06 - Comparing Alternatives

COMPARING
ALTERNATIVES
CHE40: Engineering Economy
Engr. Elisa G. Eleazar
Alternatives
Case
1: Useful Lives are Equal to the
Study Period
Case
2: Useful Lives are Different
Capitalized
Worth Method
Incremental
Project
Outline
B/C Analysis
Combination
Comparing Alternatives
Among Alternatives
Mutually Exclusive
at most one project can be
chosen
Independent
the choice is not dependent of the
choice of any other project; all or
none of the projects may be
selected
Contingent
the choice is conditional on the
choice of one or more other
projects
Alternatives
Investment Alternatives
those with initial capital
investments that produce positive
cash flows from increased
revenue, savings through reduced
costs, or both
Cost Alternatives
those with negative cash flows,
except for a positive cash flow
element from disposal of assets
at the end of the projects useful
life
Alternatives
The alternative that requires the minimum

investment of capital and produces
satisfactory functional results will be
chosen unless the incremental capital
associated with an alternative having a
larger investment can be justified with
respect to its incremental benefits.
Alternatives
When revenues and other economic

benefits are present and vary among the
alternatives, choose the alternative that
maximizes overall profitability (i.e.,
greatest positive equivalent worth at
i=MARR and satisfies all project
requirements.
Alternatives
When revenues and other economic

benefits are not present or are constant
among alternatives, consider only the
costs and select the alternative that
minimizes total cost (least negative
equivalent worth at i=MARR and satisfies
all project requirements.
Alternatives
Equivalent Worth Methods
for investment alternatives, the one

with the greatest positive
equivalent worth is selected
for cost alternatives, the one with
the least negative equivalent worth
is selected
Case 1: Useful Lives are Equal to the Study Period
An airport needs a modern material handling system for

facilitating access to and from a busy maintenance hangar.
A second-hand system will cost $75,000. A new system
with improved technology can decrease labor hours by
20% compared to the used system. The new system will
cost $150,000 to purchase and install. Both systems have
a useful life of 5 years. The market value of the used
system is expected to be $20,000 in 5 years, and the
market value of the new system is anticipated to be
$50,000 in 5 years. Current maintenance activity will
require the used system to be operated 8 hours per day for
20 days per month. If labor costs $40 per hour and the
MARR is 1% per month, which system should be
recommended?
Rate-of-Return Methods
each increment of capital must justify

itself by producing a sufficient rate of
return ( MARR) on that increment
compare a higher investment alternative
against a lower investment alternative
only when the latter is acceptable
select the alternative that requires the
largest investment of capital as long as
the incremental investment is justified by
benefits that earn at least the MARR
10
Incremental
1
Investment Analysis
Arrange the feasible alternatives based on increasing

capital investment.
Establish a base alternative.
If the incremental cash flow between the next alternative

and the current selected alternative is acceptable,
choose the next alternative.
Otherwise, retain the last acceptable alternative as the

current best.
Use iteration to evaluate differences (incremental cash

flows) between alternatives until all alternatives have
been considered.
11
Two mutually exclusive diesel generators are considered

for purchase by a power generation company. Information
relevant to compare the alternatives are summarized
below:
A
B
Capital Investment, $
Annual Maintenance
Expenses, $
Service Life
80,000
35,000
10,000
3,000
5,000
10
10
Use the ERR method to determine the better machine.

MARR is 10% per year. So is the external reinvestment
Case
rate. 1: Useful Lives are Equal to the Study Period
Salvage Value, $
100,000
12
Repeatability Assumption
assumes that the economic estimates for an
alternatives initial useful life will be repeated in the
subsequent replacement cycles
repeat part of the useful life and then use an estimated

market value to truncate it at the end
Coterminated Assumption
13
Case 2: Useful Lives are Different Among Alternatives
Use the
Useful Life <
repeatability
Study Period
assumption
Use the imputed

Useful Life >
market value
Study Period
technique
14
As the supervisor of a facilities engineering department,

you consider mobile cranes to be critical equipment. The
purchase of a new medium-sized truck-mounted crane is
being evaluated. The economic estimates for the two best
alternatives are shown below. Which of the two
alternatives would you recommend? MARR is 15%.
B
272,000
346,000
Annual Expenses, $
28,800
19,300
Useful Life, years
Salvage Value, $
25,000
40,000
15
Imputed Market Value Technique
based on assumptions about the value of the

remaining useful life for an asset
MVT = PW at end of year T of remaining CR amounts

+ PW at end of year T of original market value at end
of useful life
16
Use the imputed market value technique to develop an

estimated market value at the end of year 5 for crane B in
SP3. I = $346,000; S = $40,000; useful life = 9; MARR =
15%
17
A 50 hp motor is required to power a large capacity blower.

Two motors, A and B, mutually exclusive, have been
proposed. Their cost data are as follows.
B
9,000
8,000
Annual Expenses, $
5,000
6,000
Useful Life, years
10
15
Salvage Value, $
1,000
The MARR is 5% per year. Determine which alternative

should be selected if the analysis period is 10 years.
18
Capitalized Worth
used when the period of needed service is
indefinitely long
CW i % PW N
1
A
i
19
Capitalized Worth Method
A firm is considering the purchase of one of two new

machines. The data on each are given below:
B
3,400
6,500
Annual Expenses, $
2,000
1,800
Useful Life, years
Salvage Value, $
100
500
If perpetual service from the machine is assumed, which

machine would you recommend? The MARR is 10% per
year.
20
Capitalized Worth Method
Criterion:
larger-cost alternative as long
B/C 1
Investment, $
75,000
50,000
65,000
Annual
maintenance cost
4,000
5,000
4,700
The city of Oak Ridge is evaluating three MEAs for

refurbishing a public greenway. Benefits to the community
have been estimated and summarized. The citys discount
rate is 8% per year and the planning horizon is 10 years.
Which plan is best?
A
B
C
Annual benefits
20,000
18,000
20,000
21
Incremental B/C Analysis
Mutually Exclusive
at most one project can be
chosen
Independent
the choice is not dependent of the
choice of any other project; all or
none of the projects may be
selected
Contingent
the choice is conditional on the
choice of one or more other
projects
22
Project Combination
A small company has $20,000 in surplus capital that it

wishes to invest in new revenue-producing projects. Three
independent sets of mutually exclusive projects have been
developed. The useful life of each is five years, and all
market values are zero. You have been asked to perform
ERR analysis to select the best combination of projects.
MARR is equal to the external reinvestment rate (12%).
Mutually exclusive
Mutually exclusive
Cap Inv, $
Net Annual
Benefits, $
A1
5,000
1,500
A2
7,000
1,800
B1
12,000
2,000
B2
18,000
4,000
C1
14,000
4,000
C2
18,000
4,500
Project Combination
Mutually exclusive
Project
23
Engineering projects A, B1, B2 and C are being considered

with cash flows estimated over 10 years as shown. B1 and
B2 are mutually exclusive, C depends upon B1 and A
depends upon B2. The capital investment budget limit is
$100,000 and the MARR is 12% per year. What
combination of projects should be selected?
B1
B2
Cap Inv, $
30,000
22,000
70,000
82,000
Annual Profit, $
8,000
6,000
14,000
18,000
Salvage Value
3,000
2,000
5,000
7,000
24
Project Combination
Alternatives
Case
1: Useful Lives are Equal to the
Study Period
Case
2: Useful Lives are Different
Capitalized
Worth Method
Incremental
Project
Outline
B/C Analysis
Combination
Among Alternatives
25
COMPARING
ALTERNATIVES
CHE40: Engineering Economy
Engr. Elisa G. Eleazar

06 - Comparing Alternatives

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COMPARING

1: Useful Lives are Equal to the

2: Useful Lives are Different

The alternative that requires the minimum

When revenues and other economic

When revenues and other economic

Equivalent Worth Methods

for investment alternatives, the one

Case 1: Useful Lives are Equal to the Study Period

Case 1: Useful Lives are Equal to the Study Period

An airport needs a modern material handling system for

each increment of capital must justify

Case 1: Useful Lives are Equal to the Study Period

Arrange the feasible alternatives based on increasing

If the incremental cash flow between the next alternative

Otherwise, retain the last acceptable alternative as the

Use iteration to evaluate differences (incremental cash

Case 1: Useful Lives are Equal to the Study Period

Two mutually exclusive diesel generators are considered

Use the ERR method to determine the better machine.

repeat part of the useful life and then use an estimated

Case 2: Useful Lives are Different Among Alternatives

Use the imputed

Case 2: Useful Lives are Different Among Alternatives

As the supervisor of a facilities engineering department,

Useful Life, years

Case 2: Useful Lives are Different Among Alternatives

Imputed Market Value Technique

based on assumptions about the value of the

MVT = PW at end of year T of remaining CR amounts

Case 2: Useful Lives are Different Among Alternatives

Use the imputed market value technique to develop an

Case 2: Useful Lives are Different Among Alternatives

A 50 hp motor is required to power a large capacity blower.

Useful Life, years

The MARR is 5% per year. Determine which alternative

Case 2: Useful Lives are Different Among Alternatives

Capitalized Worth Method

A firm is considering the purchase of one of two new

Useful Life, years

If perpetual service from the machine is assumed, which

Capitalized Worth Method

larger-cost alternative as long

The city of Oak Ridge is evaluating three MEAs for

Incremental B/C Analysis

A small company has $20,000 in surplus capital that it

Engineering projects A, B1, B2 and C are being considered

1: Useful Lives are Equal to the

2: Useful Lives are Different

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