Tutorial Questions (Module 3)

DEPARTMENT OF PRODUCTION & INDUSTRIAL ENGINEERING
BIRLA INSTITUTE OF TECHNOLOGY, MESRA, RANCHI - 835215
Tutorial Questions (Module 3)

Subject: PE338 Production Economics and Financial Management
1) What is the difference between mutually exclusive alternatives and independent projects?
2) What is meant by the do-nothing alternative?
3) If you are asked to provide an annual worth (AW) comparison of alternatives after a present
worth (PW) comparison has already been done, what factor multiplied by the PW values
provides the correct AW values?
4) What is the difference between disbenefits and costs?
5) Identify the following cash flows as a benefit, disbenefit, or cost.
a) Loss of income to local businesses because of a new freeway.
b) Less travel time because of a loop bypass.
c) $400,000 annual income to local businesses because of tourism created by a national park.
d) Cost of fish from a hatchery to stock a lake at the state park.
e) Less tire wear because of smoother road surfaces.
f) Decrease in property values due to the closure of a government research lab.
g) School overcrowding because of a military base expansion.
h) Revenue to local motels because of an extended weekend holiday.
6) The Murphy County Fire Department is considering two options for upgrading its aging
physical facilities. Plan A involves remodeling the fire stations on Alameda Avenue and
Trowbridge Boulevard that are 57 and 61 years old, respectively. (The industry standard is
about 50 years of use for a station.) The cost for remodeling the Alameda station is estimated
at $952,000, while the cost of redoing the Trowbridge station is $1.3 million. Plan B calls for
buying 5 acres of land somewhere between the two stations, building a new fire station, and
selling the land and structures at the previous sites. The cost of land in that area is estimated
to be $366,000 per acre. The size of the new fire station would be 9000 square feet with a
construction cost of $151.18 per square foot. Contractor fees for overhead, profit, etc., are
expected to be $340,000, and architect fees will be $81,500. (Assume all the costs for plan B
occur at time 0.) If plan A is adopted, the extra cost for personnel and equipment will be
$126,000 per year. Under plan B, the sale of the old sites is anticipated to net a positive $500,000
five years in the future. Use an interest rate of 6% per year and a 50-year useful life for the
remodeled and new stations to determine which plan is better based on present worth
analysis.
7) Delcon Properties is a commercial developer of shopping centers and malls in various places
around the country. The company needs to analyze the economic feasibility of rainwater
drains in a 60-acre area that it plans to develop. Since the development won’t be started for
three years, this large open space will be subject to damage from heavy thunderstorms that
cause soil erosion and heavy rutting. If no drains are installed, the cost of refilling and grading
the washed-out area is expected to be $1500 per thunderstorm. Alternatively, a temporary
corrugated steel drainage pipe could be installed to prevent soil erosion. The cost of the pipe
will be $3 per foot for the total length of 7000 feet required. Some of the pipes will be
salvageable for $4000 at the end of the 3-year period between now and when the construction
Dr. Sanjiv Kumar Tiwari Page 1

begins. Assuming that thunderstorms occur regularly at 3-month intervals, starting three
months from now, which alternative should be selected based on a present worth comparison
using an interest rate of 4% per quarter?
8) An electric switch manufacturing company must choose one of three different assembly
methods. Method A will have a first cost of $40,000, an annual operating cost of $9000, and a
service life of 2 years. Method B will cost $80,000 to buy and will have an annual operating
cost of $6000 over its 4-year service life. Method C will cost $130,000 initially with an annual
operating cost of $4000 over its 8-year life. Methods A and B will have no salvage value, but
method C will have some equipment worth an estimated $12,000. Which method should be
selected? Use present worth analysis at an interest rate of 10% per year.
9) Midwest Power and Light operates 14 coal-fired power plants in several states around the
United
10) States. The company recently settled a lawsuit by agreeing to pay $60 million in mitigation
costs related to acid rain. The settlement included $21 million to reduce emissions from barges
and trucks in the Ohio River Valley, $24 million for projects to conserve energy and produce
alternative energy, $3 million for the Chesapeake Bay, $2 million for Shenandoah National
Park, and $10 million to acquire ecologically sensitive lands in Appalachia. The question of
how to distribute the money over time has been posted. Plan A involves spending $5 million
now and the remaining $55 million equally over a 10-year period (that is, $5.5 million in each
of years 1 through 10). Plan B requires expenditures of $5 million now, $25 million 2 years
from now, and $30 million 7 years from now. Determine which plan is more economical based
on a present worth analysis over a 10-year period at an interest rate of 10% per year.
11) A retail shopping center developer signed a contract to build a $100 million high-end
shopping center in City Center. The city and county governments agreed to sales and tax
rebates totaling $18.7 million over 10 years. The contract called for the developer to raze
existing buildings 2 years from the date the contract was signed and to have the shopping
center built by the end of year 3. However, due to a real estate–induced recession in the United
States, the developer sought and was granted a new contract. The new contract required the
developer to raze the existing buildings at the end of year 1, but the shopping center would
not have to be completed for 7 years from the date the contract was signed. Assume that the
cost for razing the existing buildings is $1.3 million and the developer does not build the
shopping center until 7 years from now (at a cost of $100 million). Determine the future worth
cost difference in year 7 of the two contracts at an interest rate of 10% per year.
12) A wealthy businessman wants to start a permanent fund for supporting research directed
toward sustainability. The donor plans to give equal amounts of money for each of the next 5
years, plus one now (i.e., six donations) so that $100,000 per year can be withdrawn each year
forever, beginning in year 6. If the fund earns interest at a rate of 8% per year, how much
money must be donated each time?
13) Bob, a philanthropist, is not sure what rate of return his gifts may realize once donated to his
favorite charity. Determine the capitalized cost of $10,000 every 5 years forever, starting 5
years from now at an interest rate of ( a ) 3% and ( b ) 8% per year. ( c ) Explain the significant
difference between the two capitalized costs.
14) Ten years ago, Jacobson Recovery purchased a wrecker for $285,000 to move disabled 18-
wheelers. He anticipated a salvage value of $50,000 after 10 years. During this time, his

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DEPARTMENT OF PRODUCTION & INDUSTRIAL ENGINEERING
BIRLA INSTITUTE OF TECHNOLOGY, MESRA, RANCHI - 835215
Tutorial Questions (Module 2)

Subject: PE211 Engineering Economy
average annual revenue totaled $52,000. ( a ) Did he recover his investment and a 12% per
year return? ( b ) If the annual M&O cost was $10,000 the first year and increased by a constant
$1000 per year, was the AW positive or negative at 12% per year? Assume the $50,000 salvage
was realized
15) Nissan’s all-electric car, the Leaf, has a base price of $32,780 in the United States, but it is
eligible for a $7500 federal tax credit. A consulting engineering company wants to evaluate
the purchase or lease of one of the vehicles for use by its employees traveling to job sites in
the local area. The cost for leasing the vehicle will be $4200 per year (payable at the end of
each year) after an initialization charge of $2500 paid now. If the company purchases the
vehicle, it will also purchase a home charging station for $2200 which will partially offset a
50% tax credit. If the company expects to be able to sell the car and charging station for 40%
of the base price of the car alone at the end of 3 years, should the company purchase or lease
the car? Use an interest rate of 10% per year and annual worth analysis.
16) In 2010, the city of Houston, Texas, collected $24,112,054 in fines from motorists because of
traffic violations caught by red-light cameras. The cost of operating the system was $8,432,372.
The net profit, profit after operating costs, is split equally (that is, 50% each) between the city
and the camera system operator. What will be the rate of return over a 3-year period to the
contractor that paid for, installed, and operated the system if its initial cost was $9,000,000
and the profit for each of the 3 years is the same as it was in 2010?
17) P&G sold its prescription drug business to Warner-Chilcott, Ltd. for $3.1 billion. If income
from product sales is $2 billion per year and net profit is 20% of sales, what rate of return will
the company makeover a 10-year planning horizon?
18) An equipment trust bond with a face value of $10,000 has a bond coupon rate of 8% per year,
payable quarterly. What are the amount and frequency of the dividend payments?
19) What is the face value of a municipal bond that matures in 20 years and has a bond coupon
rate of 6% per year with semiannual payments of $900?
20) The cost of grading and spreading gravel on a short rural road is expected to be $300,000. The
road will have to be maintained at the cost of $25,000 per year. Even though the new road is
not very smooth, it allows access to an area that previously could only be reached with off-
road vehicles. The improved accessibility has led to a 150% increase in the property values
along the road. If the previous market value of a property was $900,000, calculate the B/C
ratio using an interest rate of 6% per year and a 20-year study period.
21) A project to extend irrigation canals into an area that was recently cleared of mesquite trees
(a nuisance tree in Texas) and large weeds is projected to have a capital cost of $2,000,000.
Annual maintenance and operation costs will be $100,000 per year. Annual favorable
consequences to the general public of $820,000 per year will be offset to some extent by annual
adverse consequences of $400,000 to a portion of the general public. If the project is assumed
to have a 20-year life, what is the B/C ratio at an interest rate of 8% per year?

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DEPARTMENT OF PRODUCTION & INDUSTRIAL ENGINEERING

BIRLA INSTITUTE OF TECHNOLOGY, MESRA, RANCHI - 835215

Tutorial Questions (Module 3)

Dr. Sanjiv Kumar Tiwari Page 1

Dr. Sanjiv Kumar Tiwari Page 2

Tutorial Questions (Module 2)

Dr. Sanjiv Kumar Tiwari Page 3

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