Engineering Economics GENG 315 Engineering Economics GENG 315

Engineering Economics- GENG 315 Engineering Economics GENG 315 CHAPTER 6 b Comparing Alternatives for an Engineering Project

Engineering Economics- GENG 315 Objectives To develop and demonstrate the economic analysis and comparison of mutually exclusive design alternatives for an engineering project.

Engineering Economics- GENG 315 The Study (Analysis) Period q The study period (planning horizon), is the selected time period over which mutually exclusive alternatives are compared. q The selection of the study period is dependent on several factors such as: the useful life of the shorter-lived alternative, the useful life of the longer-lived alternative, service period required, company policy, and so on. q The useful lives of alternatives being compared might be same (equal) or different (Unequal) from the selected study period. q Unequal useful lives among alternatives somewhat complicate their comparison. q In such cases alternatives must be compared over the (selected) same study period of time.

Engineering Economics- GENG 315 Case 1: Useful lives are equal to the study period q In this case no adjustment to cash flow is required and the equivalent worth and Rate-of-Return methods are used to select the preferred alternative. q Equivalent worth (PW, FW, AW) based on a total investment at i = MARR are the most straightforward methods for comparing ME alternatives. q For investment alternatives, the one with the greatest positive equivalent worth is selected. q For cost alternatives, the one with the least negative equivalent worth is selected.

Engineering Economics- GENG 315 Case 2: Useful lives are different from the study period q The principle applied here is to force comparing the Multilateral environmental agreements (MEAs) over the same study period. q In such cases alternatives must be compared over the (selected) same period of time. q Methods to use: q Repeatability Method q Co-terminated Method.

Engineering Economics- GENG 315 Repeatability Method q The repeatability method involves two conditions: ØCondition 1: The study period over which the alternatives being compared is indefinitely equal or longer to the least common multiple of the useful lives of the alternatives. ØCondition 2: The economic consequences that are estimated to happen in an alternative’s initial useful life span will also happen in all succeeding useful lives spans. q Both conditions are seldom to met and satisfied in real engineering practice. Which is limit the application of the repeatability method.

If Useful Life < Study Period Investment alternatives: § The first assumption is that all net cash flows will be reinvested, in another opportunity for the remaining period at the MARR. § The second assumption is that replacing the initial investment with another asset having possibly different cash flows over the remaining life. Cost alternatives: § because each cost alternative has to provide the same level of service over the study period, contracting for the service, or leasing the needed equipment for the remaining years. § Another solution is to repeat part of the useful life of the original alternative and use an estimated market value to shorten it at the end of the study period Methods to use: The Equivalent-Worth (PW, FW, AW) of each alternative are typical conventional solutions.

If Useful Life > Study Period • The most common technique is to truncate the alternative at the end of the study period, using an estimated market value. • The underlying principle is to compare the mutually exclusive alternatives being considered in a decision situation over the same study (analysis) period. • Methods to use: • Equivalent-Worth (PW, FW, AW) method. • Rate-of-Return Analysis. • The Market Value Technique.

Engineering Economics- GENG 315 Co-terminated Method q The Co-terminated method uses a finite and identical study period for all alternatives. This requires adjustment to be made to the estimated cash flows to put all studied alternatives on a common and comparable basis so that useful life is equal to study period. ØIf a cost alternative has a useful lives < study period, the estimated annual cost of contracting for the activities involved might be assumed and used during the remaining years. ØIf a cost alternative has a useful lives > study period, the market value is used as a terminal cash flow at the end of the co-terminated life.

Co-terminated Method Increase the least study period to equal the higher alternative. In this case increase useful life of alternative A to 6 years. We may use PW method to analyze. PW = Cash flow – Initial Investment PW(10%)A = [ 1, 255 (P/A, 10%, 4) - 3, 500 ](P/F, 10%, 2) = PW(10%)A = [1, 255 (3. 1699) - 3, 500 ](0. 8264) = $395 PW(10%)B = 1, 480 (P/A, 10%, 6) -5, 000 = PW(10%)B = 1, 480 (4. 3553) -5, 000 = $1, 446 Decision: Select Alternative B because its PW is higher.

Engineering Economics- GENG 315

Repeatability Method

Co-terminated Method