CHAPTER 6

Decision Making Among Alternatives

Present Worth Analysis
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6.1 FORMULATING ALTERNATIVES

Alternatives are developed from project proposals to accomplish a stated purpose.
The logic of alternative formulation and evaluation is depicted in Figure 4.1. Some
projects are economically and technologically viable, and others are not. Once the
viable projects are defined, it is possible to formulate the alternatives.
Alternatives are one of two types: mutually exclusive or independent. Each
type is evaluated differently.
ɀ Mutually exclusive (ME). Only one of the viable projects can be selected. Each
viable project is an alternative. If no alternative is economically justifiable, do
nothing (DN) is the default selection.
ɀ Independent. More than one viable project may be selected for investment. (There
may be dependent projects requiring a particular project to be selected before an-
other, and/or contingent projects where one project may be substituted for another.)
A mutually exclusive alternative selection is the most common type in engi-
neering practice. It takes place, for example, when an engineer must select the
one best diesel-powered engine from several competing models. Mutually exclu-
sive alternatives are, therefore, the same as the viable projects; each one is
evaluated, and the one best alternative is chosen. Mutually exclusive alternatives
compete with one another in the evaluation. All the analysis techniques compare
mutually exclusive alternatives. Present worth is discussed in the remainder of
this chapter.
The do-nothing (DN) option is usually understood to be an alternative when
the evaluation is performed. If it is absolutely required that one of the defined alter-
natives be selected, do nothing is not considered an option. (This may occur when
a mandated function must be installed for safety, legal, or other purposes.) Selec-
tion of the DN alternative means that the current approach is maintained; no new
costs, revenues, or savings are generated.
Independent projects are usually designed to accomplish different purposes,
thus the possibility of selecting any number of the projects. These alternatives
do not compete with one another; each project is evaluated separately, and
the comparison is with the MARR. Independent project selection is treated in
Section 6.5.
Finally, it is important to classify an alternative’s cash flows as revenue-based
or cost-based. All alternatives evaluated in one study must be of the same type.
ɀ Revenue. Each alternative generates cost and revenue cash flow estimates,
and possibly savings, which are treated like revenues. Revenues may be dif-
ferent for each alternative. These alternatives usually involve new systems,
products, and services that require capital investment to generate revenues
and/or savings. Purchasing new equipment to increase productivity and sales
is a revenue alternative.
ɀ Cost. Each alternative has only cost cash flow estimates. Revenues are assumed
to be equal for all alternatives. These may be public sector (government) initia-
tives, or legally mandated or safety improvements.
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Competi Mandates
tion

Estimates Experience

s
ea
egy

Id
Strat Plans

Project Proposals
Not viable Not viable
1 2
3
4

m DN

Types of
projects
or

Mutually Independent
Exclusive (Select all that
(Select only one) meet criteria)

1 Total 1 Total
2
2 is
1, 2
⯗ ⯗ m is
3
m +
1, 3
DN DN 2, 3 2m
1, 2, 3
DN

Types of cash flow estimates:

Revenue or Cost

FIGURE 6.1
Logical progression
from proposals to Perform economic evaluation
alternatives to using PW or other technique
selection.

Select
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6.2 PRESENT WORTH ANALYSIS OF EQUAL-LIFE

ALTERNATIVES
In present worth analysis, the P value, now called PW , is calculated at the MARR
for each alternative. This converts all future cash flows into present dollar equiva-
lents. This makes it easy to determine the economic advantage of one alternative
over another.
The PW comparison of alternatives with equal lives is straightforward. If both
alternatives are used in identical capacities for the same time period, they are
termed equal-service alternatives.
For mutually exclusive alternatives the following guidelines are applied:
One alternative: Calculate PW at the MARR. If PW ⱖ 0, the
alternative is financially viable.
Two or more alternatives: Calculate the PW of each alternative at the
MARR. Select the alternative with the PW value that is numerically
largest, that is, less negative or more positive.
The second guideline uses the criterion of numerically largest to indicate a lower
PW of costs only or larger PW of net cash flows. Numerically largest is not the
absolute value because the sign matters here. The selections below correctly apply
this guideline.

Selected
PW1 PW2 Alternative

$⫺1500 $⫺500 2
⫺500 ⫹1000 2
⫹2500 ⫺500 1
⫹2500 ⫹1500 1

EXAMPLE 6.1
Perform a present worth analysis of equal-service machines with the costs
shown below, if the MARR is 10% per year. Revenues for all three alternatives
are expected to be the same.

Electric- Gas- Solar-

Powered Powered Powered

First cost, $ ⫺2500 ⫺3500 ⫺6000

Annual operating cost (AOC), $/year ⫺900 ⫺700 ⫺50
Salvage value, $ 200 350 100
Life, years 5 5 5
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Solution
These are cost alternatives. The salvage values are considered a “negative” cost,
so a  sign precedes them. The PW of each machine is calculated at i  10%
for n  5 years. Use subscripts E, G, and S.
PWE  2500  900(P兾A,10%,5)  200(P兾F,10%,5)  $5788
PWG  3500  700(P兾A,10%,5)  350(P兾F,10%,5)  $5936
PWS  6000  50(P兾A,10%,5)  100(P兾F,10%,5)  $6127
The electric-powered machine is selected since the PW of its costs is the low-
est; it has the numerically largest PW value.

Often a corporation or government obtains investment capital for projects by

selling bonds. A good application of the PW method is the evaluation of a bond
purchase alternative. If PW  0 at the MARR, the do-nothing alternative is selected.
A bond is like an IOU for time periods such as 5, 10, 20, or more years. Each bond
has a face value V of $100, $1000, $5000 or more that is fully returned to the pur-
chaser when the bond maturity is reached. Additionally, bonds provide the purchaser
with periodic interest payments I (also called bond dividends) using the bond coupon
(or interest) rate b, and c, the number of payment periods per year.
(bond face value)(bond coupon rate) Vb
I  [6.1]
number of payments per year c
At the time of purchase, the bond may sell for more or less than the face value,
depending upon the financial reputation of the issuer. A purchase discount is more
attractive financially to the purchaser; a premium is better for the issuer. For exam-
ple, suppose a person is offered a 2% discount for an 8% $10,000 20-year bond
that pays the dividend quarterly. He will pay $9800 now, and, according to Equa-
tion [6.1], he will receive quarterly dividends of I  $200, plus the $10,000 face
value after 20 years.
To evaluate a proposed bond purchase, determine the PW at the MARR of all cash
flows—initial payment and receipts of periodic dividends and the bond’s face value
at the maturity date. Then apply the guideline for one alternative, that is, if PW  0,
the bond is financially viable. It is important to use the effective MARR rate in the
PW relation that matches the time period of the payments. The simplest method is
the procedure in Section 5.4 for PP  CP, as illustrated in the next example.

EXAMPLE 6.2
Marcie has some extra money that she wants to place into a relatively safe
investment. Her employer is offering to employees a generous 5% discount for
10-year $5,000 bonds that carry a coupon rate of 6% paid semiannually. The
expectation is to match her return on other safe investments, which have aver-
aged 6.7% per year compounded semiannually. (This is an effective rate of
6.81% per year.) Should she buy the bond?
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Solution
Equation [6.1] results in a dividend of I ⫽ (5000)(0.06)兾2 ⫽ $150 every 6
months for a total of n ⫽ 20 dividend payments. The semiannual MARR is
6.7兾2 ⫽ 3.35%, and the purchase price now is ⫺5000(0.95) ⫽ $⫺4750. Using
PW evaluation,
PW ⫽ ⫺4750 ⫹ 150 (PⲐA,3.35%,20) ⫹ 5000 (PⲐF,3.35%,20)
⫽ $⫺2.13
The effective rate is slightly less than 6.81% per year since PW ⬍ 0. If Marcie
had to pay just $2.13 less for the bond, she would meet her MARR goal. She
should probably purchase the bond since the return is so close to her goal.

In order to speed up a PW analysis with Excel, the PV function is utilized. If

all annual amounts for AOC are the same, the PW value for year 1 to n cash flows
is found by entering the function ⫽ P ⫺ PV(i%, n, A, F). In Example 4.1, PWE ⫽
$⫺5788 is determined by entering ⫽ ⫺2500 ⫺ PV(10%,5,⫺900,200) into any cell.
Spreadsheet solutions are demonstrated in detail in Section 4.6.

6.3 PRESENT WORTH ANALYSIS OF DIFFERENT-LIFE

ALTERNATIVES
Present worth analysis requires an equal service comparison of alternatives, that is,
the number of years considered must be the same for all alternatives. If equal ser-
vice is not present, shorter-lived alternatives will be favored based on lower PW of
total costs, even though they may not be economically favorable. Fundamentally,
there are two ways to use PW analysis to compare alternatives with unequal life
estimates; evaluate over a specific study period (planning horizon), or use the least
common multiple of lives for each pair of alternatives. In both cases, the PW is cal-
culated at the MARR, and the selection guidelines of the previous section are applied.

6.3.1 Study Period

This is a commonly used approach. Once a study period is selected, only cash
flows during this time frame are considered. If an expected life is longer than this
period, the estimated market value of the alternative is used as a “salvage value”
in the last year of the study period. If the expected life is shorter than the study
period, cash flow estimates to continue equivalent service must be made for the
time period between the end of the alternative’s life and the end of the study period.
In both cases, the result is an equal-service evaluation of the alternatives. As one
example, assume a construction company wins a highway maintenance contract for
5 years, but plans to purchase specialized equipment expected to be operational for
10 years. For analysis purposes, the anticipated market value after 5 years is a
salvage value in the PW equation, and any cash flows after year 5 are ignored.
Example 6.3 a and b illustrate a study period analysis.
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6.3.2 Least Common Multiple (LCM)

This approach can result in unrealistic assumptions since equal service compari-
son is achieved by assuming:
ɀ The same service is needed for the LCM number of years. For example, the
LCM of 5- and 9-year lives presumes the same need for 45 years!
ɀ Cash flow estimates are initially expected to remain the same over each life
cycle, which is correct only when changes in future cash flows exactly match the
inflation or deflation rate.
ɀ Each alternative is available for multiple life cycles, something that is usually
not true.
Present worth analysis using the LCM method, as illustrated in Example 6.3, is
correct, but it is not advocated. The same correct conclusion is easier to reach
using each alternative’s life and an annual worth (AW) computation as discussed
in Chapter 7.

EXAMPLE 6.3
A project engineer with EnvironCare is assigned to start up a new office in a city
where a 6-year contract has been finalized to collect and analyze ozone-level
readings. Two lease options are available, each with a first cost, annual lease cost,
and deposit-return estimates shown below. The MARR is 15% per year.

Location A Location B

First cost, $ 15,000 18,000

Annual lease cost, $ per year 3,500 3,100
Deposit return, $ 1,000 2,000
Lease term, years 6 9

a. EnvironCare has a practice of evaluating all projects over a 5-year period.

If the deposit returns are not expected to change, which location should be
selected?
b. Perform the analysis using an 8-year planning horizon.
c. Determine which lease option should be selected on the basis of a present
worth comparison using the LCM.
Solution
a. For a 5-year study period, use the estimated deposit returns as positive cash
flows in year 5.
PWA  15,000  3500(P兾A,15%,5)  1000(P兾F,15%,5)
 $26,236
PWB  18,000  3100(P兾A,15%,5)  2000(P兾F,15%,5)
 $27,397
Location A is the better economic choice.
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b. For an 8-year study period, the deposit return for B remains at $2000 in
year 8. For A, an estimate for equivalent service for the additional 2 years is
needed. Assume this is expected to be relatively expensive at $6000 per year.
PWA  15,000  3500(P兾A,15%,6)  1000(P兾F,15%,6)
 6000(P兾A,15%,2)(P兾F,15%,6)
 $32,030
PWB  18,000  3100(P兾A,15%,8)  2000(P兾F,15%,8)
 $31,257
Location B has an economic advantage for this longer study period.
c. Since the leases have different terms, compare them over the LCM of
18 years. For life cycles after the first, the first cost is repeated at the begin-
ning (year 0) of each new cycle, which is the last year of the previous cycle.
These are years 6 and 12 for location A and year 9 for B. The cash flow dia-
gram is in Figure 6.2.
PWA  15,000  15,000(P兾F,15%,6)  1000(P兾F,15%,6)
 15,000(P兾F,15%,12)  1000(P兾F,15%,12)
 1000(P兾F,15%,18)  3500(P兾A,15%,18)
 $45,036
PWB  18,000  18,000(P兾F,15%,9)  2000(P兾F,15%,9)
 2000(P兾F,15%,18)  3100(P兾A,15%,18)
 $41,384
FIGURE 6.2
Location B is selected. Cash flow diagram
for different-life
PWA = ? alternatives,
Example 4.3c.
$1000 $1000 $1000
1 2 6 12 16 17 18

$3500

$15,000 $15,000 $15,000

Location A

PWB = ?

$2000 $2000
1 2 9 16 17 18

$3100

$18,000 $18,000
Location B
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The future worth (FW) of an alternative may also be used to select an alter-
native. The FW is determined directly from the cash flows or by multiplying
the PW value by the F兾P factor at the established MARR. The n value in the F兾P
factor depends upon which time period has been used to determine PW—the LCM
or a study period. Using FW values is especially applicable to large capital invest-
ment decisions when a prime goal is to maximize the future wealth of a corpora-
tion’s stockholders. Alternatives such as electric generation facilities, toll roads,
hotels, and the like can be analyzed using the FW value of investment commit-
ments made during construction. Selection guidelines are the same as those for PW
analysis.
Life-cycle cost (LCC) is another extension of present worth analysis. The LCC
method, as its name implies, is commonly applied to alternatives with cost esti-
mates over the entire system life span. This means that costs from the early stage
of the project (needs assessment and design), through marketing, warranty, and
operation phases and through the final stage (phaseout and disposal) are estimated.
Typical applications for LCC are buildings (new construction or purchases), new
product lines, manufacturing plants, commercial aircraft, new automobile models,
defense systems, and the like.
A PW analysis with all definable costs (and possibly incomes) estimatable are
considered in a LCC analysis. However, the broad definition of the LCC term sys-
tem life span requires cost estimates not usually made for a regular PW analysis,
such as design and development costs. LCC is most effectively applied when a sub-
stantial percentage of the total costs over the system life span, relative to the ini-
tial investment, will be operating and maintenance costs (postpurchase costs such
as warranty, personnel, energy, upkeep, and materials). If Exxon-Mobil is evaluat-
ing the purchase of equipment for a large chemical processing plant for $150,000
with a 5-year life and annual costs of $15,000, LCC analysis is probably not jus-
tified. On the other hand, suppose Toyota is considering the design, construction,
marketing, and after-delivery costs for a new automobile model. If the total start-
up cost is estimated at $125 million (over 3 years) and total annual costs are
expected to be 20% of this figure to build, market, and service the cars for the next
15 years (estimated life span of the model), then the logic of LCC analysis will
help the decision makers understand the profile of costs and their economic con-
sequences using PW, FW, or AW analysis. LCC is required for most defense and
aerospace industries, where the approach may be called Design to Cost (see Sec-
tion 11.1). LCC is usually not applied to public sector projects, because the ben-
efits and costs are difficult to estimate with much accuracy. Benefit/cost analysis
is better applied here, as discussed in Chapter 7.

6.4 CAPITALIZED COST ANALYSIS

Capitalized cost (CC) is the present worth of an alternative that will last “for-
ever.” Public sector projects such as bridges, dams, irrigation systems, and rail-
roads fall into this category, since they have useful lives of 30, 40, and more
years. In addition, permanent and charitable organization endowments are eval-
uated using capitalized cost.
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The formula to calculate CC is derived from the relation PW ⫽ A(P兾A,i,n),

where n ⫽ ⬁. The equation can be written
1
1⫺
PW ⫽ A £ (1 ⫹ i) n §
i
As n approaches ⬁, the bracketed term becomes 1兾i. The symbol CC replaces PW,
and AW (annual worth) replaces A to yield
A AW
CC ⴝ ⴝ [6.2]
i i
Equation [4.2] is illustrated by considering the time value of money. If
$10,000 earns 10% per year, the interest earned at the end of every year for
eternity is $1000. This leaves the original $10,000 intact to earn more next year.
In general, the equivalent A value from Equation [6.2] for an infinite number of
periods is
A ⴝ CC(i) [6.3]
The cash flows (costs or receipts) in a capitalized cost calculation are usu-
ally of two types: recurring, also called periodic, and nonrecurring, also called
one-time. An annual operating cost of $50,000 and a rework cost estimated at
$40,000 every 12 years are examples of recurring cash flows. Examples of non-
recurring cash flows are the initial investment amount in year 0 and one-time
cash flow estimates, for example, $500,000 in royalty fees 2 years hence. The
following procedure assists in calculating the CC for an infinite sequence of
cash flows.
1. Draw a cash flow diagram showing all nonrecurring and at least two cycles of
all recurring cash flows. (Drawing the cash flow diagram is more important in
CC calculations than elsewhere.)
2. Find the present worth of all nonrecurring amounts. This is their CC value.
3. Find the equivalent uniform annual worth (A value) through one life cycle of
all recurring amounts. This is the same value in all succeeding life cycles. Add
this to all other uniform amounts occurring in years 1 through infinity and the
result is the total equivalent uniform annual worth (AW).
4. Divide the AW obtained in step 3 by the interest rate i to obtain a CC value.
This is an application of Equation [6.2].
5. Add the CC values obtained in steps 2 and 4.

EXAMPLE 6.4
The property appraisal district for Marin County has just installed new software
to track residential market values for property tax computations. The manager
wants to know the total equivalent cost of all future costs incurred when the
three county judges agreed to purchase the software system. If the new system
will be used for the indefinite future, find the equivalent value (a) now and
(b) for each year hereafter.
The system has an installed cost of $150,000 and an additional cost of
$50,000 after 10 years. The annual software maintenance contract cost is $5000
for the first 4 years and $8000 thereafter. In addition, there is expected to be a
recurring major upgrade cost of $15,000 every 13 years. Assume that i  5%
per year for county funds.

Solution
a. The detailed procedure is applied.
1. Draw a cash flow diagram for two cycles (Figure 6.3).
2. Find the present worth of the nonrecurring costs of $150,000 now and
$50,000 in year 10 at i  5%. Label this CC1.
CC1  150,000  50,000(P兾F,5%,10)  $180,695
3. Convert the recurring cost of $15,000 every 13 years into an annual
worth A1 for the first 13 years.
A1  15,000(A兾F,5%,13)  $847
The same value, A1  $847, applies to all the other 13-year periods
as well.
4. The capitalized cost for the two annual maintenance cost series may be
determined in either of two ways: (1) consider a series of $5000 from
now to infinity plus a series of $3000 from year 5 on; or (2) a series
of $5000 for 4 years followed by a series of $8000 from year 5 to
infinity. Using the first method, the annual cost (A2) is $5000 forever.

i = 5% per year

0 2 4 6 8 10 12 14 20 26 Year

$5000
$8000

$15,000 $15,000
$50,000

$150,000

FIGURE 6.3 Cash flows for two cycles of recurring costs and all nonrecurring amounts,
Example 6.4.
 The capitalized cost CC2 of $3000 from year 5 to infinity is found
using Equation [6.2] times the P兾F factor.
3000
CC2  (PF,5%,4)  $49,362
0.05
The CC2 value is calculated using n  4 because the present
worth of the annual $3000 cost is located in year 4, one period ahead
of the first A. The two annual cost series are converted into a capital-
ized cost CC3.
A1  A2 847  (5000)
CC3    $116,940
i 0.05
5. The total capitalized cost CCT is obtained by adding the three CC
values.
CCT  180,695  49,362  116,940  $346,997
b. Equation [4.3] determines the A value forever.
A  CCT (i)  $346,997(0.05)  $17,350
Correctly interpreted, this means Marin County officials have committed
the equivalent of $17,350 forever to operate and maintain the property
appraisal software.

The CC evaluation of two or more alternatives compares them for the same
number of years—infinity. The alternative with the smaller capitalized cost is the
more economical one.

EXAMPLE 6.5
Two sites are currently under consideration for a bridge over a small river. The
north site requires a suspension bridge. The south site has a much shorter span,
allowing for a truss bridge, but it would require new road construction.
The suspension bridge will cost $500 million with annual inspection and
maintenance costs of $350,000. In addition, the concrete deck would have to be
resurfaced every 10 years at a cost of $1,000,000. The truss bridge and approach
roads are expected to cost $250 million and have annual maintenance costs of
$200,000. This bridge would have to be painted every 3 years at a cost of
$400,000. In addition, the bridge would have to be sandblasted every 10 years
at a cost of $1,900,000. The cost of purchasing right-of-way is expected to be
$20 million for the suspension bridge and $150 million for the truss bridge.
Compare the alternatives on the basis of their capitalized cost if the interest rate
is 6% per year.
 Solution
Construct the cash flow diagrams over two cycles (20 years).
Capitalized cost of suspension bridge (CCS):
CC1  capitalized cost of initial cost
 500  20  $520 million
The recurring operating cost is A1  $350,000, and the annual equivalent of
the resurface cost is
A2  1,000,000 (AF, 6%,10)  $75,870
A1  A2
CC2  capitalized cost of recurring costs 
i
350,000  (75,870)
  $7,097,833
0.06
The total capitalized cost is
CCS  CC1  CC2  $527.1 million
Capitalized cost of truss bridge (CCT):
CC1  250  (150)  $400 million
A1  $200,000
A2  annual cost of painting  400,000(A兾F,6%,3)  $125,644
A3  annual cost of sandblasting  1,900,000(A兾F,6%,10)  $144,153
A1  A2  A3 $469,797
CC2    $7,829,950
i 0.06
CCT  CC1  CC2  $407.83 million
Conclusion: Build the truss bridge, since its capitalized cost is lower by
$119 million.

If a finite-life alternative (e.g., 5 years) is compared to one with an indefi-

nite or very long life, capitalized costs can be used. To determine CC for the
finite life alternative, calculate the A value for one life cycle and divide by the
interest rate (Equation [6.2]).
EXAMPLE 6.6
APSco, a large electronics subcontractor for the Air Force, needs to immedi-
ately acquire 10 soldering machines with specially prepared jigs for assem-
bling components onto circuit boards. More machines may be needed in the
future. The lead production engineer has outlined two simplified, but viable,
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 94

alternatives. The company’s MARR is 15% per year and capitalized cost is the
evaluation technique.
Alternative LT (long-term). For $8 million now, a contractor will provide
the necessary number of machines (up to a maximum of 20), now and
in the future, for as long as APSco needs them. The annual contract fee
is a total of $25,000 with no additional per-machine annual cost. There
is no time limit placed on the contract, and the costs do not escalate.
Alternative ST (short-term). APSco buys its own machines for $275,000
each and expends an estimated $12,000 per machine in annual
operating cost (AOC). The useful life of a soldering system is 5 years.
Solution
For the LT alternative, find the CC of the AOC using Equation [6.2]. Add this
amount to the initial contract fee, which is already a capitalized cost.
CCLT  CC of contract fee  CC of AOC
 8 million  25,000兾0.15  $8,166,667
For the ST alternative, first calculate the equivalent annual amount for the pur-
chase cost over the 5-year life, and add the AOC values for all 10 machines.
Then determine the total CC using Equation [6.2].
AWST  AW for purchase  AOC
 2.75 million (AP,15%,5)  120,000  $940,380
CCST  940,3800.15  $6,269,200
The ST alternative has a lower capitalized cost by approximately $1.9 million
present value dollars.

6.5 EVALUATION OF INDEPENDENT PROJECTS

Consider a biomedical company that has a new genetics engineering product that it
can market in three different countries (S, U, and R), including any combination of
the three. The do nothing (DN) alternative is also an option. All possible options are:
S, U, R, SU, SR, UR, SUR, and DN. In general, for m independent projects, there
are 2m alternatives to evaluate. Selection from independent projects uses a funda-
mentally different approach from that for mutually exclusive (ME) alternatives. When
selecting independent projects, each project’s PW is compared with the MARR. (In
ME alternative evaluation, the projects compete with each other, and only one is
selected.) The selection rule is quite simple for one or more independent projects:
Select all projects that have PW ⱖ 0 at the MARR.
All projects must be developed to have revenue cash flows (not costs only) so that
projects earning more than the MARR have positive PW values.
Unlike ME alternative evaluation, which assumes the need for the service over
multiple life cycles, independent projects are considered one-time investments. This
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 95

means the PW analysis is performed over the respective life of each project and
the assumption is made that any leftover cash flows earn at the MARR when the
project ends. As a result, the equal service requirement does not impose the use of
a specified study period or the LCM method. The implied study period is that of
the longest lived project.
There are two types of selection environments—unlimited and budget
constrained.
ɀ Unlimited. All projects that make or exceed the MARR are selected. Selection
is made using the PW  0 guideline.
ɀ Budget constrained. No more than a specified amount, b, of funds can be in-
vested in all of the selected projects, and each project must make or exceed the
MARR. Now the solution methodology is slightly more complex in that bundles
of projects that do not exceed the investment limit b are the only ones evaluated
using PW values. The procedure is:
1. Determine all bundles that have total initial investments no more than b.
(This limit usually applies in year 0 to get the project started).
2. Find the PW value at the MARR for all projects contained in the bundles.
3. Total the PW values for each bundle in (1).
4. Select the bundle with the largest PW value.

EXAMPLE 6.7
Marshall Aqua Technologies has four separate projects it can pursue over the
next several years. The required amounts to start each project (initial invest-
ments) now and the anticipated cash flows over the expected lives are estimated
by the Project Engineering Department. At MARR  15% per year, determine
which projects should be pursued if initial funding is (a) not limited, and
(b) limited to no more than $15,000.

Initial Annual Net Life,

Project Investment Cash Flow Years

F $ 8,000 $3870 6
G 15,000 2930 9
H 6,000 2080 5
J 10,000 5060 3

Solution
a. Determine the PW value for each independent project and select all with
PW  0 at 15%.
PWF  8000  3870(P兾A,15%,6)  $6646
PWG  15,000  2930(P兾A,15%,9)  $1019
PWH  6000  2080(P兾A,15%,5)  $973
PWJ  10,000  5060(P兾A,15%,3)  $1553
Select the three projects F, H, and J for a total investment of $24,000.
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 96

TABLE 4.1 Present Worth Analysis of Independent Projects with

Investment Limited to $15,000, Example 6.7

Total Initial PW of Bundle

Bundle Projects Investment at 15%

1 F $ 8,000 $ 6646
2 G 15,000 1019
3 H 6,000 973
4 J 10,000 1553
5 FH 14,000 7619
6 Do-nothing 0 0

b. Use the steps for a budget-constrained selection with b  $15,000.

1 and 2. Of the 24  16 possible bundles, Table 4.1 indicates that 6 are
acceptable. These bundles involve all four projects plus do-nothing
with PWDN  $0.
3. The PW value for a bundle is obtained by adding the respective project
PW values. For example, PW5  6646  973  $7619.
4. Select projects F and H, since their PW is the largest and both projects
exceed the MARR, as indicated by PW 0 at i  15%.
Comment: Budget-constrained selection from independent projects is commonly
called the capital rationing or capital budgeting problem. It may be worked effi-
ciently using a variety of techniques, one being the integer linear programming tech-
nique. Excel and its optimizing tool SOLVER handle this type of problem rather
nicely.

6.6 USING SPREADSHEETS FOR PW ANALYSIS

Spreadsheet-based evaluation of equal-life, mutually exclusive alternatives can be
performed using the single-cell PV function when the annual amount A is the same.
The general format to determine the PW is
 P  PV(i%,n, A,F) [6.4]
It is important to pay attention to the sign placed on the PV function in order to
get the correct answer for the alternative’s PW value. Excel returns the opposite sign
of the A series because it interprets cash flows in the manner explained in Chapter
1, that is, costs are negative and the PV function value is a positive equivalent at
time 0. Therefore, to retain the negative sense of a cost series A, place a minus sign
immediately in front of the PV function. This is illustrated in the next example.
bLa01293_ch04_080-106 9/7/07 5:21 AM Page 97

EXAMPLE 6.8
Cesar, a petroleum engineer, has identified two equivalent diesel-powered genera-
tors to be purchased for an offshore platform. Use i ⫽ 12% per year to determine
which is the more economic.
Generator 1 Generator 2
P, $ ⫺80,000 ⫺120,000
S, $ 15,000 40,000
n, years 3 3
AOC, $/year ⫺30,000 ⫺8,000
Solution
Follow the format in Equation [6.4] in a single cell for each alternative. Figure
6.4 cell tags show the details. Note the use of minus signs on P, the PV func-
tion, and AOC value. Generator 2 is selected with the smaller PW of costs
(numerically larger value).

FIGURE 6.4 Equal-life alternatives evaluated using the PV function,

Example 4.8.

When different-life alternatives are evaluated, using the LCM basis, it is neces-
sary to input all the cash flows for the LCM of the lives to ensure an equal-service
evaluation. Develop the NPV function to find PW. If cash flow is identified by CF,
the general format is
⫽ P ⫹ NPV1i%,year_1_CF_cell:last_year_CF_cell2 [6.5]
It is very important that the initial cost P not be included in the cash flow series
identified in the NPV function. Unlike the PV function, the NPV function returns
the correct sign for the PW value.
EXAMPLE 6.9
Continuing with the previous example, once Cesar had selected generator 2 to
purchase, he approached the manufacturer with the concerns that the first cost
was too high and the expected life was too short. He was offered a lease arrange-
ment for 6 years with a $20,000 annual cost and an extra $20,000 payment in
the first and last years to cover installation and removal costs. Determine if
generator 2 or the lease arrangement is better at 12% per year.
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 98

FIGURE 6.5 Different-life alternatives evaluated using the NPV function, Example 4.9.
Solution
Assuming that generator 2 can be repurchased 3 years hence and all estimates
remain the same, PW evaluation over 6 years is correct. Figure 6.5 details
the cash flows and NPV functions. The year 3 cash flow for generator 2 is
S  AOC  P  $88,000. Note that the first costs are not included in the
NPV function but are listed separately, as indicated in Equation [6.5]. The lease
option is the clear winner for the next 6 years.

When evaluating alternatives in which the annual cash flows do not form an A
series, the individual amounts must be entered on the spreadsheet and Equation
[6.5] is used to find PW values. Also, remember that any zero-cash-flow year must
be entered as 0 to ensure that the NPV function correctly tracks the years.

SUMMARY
This chapter explained the difference between mutu- service cost must be estimated through the end of
ally exclusive and independent alternatives, as well the study period.
as revenue and cost cash flows. It discussed the use 2. PW evaluation over the least common multiple
of present worth (PW) analysis to select the econom- (LCM) of lives can be used to obtain equal service.
ically best alternative. In general, always choose an 3. Capitalized cost (CC) analysis, an application of
alternative with the largest PW value calculated at PW analysis with n  , compares alternatives
the MARR. with indefinite or very long lives. In short, the CC
Important points to remember for mutually value is determined by dividing the equivalent A
exclusive alternatives selection are: value of all cash flows by the interest rate i.
1. Compare equal service alternatives over the same For independent projects, select all with PW  0
number of years using a specified study period. at the MARR if there is no budget limitation.
Alternatives with lives shortened by the study When funds are limited, form bundles of projects
period have as a “salvage value” the estimated that do not exceed the limit and select the bundle that
market value. For longer lives, an equivalent- maximizes PW.
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 99

PROBLEMS
per system is estimated to be $40,000 in year 1 and
Alternative Formulation to increase by $10,000 per year through year 5.
6.1 Why is it necessary to consider do-nothing as a Determine if the project is economically justified
viable alternative when evaluating mutually exclu- using PW analysis and an MARR of 10% per year.
sive alternatives or independent projects? 6.7 An engineer and her husband operate a pet sitting
6.2 A biomedical engineer with Johnston Implants just service on the side. They want to add a daily ser-
received estimates for replacement equipment to vice of a photo placed online for pet owners who
deliver online selected diagnostic results to doctors are traveling. The estimates are: equipment and
performing surgery who need immediate informa- setup cost $600, and net monthly income over
tion on the patient’s condition. The cost is $200,000, costs $30. For a period of 2 years, will the service
the annual maintenance contract costs $5000, and make at least 12% per year compounded monthly?
the useful life (technologically) is 5 years. 6.8 The CFO of Marta Aaraña Cement Industries
a. What is the alternative if this equipment is not knows that many of the diesel-fueled systems in its
selected? What other information is necessary quarries must be replaced at an estimated cost of
to perform an economic evaluation of the two? $20 million 10 years from now. A fund for these
b. What type of cash flow series will these esti- replacements has been established with the com-
mates form? mitment of $1 million at the end of next year (year
c. What additional information is needed to con- 1) with 10% increases through the 10th year. If the
vert the cash flow estimates to the other type? fund earns at 5.25% per year, will the company
6.3 When performing an engineering economy eval- have enough to pay for the replacements?
uation, only one of several mutually exclusive 6.9 Burling Water Cooperative currently contracts the
alternatives is selected, whereas any number of removal of small amounts of hydrogen sulfide
independent projects can be selected. Explain from its well water using manganese dioxide
the fundamental difference between mutually filtration prior to the addition of chlorine and fluo-
exclusive and independent projects that makes ride. Contract renewal for 5 years will cost
these selection rules correct. $75,000 annually for the next 3 years and
6.4 The lead engineer at Bell Aerospace has $1 million $100,000 in years 4 and 5. Assume payment is
in research funds to commit this year. She is made at the end of each contract year. Burling
considering five separate R&D projects, identified Coop can install the filtration equipment for
as A through E. Upon examination, she determines $150,000 and perform the process for $60,000 per
that three of these projects (A, B, and C) accom- year. At a discount rate of 6% per year, does the
plish exactly the same objective using different contract service still save money?
techniques. 6.10 Jamal bought a 5% $1000 20-year bond for
a. Identify each project as mutually exclusive or $825. He received a semiannual dividend for 8
independent. years, then sold it immediately after the 16th
b. If the selected alternative between A, B, and C dividend for $800. Did Jamal make the return of
is labeled X, list all viable options (bundles) for 5% per year compounded semiannually that he
the five projects. wanted?
6.5 List all possible bundles for the four independent 6.11 Atari needs $4.5 million in new investment capital
projects 1, 2, 3, and 4. Projects 3 and 4 cannot both to develop and market downloadable games
be included in the same bundle. software for its new GPS2-ZX system. The plan
is to sell $10,000 face-value corporate bonds at a
Alternative Evaluation—Equal Lives discount of $9000 now. A bond pays a dividend
each 6 months based on a bond interest rate of 5%
6.6 Johnston Implants is planning new online patient per year with the $10,000 face value returned after
diagnostics for surgeons while they operate. The 20 years. Will a purchase make at least 6% per
new system will cost $200,000 to install in an year compounded semiannually?
operating room, $5000 annually for maintenance, 6.12 Fairchild Industries issued 4% bonds some years
and have an expected life of 5 years. The revenue ago. Carla’s grandfather told her he purchased one
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 100

at a 5% discount when they were issued, and it 6.15 The Bureau of Indian Affairs provides various
has paid him $1000 each 3 months for the last services to American Indians and Alaskan Natives.
15 years. He told her that he just received the 60th The Director of Indian Health Services is working
dividend and he plans to sell the bond tomorrow with chief physicians at some of the 230 clinics
for the face value and give her this money to help nationwide to select the better of two medical
with college tuition and expenses. X-ray system alternatives to be located at
a. Determine the amount Carla will receive. secondary-level clinics. At 5% per year, select the
b. Use the PW method to determine the number more economical system.
of years to maturity printed on the bond certifi-
cate at issue time. Del Medical Siemens
c. Calculate the effective annual rate of return on First cost, $ 250,000 224,000
this investment using a PW relation. Annual operating cost,
6.13Nicole and Amy share an apartment and work at $ per year 231,000 235,000
Pure H2O Engineering, and they have decided to Overhaul in year 3, $  26,000
drink more water each day. The recommended Overhaul in year 4, $ 140,000 
amount is eight 8-ounce glasses, or 64 ounces, per Salvage value, $ 50,000 10,000
day. This is a total of one gallon per day for the Expected life, years 6 6
two of them. Using this 1 gallon (or 3.78 liters
equivalent) basis for three possible sources of 6.16 Chevron Corporation has a capital and exploratory
drinking water, determine the monthly cost and budget for oil and gas production of $19.6 billion
present worth value for one year of use. For each in one year. The Upstream Division has a proj-
source, the average cost and amount of source wa- ect in Angola for which three offshore platform
ter estimated to be used to get a gallon of drinking equipment alternatives are identified. Use the
water is tabulated. Let i  6% per year com- present worth method to select the best alternative
pounded monthly and assume 30 days per month. at 12% per year.

Gallons used A B C
per First cost, $ million 200 350 475
Method Average Cost Gallon Drank
Annual cost, $ million per year 450 275 400
Bottles from store $1 per gallon 1
Salvage value, $ million 75 50 90
shelf
Estimated life, years 20 20 20
In-home filtration 27¢ per gallon 2
system 6.17 The TechEdge Corporation offers two forms of
Tap water $2.75 per 1000 gallons 5 4-year service contracts on its closed-loop water
purification system used in the manufacture of
6.14 The Briggs and Stratton Commercial Division de- semiconductor packages for microwave and
signs and manufactures small engines for golf turf high-speed digital devices. The Professional
maintenance equipment. A robotics-based testing Plan has an initial fee of $52,000 with annual
system will ensure that their new signature guar- fees starting at $1000 in contract year 1 and in-
antee program entitled “Always Insta-Start” does creasing by $500 each year. Alternatively, the
indeed work for every engine produced. Compare Executive Plan costs $62,000 up front with an-
the two systems at MARR  10% per year. nual fees starting at $5000 in contract year 1 and
Pull System Push System decreasing by $500 each year. The initial charge
Robot and support is considered a setup cost for which there is no
equipment first cost, $ 1,500,000 2,250,000 salvage value expected. Evaluate the plans at a
Annual maintenance and MARR of 9% per year.
operating cost, $ per year 700,000 600,000 6.18 Harold and Gwendelyn are engineers at Raytheon.
Rebuild cost in year 3, $ 0 500,000 Each has presented a proposal to track fatigue
Salvage value, $ 100,000 50,000 development in composites materials installed on
Estimated life, years 8 8 special-purpose aircraft. Which is the better plan
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 101

economically if i  12% per year compounded pended in its last year. There are no salvage values
monthly? to be considered. Use i  8% per year and PW
analysis to select the more economic surface,
Harold’s Gwendelyn’s provided the property is (a) used as a parking lot
Plan Plan for 20 years, and (b) sold after 5 years and the
Initial cost, $ 40,000 60,000 parking lot is completely removed.
Monthly M&O costs,
6.22 The manager of engineering at the 900-
$ per month 5,000  megawatt Hamilton Nuclear Power Plant has
Semiannual M&O
three options to supply personal safety equip-
cost, $ per 6-month  13,000 ment to employees. Two are vendors who
Salvage value, $ 10,000 8,000
sell the items, and a third will rent the equipment
Life, years 5 5 for $50,000 per year, but for no more than
3 years per contract. These items have relatively
short lives due to constant use. The MARR is
Alternative Evaluation—Unequal Lives 10% per year.
6.19 An environmental engineer must recommend one
of two methods for monitoring high colony counts Vendor R Vendor T Rental
of E. coli and other bacteria in watershed area “hot Initial cost, $ 75,000 125,000 0
spots.” Estimates are tabulated, and the MARR is Annual upkeep
10% per year. cost, $/year 27,000 12,000 0
Annual rental
Method A Method B cost, $ per year 0 0 50,000
Initial cost, $ 100,000 250,000 Salvage value, $ 0 30,000 0
Annual operating cost, 30,000 in year 1 20,000 Estimated life, 2 3 Maximum
$ per year increasing by years of 3
5000 each year
Life, years 3 6 a. Select from the two sales vendors using the
LCM and PW analysis.
a. Use present worth analysis to select the better b. Determine which of the three options is
method. cheaper over a study period of 3 years.
b. For a study period of 3 years, use PW analysis 6.23 Akash Uni-Safe in Chennai, India, makes Termi-
to select the better method. nater fire extinguishers. It needs replacement
6.20 Use the LCM method and PW analysis to solve equipment to form the neck at the top of each
problem 4.19a. The engineer has updated the esti- extinguisher during production. Select between
mates for repurchasing A. The purchase 3 years two metal-constricting systems. Use the corporate
hence is estimated to cost $150,000, and annual MARR of 15% per year with (a) present worth
costs will likely increase by $10,000, making them analysis, and (b) future worth analysis.
$40,000, $45,000, and $50,000.
6.21 Allen Auto Group owns corner property that can Machine D Machine E
be a parking lot for customers or sold for retail First cost, $ 62,000 77,000
sales space. The parking lot option can use con- Annual operating cost,
crete or asphalt. Concrete will cost $375,000 $ per year 15,000 21,000
initially, last for 20 years, and have an estimated Salvage value, $ 8,000 10,000
annual maintenance cost of $200 starting at the Life, years 4 6
end of the eighth year. Asphalt is cheaper to install
at $250,000, but it will last 10 years and cost 6.24 The Engineering Director at Akash Uni-Safe
$2500 per year to maintain starting at the end of (Problem 4.23) wants to perform the evaluation
the second year. If asphalt is replaced after over a 5-year study period. When asked how
10 years, the $2500 maintenance cost will be ex- he would resolve the dilemma that neither
bLa01293_ch04_080-106 9/6/07 8:09 PM Page 102

machine has a 5-year life, he provided the follow- life-cycle cost analysis to identify the best alterna-
ing estimates: tive at 8% per year. All estimates are in $ millions.
Machine D: Rework the machine at an additional
cost of $30,000 in year 4, plan for the AOC of Alternative Category Estimated Cost
$15,000 in year 5, and expect zero salvage T Development $250 now, $150 for years 1–3
when it is discarded. P兾T $45 now, $35 for years 1, 2
Machine E: Sell it prematurely for the $10,000 Operation $50 for years 1 through 10
salvage value. Support $30 for years 1 through 4
Evaluate the alternatives over 5 years. If you A Development $10 now
worked problem 4.23, is the selection the same? P兾T $45 year 0, $30 for years 1–3
6.25 If energy usage guidelines expect future increases
Operation $100 for years 1 through 10
in deep freeze efficiency, which one of two energy
Support $40 for years 1 through 10
efficiency improvements is more economical based
C Operation $190 for years 1 through 10
on future worth at an interest rate of 10% per year?
A 20% increase is expected to add $150 to the cur-
rent price of a freezer, while a 35% increase will 6.28 Gatorade Endurance Formula, introduced in 2004,
add $340 to the price. The estimated cost for en- contains more electrolytes (such as calcium and
ergy is $115 per year with the 20% increase in magnesium) than the original sports drink formula,
efficiency and $80 per year with the 35% increase. thus causing Endurance to taste saltier to some.
Assume a 15-year life for all freezer models. It is important that the amount of electrolytes be
6.26 HJ Heinz Corporation is constructing a distribu- precisely balanced in the manufacturing process.
tion facility in Italy for products such as Heinz The currently installed system (called EMOST)
Ketchup, Jack Daniel’s Sauces, HP steak sauce, can be upgraded to monitor the amount more pre-
and Lea & Perrins Worcestershire sauce. A 15- cisely. It costs $12,000 per year for equipment
year life is expected for the structure. The exterior maintenance and $45,000 per year for labor now,
of the building is not yet selected. One alternative and the upgrade will cost $25,000 now. This can
is to use the concrete walls as the facade. This will serve for 10 more years, the expected remaining
require painting now and every 5 years at a cost time the product will be financially successful.
of $80,000 each time. Another alternative is an A new system (UPMOST) will also serve for the
anodized metal exterior attached to the concrete 10 years and have the following estimated costs.
wall. This will cost $200,000 now and require only All costs are per year for the indicated time periods.
minimal maintenance of $500 every 3 years. A Equipment: $150,000; years 0 and 1
metal exterior is more attractive and will have a
Development: $120,000; years 1 and 2
market value of an estimated $25,000 more than
Maintain and phaseout EMOST: $20,000; years 1,
concrete 15 years from now. Assume painting
2, and 3
(concrete) or maintenance (metal) will be per-
formed in the last year of ownership to promote Maintain hardware and software: $10,000; years 3
selling the property. Use future worth analysis and through 10
i ⫽ 12% per year to select the exterior finish. Personnel costs: $90,000; years 3 through 10
Scrapped formula: $30,000; years 3 through 10
Life Cycle Cost Sales of Gatorade Endurance are expected to be
6.27 Emerald International Airlines plans to develop improved by $150,000 per year beginning in year 3
and install a new passenger ticketing system. and increase by $50,000 per year through year 10.
A life-cycle cost approach has been used to cate- Use LCC analysis at an MARR of 20% per year to
gorize costs into four categories: development, select the better electrolyte monitoring system.
programming and testing (P/T), operating, Capitalized Cost
and support. There are three alternatives under
consideration, identified as T (tailored system), 6.29 Suppose that at 35 years old you are a well-paid
A (adapted system), and C (current system). Use a project leader with Electrolux USA. You plan to
bLa01293_ch04_080-106 9/6/07 8:10 PM Page 103

work for this company for 20 more years and retire 6.34 Tom, a new honors graduate, just received a Visa
from it with a retirement income of $5000 per credit card with a high spending limit and an 18%
month for the rest of your life. Assume an earning per year compounded monthly interest rate. He
rate of 6% per year compounded monthly on your plans to use the card starting next month to reward
investments. (a) How much must you place into himself by purchasing things that he has wanted
your retirement plan monthly starting at the end of for some time at a rate of $1000 per month and pay
next month (month 1) and ending one month prior none of the balance or accrued interest. One
to the commencement of the retirement benefit? month after he stops spending, Tom is willing to
(b) Alternatively, assume you decided to deposit then start payments of interest only on the total
the required amount once at the end of each year. credit card balance at the rate of $500 per month
Determine the annual retirement savings needed for the rest of his life. Use the capitalized cost
to reach your goal. method to determine how many months Tom can
6.30 The president of GE Healthcare is considering spend before he must start making the $500 per
an external long-term contract offer that will sig- month payments. Assume the payments can be
nificantly improve the energy efficiency of their made for many years, i.e., forever. (Hint: Draw the
imaging systems. The payment schedule has two cash flow diagram first.)
large payments in the first years with continuing 6.35 A pipeline engineer working in Kuwait for BP
payments thereafter. The proposed schedule is (formerly British Petroleum) wants to perform a
$200,000 now, $300,000 four years from now, capitalized cost analysis on alternative pipeline
$50,000 every 5 years, and an annual amount of routings—one predominately by land and the sec-
$8000 beginning 15 years from now. Determine ond primarily undersea. The undersea route is
the capitalized cost at 6% per year. more expensive initially due to extra corrosion
6.31 The Rustin Transportation Planning Board esti- protection and installation costs, but cheaper secu-
mates the cost of upgrading a 4-mile section of rity and maintenance reduce annual costs. Select
4-lane highway from public use to toll road to be the better routing at 10% per year.
$85 million now. Resurfacing and other mainte-
nance will cost $550,000 every 3 years. Annual Land Undersea
toll revenue is expected to average $18.5 million Installation cost, $ million ⫺225 ⫺350
for the foreseeable future. If i ⫽ 8% per year, Pumping, operating, security,
what is (a) the capitalized cost now, and (b) the $ million per year ⫺20 ⫺2
equivalent A value of this capitalized cost? Ex- Replacement of deteriorated pipe,
plain the meaning of the A value just calculated. $ million each 40 years ⫺50 ⫺
6.32 A specially built computer system has just been Expected life, years ⬁ ⬁
purchased by Progress Greenhouse Products to
monitor moisture level and to control drip irriga- 6.36 A Dade County project engineer has received draft
tion in hydroponics beds that grow cluster cost and revenue estimates for a new exhibit and
“tradiro” tomatoes. The system’s first cost was convention center. She has asked you to perform a
$97,000 with an AOC of $10,000 and a salvage capitalized cost analysis at 6% per year. Which
value on the international market of $20,000 after plan is more economical?
4 years, when Progress expects to sell the system.
Determine the capitalized cost at 12% per year and Plan 1: Initial costs of $40 million with an expansion
explain its meaning. costing $8 million 10 years from now. AOC is
6.33A rich graduate of your university wants to set up $250,000 per year. Net revenue expectation:
a scholarship fund for economically disadvan- $190,000 the first year increasing by $20,000
taged high school seniors who have a mental apti- per year for 4 additional years and then leveling
tude to become good engineers. The scholarships off until year 10; $350,000 in year 11 and there-
will be awarded starting now and continue forever after.
to several individuals for a total of $100,000 per Plan 2: Initial cost of $42 million with an AOC of
year. If investments earn at 5% per year, how $300,000 per year. Net revenue expectation:
much must the alumnus contribute immediately? $260,000 the first year increasing by $30,000
bLa01293_ch04_080-106 8/24/07 1:01 PM Page 104

per year for 6 additional years and then leveling Independent Projects
off at $440,000 in year 8 and thereafter.
6.37 UPS Freight plans to spend $100 million on new 6.40 State the primary difference between mutually
long-haul tractor-trailers. Some of these vehicles exclusive alternatives and independent projects for
will include a new shelving design with ad- the equal-service requirement when economic
justable shelves to transport irregularly sized evaluation is performed.
freight that requires special handling during 6.41 Carlotta, the general manager for Woodsome
loading and unloading. Though the life is rela- appliance company Plant #A14 in Mexico City
tively short, the director wants a capitalized has 4 independent projects she can fund this year
cost analysis performed on the two final designs. to improve surface durability on stainless steel
Compare the alternatives at the MARR of 10% products. The project costs and 12%-per-year
per year. PW values are available. What projects are
acceptable if the budget limit is (a) no limit, and
(b) $60,000?
Design A: Design B:
Movable Shelves Adaptable Frames
First cost, $ 2,500,000 1,100,000
Initial Life, PW at 12%
Project Investment, $ Years per Year, $
AOC, $ per year 130,000 65,000
1 15,000 3 400
Annual revenue,
$ per year 800,000 625,000 2 25,000 3 8500
Salvage value, $ 50,000 20,000 3 20,000 2 500
Life, years 6 4 4 40,000 5 7600

6.38 A water supply cooperative plans to increase its 6.42 Dwayne has four independent vendor proposals to
water supply by 8.5 million gallons per day to contract the nationwide oil recycling services for
meet increasing demand. One alternative is to the Ford Corporation manufacturing plants. All
spend $10 million to increase the size of an exist- combinations are acceptable, except that vendors
ing reservoir in an environmentally acceptable B and C cannot both be chosen. Revenue sharing
way. Added annual upkeep will be $25,000 for this of recycled oil sales with Ford is a part of the re-
option. A second option is to drill new wells and quirement. Develop all possible mutually exclu-
provide added pipelines for transportation to treat- sive bundles under the additional following
ment facilities at an initial cost of $1.5 million and restrictions and select the best projects. The corpo-
annual cost of $120,000. The reservoir is expected rate MARR is 10% per year.
to last indefinitely, but the productive well life is a. A maximum of $4 million can be spent.
10 years. Compare the alternatives at 5% per year. b. A larger budget of $5.5 million is allowed, but
6.39 Three alternatives to incorporate improved tech- no more than two vendors can be selected.
niques to manufacture computer drives to play HD c. There is no limit on spending.
DVD optical disc formats have been developed
and costed. Compare the alternatives below using Initial Life, Annual Net
capitalized cost and an interest rate of 12% per Vendor Investment, $ Years Revenue, $ per Year
year compounded quarterly. A 1.5 million 8 360,000
B 3.0 million 10 600,000
Alternative Alternative Alternative C 1.8 million 5 620,000
E F G
D 2.0 million 4 630,000
First cost, $ 2,000,000 3,000,000 10,000,000
Net income,
$ per quarter 300,000 100,000 400,000 6.43 Use the PW method at 8% per year to select up to
Salvage value, $ 50,000 70,000  3 projects from the 4 available ones if no more
than $20,000 can be invested. Estimated lives and
Life, years 4 8 
annual net cash flows vary.
bLa01293_ch04_080-106 9/6/07 8:10 PM Page 105

Initial Net Cash Flow, $ per Year

Project Investment, $ 1 2 3 4 5 6
W 5,000 1000 1700 1800 2,500 2,000
X 8,000 900 950 1000 1,050 10,500
Y 8,000 4000 3000 1000 500 500 2000
Z 10,000 0 0 0 17,000

6.44 Chloe has $7,000 to spend on as many as 3 elec-

Installed Estimated Added
tronic features to enhance revenue from the tele-
Feature Cost, $ Revenue, $ per Month
marketing business she operates on weekends.
Use the PW method to determine which of these Auto-caller 4500 220
independent investments are financially accept- Web interface 3000 200
able at 6% per year compounded monthly. All are Fast search software 2200 140
expected to last 3 years.