IENG 302 Lecture 08mod

Reviewing Complex Flow Perpetuity
If there is a mix of recurring and non-recurring nonor one-time cash flows that must be onecapitalized for perpetuity: one1.) finding the NPW of all the one-time, nonnon-recurring cash flows (= CCPart 1 ) (= 2.) finding the Annual Equivalent of one cycle of all the recurring cash flows, and then computing P (= CCPart 2) from (= the perpetuity relationship A = P(i) 3.) summing (1.) and (2.) to find the total capitalized cost: CCTotal = CCPart 1 + CCPart 2
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Perpetuity Example
A new football stadium will replace the current municipal stadium at an initial cost of $250 million. One year later, the old stadium will be demolished at a net cost of $1.5 million. Annual maintenance is expected to be $900 000, and every 15 years the skyboxes will be remodeled at a cost of $500 000. Find the capitalized cost if the discount rate is 10%, compounded annually.
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Perpetuity Example
DIAGRAM: 0 1 2 3 15 30 n= g yrs $900 K $1.5 M $500 K $250 M CC1 = $250 000 000 + $1 500 000 (P|F,10%,1) = $ 251 363 650 CC2 = $900 000 + $500 000 (A|F,10%,15) = 0.10 CCT = CC1 + CC2 = $251 363 650 + $9 157 500 = $ 260 521 150 $ 9 157 500 $500 K
Reviewing NPW
Two approaches to handle differing project lives: Common Multiple Period: Projects are assumed to be repeated until a common multiple point in time is established. Study Period: Select a study period for both projects and estimate cash flows to conform to the study period.
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Equivalent Annual Worth Analysis

Equivalent Annual Worth (EAW) can be used to compare projects. Equivalent Annual Cost (EAC) can be used instead of EAW if revenues are not included. EAC = EAW
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Equivalent Annual Worth Analysis

EAW and Types of Projects: Revenue projects are expected to make money at a rate at least as high as the MARR, so select largest EAW that is u 0. Service projects are have to do situations, so select largest EAW (lowest EAC).
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Capital Cost Recovery

For a capital purchase (P) with a salvage value (S), the EAC can be calculated two ways: 1. P(A/P, i, n) S (A/F, i, n) 2. (P S) (A/P, i, n) + S( i )
Annual equivalent for loss of value Opportunity cost
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Capital Cost Recovery

Land is considered to have infinite life; it can be sold for its purchase price (neglecting inflation). P = S and EAC = S*i
Example 1
The Ragweed Pollination Company needs a new building to expand seed production. The building will cost $600,000, last for 30 years, and is expected to sell for $100,000. It will be built on property that costs $200,000, which will be sold with the building. Energy costs are projected to be $45,000 the first year increasing by $3,000 each year after that. Needed equipment will cost $70,000 and last 10 years with no salvage value. It will be replaced with identical equipment 10 and 20 years from now. Annual maintenance is projected to be $20,000. Determine the Equivalent Annual Cost (EAC) for the proposed expansion using a MARR of 18% compounded annually.
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1st Costs:
200 000 600 000 70 000
Land Building Equipment Maintenance Energy
Annuals:
20 000 45 000
Increases: Replacements:
3 000/yr Energy 70 000 70 000 Equipment (yr 10) Equipment (yr 20) Building (yr 30) Land
Salvage:
100 000 200 000
Lifetime: MARR: FIND: EAC (= EAW)
30 yrs 18%, cpd annually
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$200 K DIAGRAM: EAC = ? 0 1 2 3 10 20 $100 K n=30 yrs $20 K $200 K $600 K $70 K $70 K EAC = A0 + AN + AI + AR + AS = (200 000 + 600 000 + 70 000) (A|P,18%,30) + (20 000 + 45 000) + 3 000 (A|G,18%,30) + [70 000 (P|F,18%,10) + 70 000 (P|F,18%,20)] (A|P,18%,30) (100 000 + 200 000) (A|F,18%,30) = 157 731 + 65 000 + 16 034 + 2 888 390 = $241 263 / yr
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$45 K G=$3 K
$70 K
Example 2
A 1000-foot tunnel must be constructed as part of a new aqueduct system for a major city. Two alternatives are being considered. One is to build a full-capacity tunnel now for $400,000. The other alternative is to build a halfcapacity tunnel now for $200,000, and then to build a second parallel half-capacity tunnel 20 years hence for $300,000. The cost of repair of the tunnel lining at the end of every 10 years is estimated to be $20,000 for the full capacity tunnel and $18,000 for each half-capacity tunnel. Determine whether the full capacity tunnel or the halfcapacity tunnel should be constructed now. Solve the problem by annual worth analysis, using an interest rate of 6% per year compounded annually, and a 50-year analysis period. (Note: There will be no tunnel lining repair at the end of the 50 years.)
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DIAGRAM: Full Tunnel 10 0 $20 K
20
30
40
n=50 yrs
$20 K
$20 K
$20 K
$400 K EAW F = (A|P,6%,50)[ 400 000 20 000(P|F,6%,10) 20 000(P|F,6%,20) 20 000(P|F,6%,30) 20 000(P|F,6%,40)] = $26 807 / yr DIAGRAM: Half Tunnel 10 0 $200 K $18 K 20 $18 K 30 $18 K $18 K n=50 yrs
40 $18 K $18 K
$300 K EAW H = (A|P,6%,50)[ 200 000 18 000(P|F,6%,10) (300 000 +18 000)(P|F,6%,20) (18 000 +18 000)(P|F,6%,30) (18 000 +18 000)(P|F,6%,40)] = $20 223 / yr CHOOSE THE HALF TUNNEL OPTION
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Example 3
Your in-laws paid cash for a home they purchased 18 years ago for $100,000. They just sold it for $100,000. They were bragging that, neglecting such expenses as taxes, insurance, and utilities, it did not cost them anything to live in the house for the 18 years. Having just completed an engineering economics course as a part of your engineering degree, you knew immediately that your in-laws reasoning was incorrect. Identify and describe the engineering economic principle involved. Include in your explanation what it actually cost your in-laws each year to own the house provided that they value money at 6% per year compounded annually. (Do not include changes in the purchasing power of money, and continue to neglect taxes, maintenance, insurance and utilities)
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What is the Engr Econ principle of Example 3?

The economic principle is OPPORTUNITY COST:
EAC = (P S)(A|P,i,N) + S(i) = ($100 000 $100 000)(A|P,6%,18) + $100 000(6%) = $0 + $6 000 = $6 000 / year to live in the house for each of the past 18 years.
Effectively, you could tell your in-laws that if they had truly lived in the house for free, they could have spent $6 000 per year on better raising your spouse but then, again, maybe you shouldnt.
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IENG 302 Lecture 08mod

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Reviewing Complex Flow Perpetuity

Equivalent Annual Worth Analysis

Equivalent Annual Worth Analysis

Capital Cost Recovery

Capital Cost Recovery

200 000 600 000 70 000

Land Building Equipment Maintenance Energy

100 000 200 000

Lifetime: MARR: FIND: EAC (= EAW)

30 yrs 18%, cpd annually

DIAGRAM: Full Tunnel 10 0 $20 K

What is the Engr Econ principle of Example 3?

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