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Annual Worth
Analysis
Lecture slides to accompany
Engineering Economy
7th edition
Leland Blank
Anthony Tarquin
6-1
Chapter 1
Economic measures of worth for cash flows
over a specific period.
Construction of cash flow diagram
Cash flow diagram;
1-2
Chapter 2
Single amount factor;
Compound amount F/P
Present worth P/F
Compound amount
F/A
A/F
Sinking fund
1-3
Chapter 3
Cash flow Series
Arithmetic gradient
Geometric gradient
To compute Present worth or Future worth
Present worth PG
Future worth FG
Shifted series
Present worth PG
Future worth FG
Effective interest rate
Continuous compounding
Interest rate vary over time
1-4
Chapter 4
Nominal and effective interest rate
Account for compounding
Chapter 5
Present worth (PW) analysis
The present value of future amount of money (P/F)
Alternative proposals
Mutually exclusive alternative
Independent project
LEARNING OUTCOMES
1. Explain and compute AW
2. Compute Capital Recovery and
AW values
3. Perform AW analysis for one or
ME alternatives
2012 by McGraw-Hill
What is AW
AW is the equivalent annual worth of cash
flows of projects.
PW is the present worth, and
FW is the future worth
1-8
Salvage value, S
Annual amount, A
3,000
0
5,000
5,000
10,000
2012 by McGraw-Hill
5,000
5,000
10,000
PW= -16,198
AW=
FW =
-9,333
-9,333
-19,600
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2012 by McGraw-Hill
Example 6-1
In Example 5.3, National Homebuilders, Inc. evaluated cut-andfinish equipment from vendor A (6-year life) and vendor B (9year life). The PW analysis used the LCM of 18 years. Consider
only the vendor A option now. The diagram in Figure 61 shows
the cash flows for all three life cycles (first cost $15,000; annual
M&O costs $3500; salvage value $1000).
Demonstrate the equivalence at i 15% of PW over three life
cycles and AW over one cycle. In Example 5.3, present worth
for vendor A was calculated as PW $45,036.
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1-13
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CR = -P(A/P,i%,n) + S(A/F,i%,n)
Use previous example: (note: AOC not included in CR )
CR = -20,000(A/P,10%,3) + 5000(A/F,10%,3) = $ 6532 per year
Now
AW = CR + A
AW = 6532 8000 = $ 14,532
6-15
2012 by McGraw-Hill
Example 6-2
Lockheed Martin is increasing its booster thrust power in
order to win more satellite launch contracts from European
companies interested in opening up new global
communications markets. A piece of earth-based tracking
equipment is expected to require an investment of $13
million, with $8 million committed now and the remaining $5
million expended at the end of year 1 of the project. Annual
operating costs for the system are expected to start the fi rst
year and continue at $0.9 million per year. The useful life of
the tracker is 8 years with a salvage value of $0.5 million.
Calculate the CR and AW values for the system, if the corporate
MARR is 12% per year.
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Solution
Capital recovery: Determine P in year 0 of the
two initial investment amounts, followed by the
use of Equation [6.3] to calculate the capital
recovery. In $1 million units,
P = -8 -5( P/F ,12%,1) = -$12.46
CR = -12.46( A/P ,12%,8) + 0.5( A/F ,12%,8)
= -12.46(0.20130) + 0.5(0.08130)
= - $2.47
AW = -2.47 - 0.9 = - $3.37 million per year
1-18
6-19
2012 by McGraw-Hill
ME Alternative Evaluation by AW
A company is considering two machines. Machine X has a first cost of
$30,000, AOC of $18,000, and S of $7000 after 4 years.
Machine Y will cost $50,000 with an AOC of $16,000 and S of $9000 after
6 years.
Which machine should the company select at an interest rate of 12%
per year?
Solution:
2012 by McGraw-Hill
Example 6-3
Heavenly Pizza, which is located in Toronto, fares very well with its
competition in offering fast delivery. Many students at the area
universities and community colleges work part-time delivering orders
made via the web. The owner, Jerry, a software engineering graduate,
plans to purchase and install five portable, in-car systems to increase
delivery speed and accuracy.
The systems provide a link between the web order-placement software
and the On-Star system for satellite-generated directions to any address
in the area. The expected result is faster, friendlier service to customers
and larger income.
Each system costs $4600, has a 5-year useful life, and may be salvaged
for an estimated $300. Total operating cost for all systems is $1000 for
the fi rst year, increasing by $100 per year thereafter. The MARR is 10%.
Perform an annual worth evaluation for the owner that answers the
following questions. Perform the solution by hand and by spreadsheet.
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Solution (Spreadsheet)
MARR
10%
# of systems
Cost/system
Income/year
Year
(a) CR value
-4,600
$
6,000
Investment
Annual
Annual
and salvage
costs
income
Net income
-23,000
-23,000
-1,000
6,000
5,000
-1,100
6,000
4,900
-1,200
6,000
4,800
-1,300
6,000
4,700
1,500
-1,400
6,000
6,100
-5,822
(b) AW value
-1,003
= - PMT($B$2, 5, NPV($B$2,B10:B14)+B9)
= - PMT($B$2, 5, NPV($B$2,E10:E14)+E9)
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AW of Permanent Investment
Use A = Pi for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives
2012 by McGraw-Hill
6-29
2012 by McGraw-Hill
Assignments
Problems
1-30
Question 6-4
James developed the two cash flow diagrams shown
at the bottom of this page. The cash flows for
alternative B represent two life cycles of A. Calculate
the annual worth value of each over the respective
life cycles to demonstrate that they are the same.
Use an interest rate of 10% per year.
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6.4
AWA = -5000(A/P,10%,3) - 25 + 1000(A/F,10%,3)
= -5000(0.40211) - 25 + 1000(0.30211)
= $-1733.44
AWB = -5000(A/P,10%,6) - 25 - 4000(P/F,10%,3)(A/P,10%,6) +
1000(A/F,10%,6)
= -5000(0.22961) - 25 - 4000(0.7513)(0.22961) + 1000(0.12961)
= $-1733.46
AW values are the same; slight difference due to round-off
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Question 6-5
An asset with a fi rst cost of $20,000 has an annual
operating cost of $12,000 and a $4000 salvage
value after its 4-year life. If the project will be needed
for 6 years, what would the market (salvage) value
of the 2-year-old asset have to be for the annual
worth to be the same as it is for one life cycle of the
asset? Use an interest rate of 10% per year.
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Solution 6-5
AW4 = -20,000(A/P,10%,4) 12,000 + 4000(A/F,10%,4)
= -20,000(0.31547) 12,000 + 4000(0.21547)
= $-17,448
-17,448 = -20,000(A/P,10%,6) 12,000 - (20,000
4000)(P/F,10%,4)(A/P,10%,6) + S(A/F,10%,6)
= -20,000(0.22961) 12,000 - (20,000 4000)(0.6830)(0.22961)
+ S(0.12961)
(0.12961)S = 1,653.38
S = $12,756
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Question 6-10
Ten years ago, Jacobson Recovery purchased a
wrecker for $285,000 to move disabled 18-wheelers.
He anticipated a salvage value of $50,000 after 10
years. During this time his average annual revenue
totaled $52,000. ( a ) Did he recover his investment
and a 12% per year return? ( b ) If the annual M&O
cost was $10,000 the fi rst year and increased by a
constant $1000 per year, was the AW positive or
negative at 12% per year? Assume the $50,000
salvage was realized.
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Solution 6-10
(a) CR = -285,000(A/P,12%,10) + 50,000(A/F,12%,10)
= -285,000(0.17698) + 50,000(0.05698)
= $-47,590 per year
At revenue of $52,000 per year, yes, he did
(b) AW = -285,000(A/P,12%,10) + 50,000(A/F,12%,10) +
52,000 - 10,000 -1000(A/G,12%,10)
= -285,000(0.17698) + 50,000(0.05698) + 42,000 1000(3.5847)
= $- 9,175 per year
AW was negative
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Solution 6-13
AWX = -75,000(A/P,10%,4) 32,000 + 9000(A/F,10%,4)
= -75,000(0.31547) 32,000 + 9000(0.21547)
= $-53,721
AWY = -140,000(A/P,10%,4) 24,000 + 19,000(A/F,10%,4)
= -140,000(0.31547) 24,000 + 19,000(0.21547)
= $-64,072
Use Method X
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Question 6-23
The State of Chiapas, Mexico, decided to fund a
program for literacy. The first cost is $200,000 now,
and an update budget of $100,000 every 7 years
forever is requested. Determine the perpetual
equivalent annual cost at an interest rate of 10% per
year.
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Thank you
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