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Lec%2022_Full - IE 343 Engineering Economics Lecture 22...

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IE 343 Engineering Economics Lecture 22: Chapter 6 - Comparison and Selection among Alternatives Instructor: Tian Ni Oct.19, 2011 IE 343 Fall 2011 1
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IE 343 Fall 2011 Comparing Alternatives We will focus on mutually exclusive alternatives. Select no more than one alternative among many. Fundamental goal of capital investment: You should invest an additional dollar only if it can obtain at least the MARR. So, if the investment of the additional dollar has a PW(MARR) greater than or equal to 0, then it is acceptable. 2
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Each investment alternative requires initial investment and produces positive cash flows (revenues, savings, etc). Unless specified, we will assume there is an option of not choosing any alternative, i.e., “do nothing" . Selection Rule: Choose the alternative that maximizes overall profitability. (i.e. select the alternative that has the greatest positive Equivalent Worth like PW, FW, AW at MARR and satisfies all project requirements) IE 343 Fall 2011 Investment alternatives 3
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Each cost alternative has only negative cash flows except possibly the salvage value. You must choose one of the alternatives, i.e., no “do nothing" option exists. Selection Rule: Consider only the costs and select the alternative that minimizes total costs. (i.e. select the alternative that has the least negative Equivalent Worth like PW, FW, AW at MARR and satisfies all project requirements) IE 343 Fall 2011 Cost alternatives 4
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Study period is the time period over which the comparison of alternatives is made. Case 1. Study period = useful life (of all alternatives) Case 2. Study period ≠ useful life (of at least one alternative) Rule : Compare mutually exclusive alternatives over the same period of time. IE 343 Fall 2011 Study period and useful lives of alternatives 5
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Procedure to find the best alternative using the equivalent-worth methods: 1) Find the equivalent worth (EW) of each alternative at i%=MARR. 2a) Investment alternatives: select the alternative with the greatest positive equivalent worth . 2b) Cost alternatives: select the alternative with the least negative equivalent worth . Note: Equivalent Worth method is an uniformed correct method to compare alternatives. IE 343 Fall 2011 Equivalent-Worth methods (PW, AW, FW) 6
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Procedure to find the best alternative using the IRR (same as ERR) method for investment alternative : 1) Find a profitable alternative starting from the one with lowest capital investment using IRR or EW method, i.e. alternative A 2) Assume alternative B has a higher capital investment than A 3) Justify the additional capital investment (B-A) using IRR. If IRR (B-A) MARR, the additional capital investment is profitable, so select alternative B. If IRR (B-A) < MARR, the additional capital investment is not profitable, so select alternative A IE 343 Fall 2011 Rate-of-Return methods (IRR, ERR) 7
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Procedure to find the best alternative using the IRR
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Lec%2022_Full - IE 343 Engineering Economics Lecture 22...

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