Lecture No 18 Chapter 5 Contemporary Engineering Economics Copyright 2016 Comparing Mutually Exclusive Projects Basic Terminologies Revenue Versus Service Projects Revenue Projects ID: 641003
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Slide1
Comparing Mutually Exclusive Alternatives
Lecture No
. 18
Chapter 5
Contemporary Engineering
Economics
Copyright ©
2016Slide2
Comparing Mutually Exclusive
Projects: Basic TerminologiesSlide3
Revenue Versus Service Projects
Revenue Projects
Service Projects
Project revenues depend on the choice of alternatives
Project revenues do not depend on the choice of alternatives
Revenue and cost streams vary with the choice of alternatives
Fixed (or constant) revenues for all alternativesSlide4
Analysis Period Versus Required Service Period
Analysis Period
The time span over which the economic effects of an investment will be
evaluated
(study period or planning horizon)
Required Service Period
The time span over which the service of equipment (or investment) will be
neededSlide5
Road Map: A Process of Making a Choice Among Mutually Exclusive AlternativesSlide6
Comparing Mutually Exclusive Projects
Principle
: Projects must be compared over an
equal time
span.
Rule of Thumb
: If the required service period is given, the
analysis period
should be the same as the
required service period
.Slide7
Case 1
Analysis Period Equals Project Lives
What to do
:
Compute the NPW for each project over its life and select the project with the largest NPW.Slide8
Comparing Projects Requiring Different Levels of Investment
Assume that the unused funds will be invested at MARR.
This portion
of investment
will earn a 10% return on
investment.Slide9
Analysis Period Implied in Comparing Mutually Exclusive AlternativesSlide10
Case 2
Project Lives Longer Than the Analysis Period
What to do
Estimate the
salvage value
at the end of the required service period.
Compute the NPW for each project over the required service period.
PW(15%)
A
= −$362
PW(15%)
B
= −$364Slide11
Case 3A: Service Projects
Project Lives Shorter than the Analysis Period
What to do
Come up with
replacement projects
that match or exceed the required service period.
Compute the NPW for each project over the required service period.
PW(15%)
A
= −$34,359
PW(15%)
B
= −$31,031Slide12
Case 3B: Revenue
Projects
Analysis Period Coincides with the Project with the Longest Life in the Mutually Exclusive Group
What to do
Compute the NPW of each project over its analysis period, assuming no cash flows after the service life for the shorter-lived project.
PW(15%)
Drill
= $2,208,470
PW(15%)
Lease
= $2,180,210Slide13
Case 4
Analysis Period Is Not Specified
What to do
Come up with replacement projects that serve out the
least common multiple period (LCM)
.
Compute the NPW for each project over the LCM.
PW(15%)
A
= −$53,657
PW(15%)
B
= −$48,534Slide14
Summary
Present worth is an equivalence method of analysis in which a project’s cash flows are discounted to a lump sum amount
at the
present time.
The
MARR,
or minimum attractive rate of
return,
is the interest rate at which a firm can always earn or borrow money.
MARR is generally dictated by management and is the rate at which NPW analysis should be conducted
.
Two measures of investment, the net future worth and the capitalized equivalent worth, are variations
of
the NPW criterion.Slide15
The term
mutually exclusive
means
that when
one of several alternatives that meet the same need is selected, the others will be rejected.
Revenue projects
are those for which the income generated depends on the choice of project.
Service projects
are those for which income remains the same, regardless of which project is selected.
The analysis period (study period) is the time span over which the economic effects of an investment will be evaluated.Slide16
The
required service period
is the time span over which the service of equipment (or investment) will be needed.
The analysis period should be chosen to cover the required service period.
When not specified by management or company policy, the analysis period to use in a comparison of mutually exclusive projects may be chosen by the individual analyst
.