Engineering Economics

VII-Annual Cash Flow Analysis

Date:05/11/2017

1
 Part I

2
Techniques for Cash Flow Analysis
 PresentWorthAnalysis
 Annual Cash FlowAnalysis
 Rate of ReturnAnalysis
 IncrementalAnalysis
 OtherTechniques:
 FutureWorthAnalysis
 Benefit-Cost RatioAnalysis
 Payback PeriodAnalysis

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Outcome of Today’s Lecture
 After completing this lecture…
 The students should be able to:
 Define equivalent uniform annual cost (EUAC) and Equivalent
uniform annual benefits (EUAB)
 Resolve an engineering economic analysis problem into its annual
cash flow equivalent
 Conduct an equivalent uniform annual worth (EUAW) analysis
for a single investment
 Use EUAW, EUAC, and EUAB to compare alternatives with equal,
common multiple, or continuous lives, or over some fixed study
period.

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Annual Cash Flow Analysis
 Concepts ofAnnual Cash FlowAnalysis

 ComparingAlternatives usingAnnual Cash FlowAnalysis:

 Same-Length Analysis Period
 Different-Length Analysis Periods
 Infinite-Length Analysis Period
 Other Analysis Periods

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Techniques for Cash Flow Analysis

6
Example 1
 Compute the value of C for the following diagram, based on“10%
interest rate.

G=$15
$15

0
= +
0 4 0 4

C = $15 + $15 (A/G,10%,4)

= $15 + $15 (1.381) = $35.72

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Example 2
 As shown in the cash flow diagram, there is an annual disbursement of
money that varies from year to year from $100 to $300 in a fixed pattern
that repeats forever. If interest is 10%, compute the value of A, also
continuing forever,that is equivalent to the fluctuating disbursements.

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Example 2
Pattern
repeats
infinitely

There is a repeating series:; 100 – 200 – 300 – 200. Solving this series forA
gives us the A for the infinite series.

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Example 2

$100 200
100 100

+
0 4 0 4

A= $100 + [$100 (P/F,10%,2) + $200 (P/F,10%,3) + $100 (P/F,10%,4)] (A/P,10%,4)

= $100 + [$100 (0.8254) + $200 (0.7513) + $100 (0.6830)] (0.3155)
= $100 + [$301.20] (0.3155)
= $195.03

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Annual Cash Flow Analysis
 The basic idea is to convert all cash flows to a series of EUAW (equivalent
uniform annual worth):
Net EUAW = EUAB -EUAC
 EUAC: Equivalent UniformAnnual Cost
 EUAB: Equivalent UniformAnnual Benefit
 An expenditure increases EUAC and a receipt of money decreases EUAC.
 When there is an arithmetic gradient,use the (A/G,i%,n) factor.
 To convert a PW of a cost to EUAC,use:
EUAC = (PW of cost) (A/P, i%,n)
 Where there is salvage value?
A = F(A/F,i%,n)
 A salvage value will reduce EUAC and increase EUAB
 If there are irregular cash flows, try to first find PW of these flows;then,
EUAC may be calculated from this PW.
 Criteria for selection of an alternative:
 Maximize Net EUAW (EUAB –EUAC)
 Minimize EUAC OR Maximize EUAB

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Analysis Period
 Four different analysis-period situations occur:

 1. Analysis Period Equal to Alternative Lives

 2. Analysis Period a Common Multiple
 3. Analysis Period for a Continuing Requirement
 4. Infinite Analysis Period

 Analysis period may be equal to life of the shorter-life

alternative, the longer-life alternative, or something
different. In this case, terminal values at the end of a
specific year become very important.

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 Part II
Analysis Period Equal to Alternative Lives

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Analysis Period Equal to Alternative Lives
 We have an ideal situation (rarely the case in ‘real-life’ ):
 Study period = life-cycle of any of the alternatives

 Example 3: In addition to the do-nothing alternative, three alternatives

are being considered for improving the operation of an assembly line. Each
of the alternatives has a 10-years life and a scrap value equal to 10% of its
original cost.If interest is 8%,which alternative should be adopted.

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 Analysis Period Equal to Alternative Lives
PlanA Plan B
$1500 $9,000 $2500
$14,000

0 0
10 10

$8000 $6000

$15,000 $25,000

Plan C $14,000 $3300

0
10

$6000
14 $33,000
Analysis Period Equal to Alternative Lives

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Example 4

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Example 4

Around the Lake Under the Lake

First Cost $75,000 $125,000
Maintenance $3,000/yr $2,000/yr
Annual Power Loss $7,500/yr $2,500/yr
Property Taxes $1,500/yr $2,500/yr
Salvage Value $45,000 $25,000
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Useful Life 15 years 15 years
 Example 4
$45000 $25000
Around the Lake Under the Lake
0 15 0 15

$3000 $2000

$7500 $2500

$1500 $2500

$75,000 $125,000
Around the Lake
EUAC = $75,000 (A/P, 7%, 15) + $12,000 - $45,000 (A/F, 7%, 15)
= $75,000 (0.1098) + $12,000 - $45,000 (0.0398)
= $18,444
Under the Lake
EUAC = $125,000 (A/P, 7%, 15) + $7,000 - $25,000 (A/F, 7%, 15)
= $125,000 (0.1098) + $7,000 - $25,000 (0.0398)
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= $19,730
Go around the lake.
 Part III
Analysis Period a Common Multiple

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Analysis Period a Common Multiple of
Alternative Lives
 Assume a replacement with an identical item with same cost and
performance.When the lives of two alternatives vary, one can use a
common multiple of the two lives to determine the better project.
Nevertheless, compare alternatives based on their own service lives.

 Example 5: Two pumps are being considered for purchase. If interest is

7%, which pump should be bought. Assume that Pump B will be replaced
after its useful life by the same one.

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Analysis Period a Common Multiple of
Alternative Lives
$1000
$1500

0 6
0 12

$5,000
$7,000

(EUAC-EUAB)A
(EUAC-EUAB)B

See Example 6.7 Newmann.For 12 year analysis,the annual cost will be the same = $909.
See next slide. So,different with PW analy.sis

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Analysis Period a Common Multiple of
Alternative Lives
Example 6.7 Newmann.for 12 year analysis,the annual cost will be the same = $909.

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Analysis Period with a Repeatability Assumption
Under the circumstances of identical replacement (repeatability):

 If two or more alternatives have

unequal lives, only evaluate the
annual worth (AW) for one life
cycle of each alternative

 The annual worth of one cycle

is the same as the annual worth
of all future cycles

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Example 6

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 Example 6
Machine X MachineY $2000

0 5 12
0

$150
$5,000 $8,000

 Machine X
 EUAC= $5,000 (A/P,8%,5)= $5,000 (0.2505) = $1,252
 MachineY
 EUAC= $8,000(A/P,8%,12) + $150 - $2,000 (A/F,8%,12)
=8000(0.1327) +150 -2000( 0.0527) = $1,106
 Select MachineY.

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 Part IV
Analysis Period for a Continuing Requirement

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Analysis Period for a Continuing Requirement
 Many civil infrastructure provide a continuing requirement/service.
There is no distinct analysis period; therefore, assume it is long but
undefined.
 Compare different-life alternatives assuming identical replacement.
In this case, compare the annual cash flows computed for
alternatives based on their own different service lives.

 Example 7:
Assuming the need for pump A or
B will exist for some continuing
period.Which pump to choose?

(EUAC-EUAB)A

(EUAC-EUAB)B

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 Part V
Infinite Analysis Period

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Infinite Analysis Period
 At times we may have an alternative with a finite useful life in an infinite
analysis period situation.
 With identical replacement:
 EUAC for infinite analysis period = EUAC for limited life

 Example 8:
Consider the following three mutually exclusive alternatives

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Infinite Analysis Period

 EUAC for infinite analysis period = P (A/P ,i, ∞)+ any other annual (costs-benefits)
 (A/P, i,∞) = i

 (EUAC-EUAB)A= $100(A/P,8%, ∞) -$10.00 = $100* 0.08 -$10.00 =$-2.00

 (EUAC-EUAB)B= $150(A/P,8%,20) -$17.62 = $150 * 0.1019-$17.62 =$-2.34
 (EUAC-EUAB)C= $200(A/P,8%,5) -$55.48 = $200 * 2.505 -$55.48 =$-5.38

 Select alternative C

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Example 9

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Example 9
 Because we may assume identical replacement, we may compare 20 years
of B with an infinite life for A by EUAB –EUAC.
 AlternativeA

 EUAB – EUAC (for an inf.period) = $16 - $100 (A/P,10%,∞)

 = $16 - $100 (0.10)= +$6.00
 Alternative B = $24 - $150 (A/P,10%,20)
 EUAB – EUAC (for 20 yr.period) = $24 - $150 (0.1175)= +$6.38


33  Choose Alternative B.
Summary

 Popular analysis technique:

 Easily understood -results are reported in $ per time period,
usually $ per year
 AW method is often preferred to the PW method
 Only have to evaluate one life cycle of an alternative
 Assumption for AW method: Cash flows in one cycle are assumed
to replicate themselves in future cycles
 No need to convert lifetimes of all projects to their least common
multiple!
 AW offers an advantage for comparing different-life alternatives
 For infinite life alternatives, simply multiply P by i to get AW value

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 Exercise
 6.16
6.39
6.49

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