Lecture 6

Engineering
Economics
Present Worth Method of
Comparison
Introduction
 In this method of comparison, the cash flows of each
alterative will be reduced to time zero by assuming an
interest rate i.
 The best alternative will be selected depending on the type
of decision by comparing the present worth amounts of the
alternatives.
 The alternatives being considered may require different
amounts of capital investment
 The alternatives may have different useful lives
 The subject of this section will help:
 Analyze and compare feasible alternatives
 Select the preferred alternative
Cash Flow Analysis Methods
 The cash-flow analysis methods (PW) used in this process.
 The sign of various amounts in a cash flow is decided on the type of
decision problem.
 In Revenue dominated cash flows, the profit, revenue, salvage value
(all inflows) will be assigned positive sign while the all costs
(outflows) will be assigned with negative sign.
PW = - P + R1[1/(1 +i)1] + R2[1/(1 +i)2] + ………….…+ Rn[1/(1 +i)n] + S
[1/(1 +i)n]
P = Initial investment
Rn = Net revenue at the end of nth year.
S = Salvage value at the end of nth year.
 Decision criteria: Select the alternative with the maximum present
worth will be selected.
Rule For Choosing Among Alternatives
 In cost dominated cash flows the cost will be assigned with
positive signs and all inflows will be assigned negative sign.
 PW = P + C1[1/(1 +i)1] + C2[1/(1 +i)2] + …….…+ Cn[1/(1 +i)n] -
S [1/(1 +i)n]
 Decision Criteria: Select the alternative with the minimum cost,
the alternative with the least present worth amount will be
selected.
Comparing Mutually Exclusive Projects
Cost dominated analysis
There are two alternatives for purchasing a concrete mixer. The cash flow
details of alternatives are as follows;
Alternative-1: Initial purchase cost = Rs.3,00,000, Annual operating and
maintenance cost = Rs.20,000, Expected salvage value = Rs.1,25,000,
Useful life = 5 years.
Alternative-2: Initial purchase cost = Rs.2,00,000, Annual operating and
maintenance cost = Rs.35,000, Expected salvage value = Rs.70,000, Useful
life = 5 years.
Using present worth method, find out which alternative should be selected,
if the rate of interest is 10% per year.
Practice Questions
 An industry is planning to expand its production operation,
having different technologies for meeting the goal. The initial
outlay and annual revenues with respect to each of the
technologies are summarized in the given table.
Initial outlay Annual revenue Life (Years)
Technology 1 12,00,000 4,00,000 10
Technology 2 20,00,000 6,00,000 10
Technology 3 18,00,000 5,00,000 10
 Suggest the best technology which is to be implemented based

on the present worth method of comparison assuming 20%
interest rate, compounded annually.
Practice Questions
 An engineer has two bids for an elevator to be installed in a new
building. The details of the bids for the elevators are as follows:
Bid Engineer’s estimates

Initial cost Service life Annual Opt & Main.
cost
Alpha 4,50,000 15 27,000
Company
Beta Company 5,40,000 15 20,500
 Determine which bid should be accepted based on PW

comparison assuming 15% interest rate compounded annually
Practice Questions
 Investment proposals A and B have the net cash flows as
follows:
Proposal End of years
0 1 2 3 4
A (Rs.) -10,000 3,000 3,000 7,000 6,000
B (Rs.) -10,000 6,000 6,000 3,000 3,000
 Compare the present worth of A with that of B at i = 18%. Which

proposal should be selected.
Practice Questions
 A granite company is planning to buy a fully automated
granite cutting machine.
 If it is purchased under down payment, the cost of the
machine is Rs. 16,00,000.
 If it is purchased under installment basis, the company has
to pay 25% of the cost at the time of purchase and
remaining amount in 10 annual equal installments of Rs.
2,00,000 each.
 Suggest the best alternative for the company using the
present worth basis at i = 18% , compound annually.
Practice Questions
 A finance company advertises two investment plans.
 In plan 1, the company pays Rs. 12,000 after 15 years for
every Rs. 1,000 investment now.
 In plan 2, for every Rs. 1,000 invested, the company pays
Rs. 4,000 at the end of the 10th year and Rs. 4,000 at the
end of 15th year.
 Select the best investment plan from the investor’s point of
view at i = 12%, compound annually.
Practice Questions
 Novel investment Ltd. Accepts Rs. 10,000 at the end of
every year for 20 years and pays the investor Rs. 8,00,000
at the end of the 20th year.
 Innovative investment Ltd. Accepts Rs.10,000 at the end
of every year for 20 years and pays the investor Rs.
15,00,000 at the end of the 25th year.
 Which is the best investment alternative? Use present
worth base with i = 12%.
Practice Questions
 A small business with an initial outlay of Rs. 12,000
yields Rs.10,000 during the first year of its operation and
the yield increases by Rs.1,000 from its second year of
operation up to its 10th year of operation.
 At the end of the life of the business, the salvage value is
zero.
 Find the present worth of the business by assuming an
interest rate of 18%, compounded annually.
Cost-Dominated cash flow analysis
 A university lab is a research contractor to NASA for in-
space fuel cell systems that are hydrogen- and methanol-
based. During lab research, three equal-service machines
need to be evaluated. Perform the present worth analysis
with the costs shown below. The MARR is 10% per year.
Electric- Gas- Solar-
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First cost, $ 4500 3500 6000
Operating cost $/year 700 700 50
Annual Salvage value S, 200 350 100
Life, years 8 8 8
Cost-Dominated cash flow analysis

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Engineering

Technology 1 12,00,000 4,00,000 10

Technology 2 20,00,000 6,00,000 10

Technology 3 18,00,000 5,00,000 10

 Suggest the best technology which is to be implemented based

Bid Engineer’s estimates

Beta Company 5,40,000 15 20,500

 Determine which bid should be accepted based on PW

A (Rs.) -10,000 3,000 3,000 7,000 6,000

B (Rs.) -10,000 6,000 6,000 3,000 3,000

 Compare the present worth of A with that of B at i = 18%. Which

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