3 - Present Worth Analysis for Students
.pdf
School
Pennsylvania State University**We aren't endorsed by this school
Course
IE 302
Subject
Industrial Engineering
Date
Dec 26, 2024
Pages
14
Uploaded by SuperQuail4506
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 1 Chapter 5 – Present Worth Analysis •Although we will discuss methods to select the best economic alternative, in real life other factors may influence the decision that we make •Examples – •_____________________ – situation that involves ______________ one quality or aspect of something in return for _______________ another quality or aspect §Example – •To be able to compare economic alternatives, we need to first construct the appropriate __________________________ profiles •There are two classes of methods used to compare discounted cash flow methods 1._______________ methods – the preferred method has the ________________ ______________ or _____________________________ 2.___________________________ – money should continue to be invested as long as each additional investment yields a return that is greater than the ________________________ •Some important considerations o______________-Tax vs. ______________-Tax Analysis – either will work, but you must be consistent o___________ versus _______________ Lives – when comparing investment alternatives, they must be compared over a common time period; this is called the ___________________________ o_______________________ of projects – the decision regarding one project does __________________ the decision to accept or reject any other project §Example –
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 2 o_______________________ projects – the acceptance of one project implies the ___________________ of the other alternatives §Example – Initial project screening: Payback Period and Discounted Payback Period•Payback analysis determines the period of time required for the _____________ or other ______________ from an investment to equal the ________ of the investment. •__________________________ in the simplest form assumes oIf you invest $1000 and see uniform revenues of $100 per month, then your initial investment will be returned to you in oAll else being equal, you would prefer a ______________ payback period versus a longer one oBecause this method is so simple it is widely used in practice Example 3 - 1 Select the best alternative based on PBP. EOY A Cumulative CFAB Cumulative CFB0 -$50,000 -$75,000 1 $20,000 $20,000 2 $20,000 $25,000 3 $20,000 $30,000 4 $20,000 $35,000 5 $30,000 $40,000 PBP PW@10%
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 3 Example 3 - 2 Select the best alternative based on PBP. EOY A B C 0 -$300 -$600 -$200 1 $47 $98 $35 2 $47 $98 $35 3 $47 $98 $35 4 $47 $98 $35 5 $47 $98 $35 6 $47 $98 $35 7 $47 $98 $35 8 $47 $98 $35 9 $47 $98 $35 10 $47 $98 $35 PW@8% $15.37 $57.59 $34.85 PBP
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 4 Discounted Payback Period (DPBP) DPBP doesconsider the TVOM. If there is a uniform series and no salvage value, the DPBP can be easily calculated. Example 3 - 3 Compute the discounted payback periods of each of the alternatives whose cash flows are shown below. EOY A B C 0 -$300 -$600 -$200 1 $47 $98 $35 2 $47 $98 $35 3 $47 $98 $35 4 $47 $98 $35 5 $47 $98 $35 6 $47 $98 $35 7 $47 $98 $35 8 $47 $98 $35 9 $47 $98 $35 10 $47 $98 $35 PW@8% $15.37 $57.59 $34.85 DPBP
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 5 Some important drawbacks of Payback Analysis: -For PBP there is no consideration of ______________________________! -Economic consequences beyond the PBP or DPBP are usually _________________. oExample – -This method is _________________________ to the other methods studied. oPW, AW, FW, IRR, and B/C will result in the same decision. With payback analysis, you may not select the best alternative. -Does not consider measures of _______________________, only how long it will take to pay back an investment. Despite the drawbacks of payback analysis, PBP (࠵? = 0%) is still commonly used in practice because 1.it is easy to understand 2.the calculations can be readily made by people unfamiliar with economic analysis 3.it does not require choosing a MARR -Payback analysis measures the speed of the return on investment, therefore providing a rough measure of the “liquidity” of an investment -If you are required to use payback analysis, then DPBP at least includes the impact of TVOM PUNCHLINE:Payback analysis should be used only as an __________________________ tool, or as a ______________________________ to a more complete economic analysis
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 6 Discounted Cash Flows•We will evaluate alternatives using an interest rate we will call the ________________ __________________________________ •Assume that the firm’s money is either invested in an ______________________ that is earning the MARR, or can be _______________ at a cost that is equal to the MARR. •We want to calculate the _________________________________ of each alternative •Bring all cash flows back to _____________ and assume __________________ •Assume costs are negative and benefits are positive. •For single alternatives, if _______________ then the alternative is economically viable. •Although it is referred to as ‘‘a single alternative,’’ when evaluating such an alternative, we are considering doing something versus an implied second alternative of ___________________________. •For multiple alternatives, the alternative with the _________________ NPW is the most desirable. •When all the cash flows are negative, we may consider the PW of the costs, and then we choose the alternative with the __________________ PW of costs. •Present worth (PW) of alternative ࠵?at ࠵?࠵?࠵?࠵? = ࠵?%•All alternatives must be evaluated over the __________________________. We call this period the analysis period, the planning horizon, or the project life, and denote it as n. •The length of the planning horizon depends on the industry •Rapidly changing technologies – rather short planning horizons •Stable technologies (e.g., steelmaking) – 10-20 years
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 7 •Government agencies – 30 years or more •When the useful lives of alternatives differ, two methods to resolve this problem are: •Use the ______________________________ of their useful lives. •Choose an analysis period that is not necessarily ________________ to any of the alternatives’ lives. •Need to consider the __________________________________. •When the planning horizon is infinite, we calculate the _______________________ or the ____________________________ of the investments.
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 8 PW Analysis Examples Example 3 - 4 A firm is contemplating purchasing a new production machine that will cost $200,000 initially, have annual operating and maintenance costs of $35,000, yield annual savings in material and labor of $70,500, have a useful life of 10 years, and have a salvage value of $10,000 at that time. Note that ࠵?࠵?࠵?࠵?= 10%. Should the firm purchase the machine? Solve using Present Worth (PW) analysis.
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 9 Example 3 - 5 Two pumps are being considered for purchase. Pump A Pump B Initial cost $7000 $5000 End-of-useful-life salvage value $1500 $1000 Useful life 12 6 If ࠵?࠵?࠵?࠵? = 7%, which pump should be purchased? Solve using PW analysis. Suppose we only need the pump for 6 years. What salvage value of pump A would make us indifferent between the two pumps?
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 10 Example 3 - 6 Two alternative designs are under consideration for a new ride called the Scream Machine at a theme park located in Florida. The two candidate designs differ in complexity, cost and predicted revenue. Alternative A will require an investment of $300,000 and is estimated to produce after-tax revenue of $55,000 annually over a 10-year horizon. Alternative B will require an investment of $450,000 and is expected to generate annual after-tax revenue of $80,000. A negligible salvage value is assumed for both designs. The theme park management could decide to do nothing; if so, the present worth of doing nothing will be zero. Which alternative design, if either, should the theme park select if its ࠵?࠵?࠵?࠵?= 8%?
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 11
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 12 Infinite Analysis Period: Capitalized Worth or Capitalized Cost -Capitalized worth is the present worth equivalent of an ________________________ series of cash flows – sum of money that would need to be set aside now, at some interest rate, to yield the funds to provide the service or product ________________. oIn most applications, infinite investment periods have few if any ____________________, and therefore we consider the ___________________. oCommon in ________________________ – long term investment projects such as bridges, tunnels, railways, highways, hydroelectric plants, dams, pipelines, etc. -Another application would be the establishment of ________________________ where the estimated life is long, or indefinite, e.g., scholarship funds, endowed faculty chairs, admission to Dallas Museum of Art. Calculating Capitalized Cost
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 13 Capitalized Cost Examples Example 3 - 7 A graduate of the Penn State wants to endow a scholarship to be awarded to Industrial Engineering undergraduate students. If a full scholarship costs $30,000 per year, and the payout from the endowment is 4.5% per year, what size gift is required to ensure the scholarship is available every year from now on? Example 3 - 8 Every 10 years, the dome of the state capital building has to be cleaned, sandblasted and retouched. It costs $750,000 to complete the work. If the refurbishment is due now, using a 5% ࠵?࠵?࠵?࠵?, what is the capitalized cost for refurbishing the capital dome?
IE 302: Engineering Economic Analysis Notes prepared by Dr. Tish Pohl and Adapted by Dr. Sarah Root Note Set 3 – Present Worth Analysis 14 Example 3 - 9 Two alternatives are under consideration for delivering water from a mountainous area to an arid area in a developing country: Alternative A:A coated heavy-gauge plastic pipeline can be installed, with pumps spaced appropriately along the pipeline. The initial cost is $125 million, with major replacements every 15 years at a cost of $10 million. Pumping and other annual operating and maintenance costs are estimated to be $5 million. Alternative B:A canal can be built at a cost of $200 million. Its annual operating and maintenance costs are anticipated to be $1 million. Major upgrades of the canal are anticipated every 10 years, at a cost of $5 million. Based on a 5% ࠵?࠵?࠵?࠵?and an infinitely long planning horizon, which alternative has the lowest capitalized cost?