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Lecture 9 - Selection Problems - CE 395 Engineering...

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Unformatted text preview: CE 395 Engineering Economics Spring 2005 W. Hitchcock 1. IRR and ERR Review 2. Selection Between Alternatives Part 1 External Rate Of Return Analysis 3 Step Process To perform ERR a net cash flow table must be developed. Analysis is in three steps: 1. Discount all net cash outflows to the present using the known external rate of return. 2. Compound all net cash inflows to the future (end of the last period of the analysis) 3. Determine the rate of return such that the PW of the outflows equals the FW of the inflows. Example ERR (external i = 8%) Time 0 1 2 3 4 5 Cost -$20,000 -$10,000 $11,000 $11,000 $11,000 $11,000 Benefit Comparing Mutually Exclusive Alternatives Present Worth and Annual Cash Flow Analysis Criteria Application Case Fixed Input Situation Input Fixed Choice Criteria Maximize PW of benefits or EUAB Minimize PW of costs or EUAC Maximize NPW or EUAB - EUAC Fixed Output Fixed use requirement or benefits Neither the input or other costs or the benefits are fixed Neither Fixed Rate of Return Analysis Criteria Application Case Fixed Input Fixed Output Neither Fixed Situation Input Fixed Fixed use requirement or benefits Neither the input or other costs or the benefits are fixed Choice Criteria Maximize ROR Maximize ROR If 2 alternatives: Compute the ROR. If the ROR is ok choose higher cost alternative. Multiple Alternatives: Use comparative ROR between alternatives Note: Before performing incremental ROR analysis, insure that each alternative's ROR is acceptable Benefit/Cost Ratio Analysis Criteria Application Case Fixed Input Fixed Output Neither Fixed Situation Input Fixed Fixed use requirement or benefits Neither the input or other costs or the benefits are fixed Choice Criteria Maximize B/C Maximize B/C If 2 alternatives: Compute the B/C. If the B/C is greater than 1.0, choose higher cost alternative. Multiple Alternatives: Use comparative B/C between alternatives Note: Before performing incremental B/C ratios, insure that each alternative's B/C is > 1.0 Financial Comparative Analysis Examples Fixed Input Consider the three investment alternatives: A Initial Cost Annual Benefits 1st 5 years Annual Benefits years 6 to 10 $600 $100 $50 B $600 $120 $100 C $600 $110 $120 D $600 $150 $50 Determine the best alternative using the four methods of analysis. An MARR of 9% is used by the company A company must decide between three equipment options listed below: Initial Cost Annual Maint Costs first 5 years Annual Maint Costs 2nd 5 years A $13,000 $200 $300 B $10,000 $300 $450 C $15,000 $150 $150 Financing Comparative Analysis Examples Fixed Output Salvage Value at $1,000 $0 $4,000 end of yr 10 Determine the best alternative using the four methods of analysis. An MARR of 9% is used by the company Financing Comparative Analysis 2 Options Neither Input or Output Fixed A company has the opportunity to choose between two equipment purchases both believed to increase profits over the existing equipment being used. Consider the information below: Machine A Initial Cost Increased Annual Benefit Salvage Value after 12 years $350 $98 $65 Machine B $700 $120 $150 Determine the best alternative using the four methods of analysis. An MARR of 12% is used by the company ...
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