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0 = -AWD + AWR
-8000
-3500
0
10
-13000
-1600
2000
5
Note: Only costs are involved. Therefore, we automatically select the one that is best.
Here lives are 10 and 5 years. Analysis must be over LCM years which is 10 years. We must
now write down the incremental cash flow. We always order projects with lower initial cost
first. (In multiple projects, lowest to highest ordering is done).
Year
Cash flow A
0
15
5
-8000
-3500
-
6 10
10
-3500
-
Cash flow B
-13000
-1600
{+2000
-13000}
-1600
+2000
-5000
+1900
-11000
+1900
+2000
Using PW method:
0 = -5000 + 1900.(P/A,i*,10) 11000.(P/F, i*,5) + 2000. (P/F,i*,10)
[i* is used for the cash flow (B A) to distinguish it from iA* or iB* ]
If we substitute i* = 15%, in the above
= -5000 + 1900.(5.0188) 11000.(0.4972) + 2000.(0.2472) = -439.08
It is negative, therefore i* < MARR (=15%)
Therefore, extra investment for B is not justified. Select A.
We can also solve using AW method. Here, we have two options.
1. Use incremental cash flow. Then, we must use cash flow up to LCM. For the cash flow for
10 years,
0 = -5000.(A/P,i*,10) + 1900 11000.(P/F,i*,5).(A/P,i*,10) + 2000.(A/F,i*,10)
Substituting i* = MARR (=15%), we get -87.488 which is negative.
Therefore, i* < MARR.
B is not justified; we select A.
2. Use AW of each project for one cycle only.
We write,
AWA for one cycle, which is for 10 years,
and
Then,
Hence,
0 = -13000.(A/P,i*,5) 1600 + 2000.(A/F,i*,5) [-8000.(A/P,i*,10) 3500]
For i* = 15%, the value of above = -87.3
Therefore, i* < 15% (MARR)
B is not justified; we select A.
-10000
-12000
-18000
-24000
-33000
AOC
-5000
-5500
-7000
-11000
-16000
SV
2000
2500
3000
3500
4500
Annual income
9000
10000
10500
12500
14500
Initial investment
a) If proposals are independent, we select every alternative that has i* MARR or i* 18%.
Using PW,
For A: 0 = -10000 5000.(P/A,i*,8) + 2000.(P/F,i*,8) + 9000.(P/A,i*,8)
To see if i* 18%, we substitute i* = 18% in this equation:
= -10000 5000x4.0776 + 2000x0.266 + 9000x4.0776 = 6842.4
Since it is positive, it means i* > MARR or i* > 18%.
Therefore, we select A.
We repeat the above for B, C, D, and E:
We find that, for B: i* > 18%, therefore, we select B also.
For C:
For D:
For E:
-10000
-12000
AOC
-5000
-5500
SV
2000
2500
Annual income
9000
10000
Initial investment
Alternatives compared: B to A
Incremental investment
-2000
Incremental AOC
-500
Incremental SV
500
Incremental income
PW method:
1000
For i* = 18%,
-15000
-18000
-35000
-25000
-52000
5000
6000
9000
7000
12000
Problem indicates only ONE, best one, to be selected, i.e. mutually exclusive. Here, the
alternatives have revenue or income as well. We can do the selection by either one of the
following two methods:
i) Determine, individually, which alternatives have i* MARR. Then, select those with
i* MARR for incremental analysis to select the best one (as in Problem 1), or
ii) Start with the first alternative as challenger to Do Nothing (DN). Depending on the
outcome (if i* MARR, select first alternative as defender to be challenged by the second
one. If i* < MARR, reject first alternative and go to second alternative as challenger against
DN, and so on).
Well follow (ii) as i* values are not available as in Problem 1.
To start the process, we line up the alternatives with increasing first costs.
A
First cost
Annual income
-15000
-18000
-25000
-35000
-52000
5000
6000
7000
9000
12000
Alternative compared: A to DN
0 = -15000 + 5000.(P/A,i*,10)
or (P/A,i*,10) = 3
(From the Table for i = 15%, if (P/A,i*,10) 5.018, then i* MARR or 15%)
4
or (P/A,i*,10) = 3
Again, based on the Table for i=15%, i*>MARR; select B as defender, and eliminate A.
D B: 0 = -7000 + 1000.(P/A,i*,10)
or (P/A,i*,10) = 7
or (P/A,i*,10) = 5.667
Select B.
Problem 3.
Determine which of the following projects should be selected using the incremental-rate-ofreturn method. All the projects are expected to have a 10-year life and MARR is 18% per
year.
A
First cost
-28000
-33000
-22000
-51000
-46000
AOC
-20000
-18000
-25000
-12000
-14000
Here, we do not have any revenue (income). We must, therefore, choose ONE, best one, using
incremental method. (There cannot be comparison to DN or calculation for i* for each
alternative).
We start by ordering alternatives with increasing costs.
C
First cost
-22000
-28000
-33000
-46000
-51000
AOC
-25000
-20000
-18000
-14000
-12000
We start with the first one (C) as defender and the second one (A) as the challenger.
A C: 0 = -6000 + 5000.(P/A,i*,10) or (P/A,i*,10) = 1.2
(From the Table for i = 18%, if (P/A,i*,10) 4.494, then i* MARR or 18%)
Therefore, i* > MARR, eliminate C.
B A: 0 = -5000 + 2000.(P/A,i*,10)
or (P/A,i*,10) = 2.5
or (P/A,i*,10) = 3.25
or (P/A,i*,10) = 2.5
Select D.
Problem 4.
A company is considering the projects shown below, all of which can be considered to last
forever. If the company MARR is 18% per year, use rate-of-return analysis to determine
which should be selected
a) If the alternatives are independent, and
b) If the alternatives are mutually exclusive.
A
First cost
Annual income
-10000
-20000
-15000
-70000
-50000
2000
4000
2950
10000
6000
P = A/i
-10000
-15000
-20000
2000
2950
4000
We have already determined that i* for A is greater than MARR. This means it is better than
Do Nothing. After stating this fact, proceed to compare A and C incrementally.
A vs. DN:
C A:
Problem 5.
A metal plating company is considering four different methods of recovering by-product
heavy metals from manufacturing sites liquid waste. The investment costs and incomes
associated with each method have been estimated. All methods have a 10-year life. The
MARR is 12% per year.
a) If the methods are independent, because they can be implemented at different plants, which
ones are acceptable?
b) If the methods are mutually exclusive, determine which one method can be selected using
ROR evaluation.
Method
First Cost
SV
Annual Income
-15000
1000
4000
-18000
2000
5000
-25000
-500
6000
-35000
-700
8000
a) Using PW method:
Method A:
Substituting MARR(=12%) for i*, the RHS is positive (=7922.8), hence i*>MARR
Therefore, select A.
Method B:
Substituting MARR(=12%) for i*, the RHS is positive (=10895), hence i*>MARR
Therefore, select B also.
Method C:
Substituting MARR(=12%) for i*, the RHS is positive (=8740.2), hence i*>MARR
Therefore, select C as well.
Method D:
Substituting MARR(=12%) for i*, the RHS is positive (=9976.2), hence i*>MARR
Therefore, select D too
Hence, we select A, B, C and D.
Alternatively, we could have used AW method. Then,
Method A:
At 12%, the value to right hand side (RHS) = 1402.28. Hence, i* > MARR
We select A.
Similar analysis for B, C, and D also show that i* > MARR for all of these methods.
Hence, we select A, B, C and D.
b) A DN: It is already shown in (a) that i* for Method A > MARR. Therefore, A is selected
over DN. Alternatively, we can write (using PW method):
0 = -15000 + 4000.(P/A,i*,10) + 1000.(P/F,i*,10)
i* > MARR, select A
B A:
With i* = 12%, RHS is negative; Hence, i* < MARR (=12%). Therefore, select B again.
D B:
Problem 6.
Company X is designing a processing facility. Two options are being considered with the
following cash flows:
Capital investment
Annual expenses:
Operation
Maintenance
Salvage value
Useful life, years
A
$66400
B
$95200
$4330
$2200 in year 1,
and increasing
$1000/yr thereafter
0
5
$3440
$1000 in year 4,
and increasing
$200/yr thereafter
$10000
9
The MARR is 20% per year. Using the rate of return method, determine which option
should be selected?
In this example if we wish to use either of the equations:
0 = -AWD AWR
or
0 = - PWD - PWR
we have to determine the incremental cash flow for LCM of years, i.e. 45 years in this case.
Incremental cash flow will be obtained by considering 9 cycles of A and 5 cycles of B. This
makes it a laborious exercise. It is, therefore, better to use AW formula,
0 = AWB AWA
where AWs of A and B for one cycle only is used. (Note that if we wish to use PWA and PWB
values, then we have to calculate the values over LCM of years).
0 = -95200(A/P,i*,9) + 10000(A/F,i*,9) 3440
- [1000(P/A,i*,6) + 200(P/G,i*,6)](P/F,i*,3)(A/P,i*,9)
- {-66400(A/P,i*,5) 4330 [2200 + 1000.(A/G,i*,5)]}
Substituting i* = 20%,
Select B.
8
Problem 7.
The four alternatives described below are being evaluated.
a) If the proposals are independent, which should be selected when MARR = 18% per year?
b) If the proposals are mutually exclusive, which one should be selected when MARR=9.5%
per year?
Incremental ROR,%, When compared
with alternative
Alternative
Init. Investment
ROR,%
-40000
29
-75000
15
-100000
16
20
-200000
14
10
13
B to A:
C to A:
D to A:
12