Chapter 6 Comparing Alternatives

Chapter 6 Comparing Alternatives - Comparing Alternatives...

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1 Comparing Alternatives Chapter 6 We now turn our attention to the comparison of two or more alternatives. Note that even if we have outlined only one alternative for a particular project, there is always the “do nothing” alternative. There are several categories of alternatives we may be considering: 1.Mutually exclusive - at most one project out of the group can be chosen. 2.Independent - the choice of a project is independent of the choice of any other project in the group, so that all or none of the projects may be selected or some number in between. 3.Contingent - the choice of a project is conditional on the choice of one or more other projects.
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2 Notes on selecting the best alternative: If we begin with a set of independent or contingent alternatives, we need to ultimately come up with a list of mutually exclusive alternatives to compare. If the extra benefits obtained by investing additional capital are better than those that could be obtained from investment of the same capital elsewhere at the MARR, the investment should be made. We will consider examples where the analysis period or required service period is the same as the useful life of the alternatives and when it is not. We will also consider infinite analysis periods. Ultimately, the comparison must be done over an equal study period for each alternative. We will use various equivalent worth methods and rate of return methods as a basis for comparison.
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3 Basic Example Alternative A will have a capital investment of $70,000 with annual revenues of $20,000 for 5 years. At a 10% MARR, is this investment worthwhile? Would we prefer Alternative B instead if it required a capital investment of $80,000 ($10,000 more than Alternative A), but returned $23,000 for 5 years?
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4 Two types of alternatives Investment alternatives - are those whose revenues depend on the choice of alternative and therefore are considered in the analysis. The investment produces positive cash flows from increased revenues, savings, or both. Under the EW methods and equal study periods, we would select the alternative with the highest EW. Cost Alternatives - those whose revenues do not depend on the choice of project. Revenues are therefore excluded from the analysis. The cash flows are all negative except for a possible positive cash flow from disposal of assets. Using the EW methods and equal study periods, we would select the alternative with the least negative EW (lowest costs). Note that we assume that the alternatives meet the functional requirements for the project but have some difference in performance capabilities, useful lives, output quality, etc. The economic impact of these differences must be included in the analysis.
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5 Two Basic rules for comparing alternatives Rule 1: When revenues and other economic benefits are present and vary among the alternatives, choose the alternative that maximizes overall profitability. That is, select the alternative that has the greatest positive
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This note was uploaded on 04/17/2008 for the course IE 1036 taught by Professor Karenbursic during the Fall '06 term at Pittsburgh.

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Chapter 6 Comparing Alternatives - Comparing Alternatives...

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