YR CPD. ANNUALLY

NPWA1 = - $3,400 - $2,000(P|A,12%,3) + $100(P|F,12%,3)

= - $3,400 - $2,000(2.4018) + $100(0.7118)
= - $3,400 - $4,804 + $71
NPWA1 = -$8,133 Must be a “have-to-do” decision

Problem 3 $100 $100

0 1 2 3 4 5 6
DIAGRAM: MACHINE A
$2K $2K
CYCLE 1 CYCLE 2
$3,400 $3,400

NPWA= NPWA1 + NPWA2

= - $8,133 - $8,133(P|F,12%,3)
= - $8,133 - $8,133(0.7118)
= - $8,133 - $5,789
Must be a “have-to-do” decision
v NPWA = -$13,922

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
- Problems

Problem 3
DIAGRAM: MACHINE A

NPWB = - $6,500 - $1,800(P|A,12%,6) + $500(P|F,12%,6)

= - $6,500 - $1,800(4.1114) + $500(0.5066)
= - $6,500 - $7,401 + $353
v NPWB = -$13,548 Pick Machine B if
it is a “have-to-do” decision
v NPWA = -$13,922

Or pick neither

(Net) Present Worth Analysis

When project lives are different:
Common Multiple Period: Projects are
assumed to be repeated until a
common multiple point in time is
established.

OR

Study Period: Select a study period for

both projects and estimate cash
flows to conform to the study period.

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
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Problem 4
Two alternatives are being considered regarding construction of
a new high-voltage transmission line. Alternative I would build
the transmission towers and the line at a capacity of 230 kVA,
which is expected to be adequate for 15 years. After 15 years the
230 kVA lines would be removed and 560 kVA lines placed on the
existing towers. Alternative II would build the transmission
towers and the 560 kVA lines immediately. Given below are the
pertinent data on the costs of these facilities.
Expected Expected
Item Present Cost Service Life Salvage Value
Trans. Towers $15,000,000 55 years 0 after 30 yrs
230 kVA lines $8,000,000 15 years 10% of 1st cost
560 kVA lines $12,000,000 35 years 10% of 1st cost
Salvage values for both transmission lines are 10% of first cost
regardless of age at retirement.
The cost of 560 kVA lines will inflate at the rate of 10% per year.
The MARR is 15%. Use Present Worth analysis to determine
which alternative is least expensive for a 35 year study period.

Problem 4
GIVEN: 230 kVA line 560 kVA line
LIFETIME 15(+20) YRS 35 YRS
1ST COST $15,000,000 (for towers) + $15,000,000 (for towers) +
$8,000,000 (for line) $12,000,000 (for line)
= $23,000,000 = $27,000,000
ANN. REV. None given None given

ADDITIONAL Purchase of new 560 kVA line at None given

COST year 15
SALVAGE 1) $800,000 from sale of first (10% of initial cost)
line after year 15: (10% ) $1,200,000
2) 10% of initial cost for 560 kVA
line after year 35
MARR 15 % APR

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
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Problem 4
For Option 1:
Cost of 560 kVA inflates at 10% year (g)
1st cost of 560 kVA line at year 15:
= $12,000,000(1+g)N
= $12,000,000(1+0.1)15
= $50,126,978

Salvage value of 560 kVA line at year 35: 10% of $50,126,978

= $5,012,698

Problem 4
GIVEN: 230 kVA line 560 kVA line
LIFETIME 15(+20) YRS 35 YRS
1ST COST $15,000,000 (for towers) + $15,000,000 (for towers) +
$8,000,000 (for line) $12,000,000 (for line)
= $23,000,000 = $27,000,000
ANN. REV. None given None given

ADDITIONAL Purchase of new 560 kVA line at None given

COST year 15: $50,126,978
SALVAGE 1) $800,000 for 230 kVA line $1,200,000
after year 15: (10% ) (10% of initial cost)
2) 5,012,698 for 560 kVA line
after year 35 (10%)
MARR 15 % APR

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ENGR 390 Lecture 12: Present Worth Analysis Winter 2007
- Problems

Problem 4

= $49,326,978

NPW1 = - $23,000,000 - $49,326,978 (P|F,15%,15) + $5,012698(P|F,15%,35)

= - $23,000,000 - $49,326,978(0.1229) + $5,012,698(0.0075)
= - $23,000,000 - $6,062,286 + $37,595
NPW1 = -$28,968,691

Problem 4

NPW2 = -$27,000,000 + 1,200,000(P|F,15%,35)

= -$27,000,000 + $1,200,000(0.0075)
= -$27,000,000 + $9,000
v NPW2 = -$26,991,000 Pick Alt. 2 if it is
a “have-to-do” decision

v NPW1 = -$28,968,691

S.V. Atre 9