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ME 291

Engineering
Economy

ME-291 Engineering
Economy
Lecture 17

Chapter 6

Annual Worth Analysis

Faculty of Mechanical Engineering


Ghulam Ishaq Khan Institute, Topi, Swabi
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Annual Worth Analysis (AWA)

• AW value is equivalent to the PW and FW values at the


MARR for n years.

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AW = PW(A/P, i, n)=FW(A/F, i, n)
• When all cash flow estimates are converted to an AW
value, this value applies for every year of the life-cycle,

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and for each additional life cycle.
• Advantage: The AW value has to be calculated for only
one life cycle. Therefore, it is not necessary to use LCM
of lives, as it is for PW or FW analysis.
• Some Applications:
• Asset replacement & retention (maintenance) time
studies to minimize annual costs.
• Break even studies and make or buy studies etc.

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Three fundamental assumptions of
the AW method

When alternatives being compared have different lives,


the AW method makes the assumptions that:

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• The services provided are needed for the indefinite
future (forever).
• The selected alternative will be repeated for

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succeeding life cycles in exactly the same manner as
for the first life cycle.
• All cash flows will have the same estimated values in
every life cycle.

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Example 6.1

• Consider a location A, which has a 6-year life cycle. The


diagram shows cash flows for all three life cycles (first cost

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$15,000; annual cost $3500; deposit return $1000).
Demonstrate the equivalence at interest rate=15% of PW
over the three life cycles and AW over one cycle. If the 18
years LCM is considered, the PW calculated is $ -45,036.

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Example 6.1 (Contd…)

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Example 6.1 (Contd…)

• AW = -15, 000(A/P, 15%, 6) + 1000(A/F,


15%, 6) – 3500 = $ -7349

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• Using PW for 18 years:
• AW = -45, 036(A/P, 15%, 18) = $ -7349

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• Using FW and AW equivalence relation:
• FW = PW(F/P, 15%, 18) = -45, 036(12.3755)
• FW = $ -557, 343
• AW = -557, 343(A/F, 15%, 18) = $ -7351

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Capital Recovery and AW

An alternative should have the following cash flow estimates:


– Initial investment P
– Salvage value S

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– Annual amount A

The AW is comprised of two components: Capital recovery of

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the initial investment P at a stated interest rate (usually the
MARR) and the equivalent annual amount A. The symbol
CR is used for the capital recovery component.

AW = - CR – A
- ive sign here represents costs

CR is the equivalent annual cost of owning the asset plus return


on initial investment.

CR = - [ P ( A / P , i , n ) – S ( A / F , i , n ) ]

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Example 6.2

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Example 6.2 (Contd…)

• CR = -{[8.0 + 5.0(P/F, 12%, 1)](A/P, 12%, 8)


– 0.5(A/F, 12%, 8)}

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• CR = $ -2.47 million
• It means that every year of 8 years, the

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equivalent total revenue from the tracker
must be at $ -2.47 million just to recover the
initial present worth investment plus the
required return of 12%. This does not include
AOC of $ 0.9 million.
• AW = -2.47 – 0.9 = $ -3.37 million per year

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Evaluating alternatives by Annual
Worth Analysis

• The rules are the same as that of PW


• For mutually exclusive alternatives, calculate AW at

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the MARR.
– One alternative: AW≥0, MARR is met or exceeded

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– Two or more alternatives: choose the lowest cost
or highest income (numerically largest) AW value.

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Example 6.3

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Example 6.3 (Contd..)

• The CR and AW answer the first two questions (a


and b)

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• CR = 5(4600)(A/P, 10%, 5) – 5(300)(A/F, 10%, 5) =
$ 5822
• $ 1200 < CR so project is not viable financially.

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Example 6.3 (Contd..)

• AW = -5822 + 550 – 50(A/G, 10%, 5)


• AW = $ -5362

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• This shows once again that alternative is
clearly not financially viable at MARR =

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10%
• Note that estimated $ 1200 income per year
has reduced the required annual amount
from $ 5822 to $ 5362
• To do Computer analysis, use NPV and PMT
functions………..see the solution in book.
• NPV is used to determine P and PMT finds
the equivalent A value.

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AW of a Permanent Investment

• This section discusses the annual worth equivalent of


the Capitalized Cost.

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• A=Pi
• Effect same as Capitalized cost.

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• For the evaluation of public sector projects, such as
flood control, irrigation canals, bridges, and other
large scale projects.
• Cash flows recurring at regular or irregular intervals
are handled exactly as in conventional AW
computations; they are converted to the equivalent
uniform annual amounts A for one cycle.

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Example 6.5

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Example 6.6

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Excel sheet

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Problem 6.7

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Problem 6.16

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