CHAPTER 5
Present Worth Analysis
Covered Topics
1. Formulating alternatives
2. Single and equal-life alternatives
3. Different-life alternatives
4. Capitalized cost alternative evaluation
5. Independent alternatives
Formulating Alternatives
Types of alternatives
Mutually exclusive (ME) - only one viable project can
be accepted. Do-nothing (DN) alternative is selected if
none are justified economically
• Single alternative
• Multiple alternatives
Independent - more than one project can be selected.
DN is one of the projects
PW of a Single Alternative
Example: MARR = 10%
Single project analysis First cost, P = $-2500
Annual revenue, R = $2000
• Calculate PW at stated Annual cost, AOC = $-900
Salvage value, S = $200
MARR Life, n = 5 years
PW = P +S(P/F,10%,5)
+ (R-AOC)(P/A,10%,5)
• Criterion: If PW ≥ 0, = -2500 + 200(P/F,10%,5)
+ (2000-900)(P/A,10%,5)
= $1794
project is economically
justified PW > 0; project is
economically justified
Types of PW Analysis Problems
1. PW Analysis of Equal-Life Alternatives
2. PW Analysis of Different-Life Alternatives
Equal-life ME Alternatives
• Calculate PW of each alternative at MARR
• Equal-service of alternatives is assumed
• Selection criterion: Select alternative with most favorable PW
value, that is,
numerically largest PW value
PW1 PW2 Select Note :
$-1,500 $-500 2 Not the
absolute
-2,500 500 2 value
2,500 1,500 1
Equal-life ME Alternatives
• Example:
Two ME cost alternatives for traffic analysis. Revenues
are equal. MARR is 10% per year. Select one.
Estimate Electric-powered Solar-powered
P, $/unit -2,500 -6,000
Annual operating cost -900 -50
AOC, $/year
Salvage, $ 200 100
n, years 5 5
Equal-life ME Alternatives
Determine PWE and PWS; select best PW
PWE = -2500-900(P/A,10%,5)+200(P/F,10%,5)
= $-5788
PWS = -6000-50(P/A,10%,5)+100(P/F,10%,5)
= $-6127
Conclusion: cost of the Electric is less than the cost
of Solar; select electric-powered.
Equal-life ME Alternatives
Example:
Adam plans to buy a used car. He has two options as shown:
Escort Corolla
Purchase Cost $5000 $7500
Maintenance Cost / Year $900 $500
Salvage Value $2000 $3000
Life (years) 3 3
Which one should he buy at 10% interest?
Equal-life ME Alternatives
$2,000
+
Option A
Cash
flow
0 1 2 3 Time
$900
$5,000
PWA = -5000 – 900(P/A,10%,3) +2000(P/F,10%,3)
= -5000 – 900(2.4869) + 2000(0.7513)
= -$5735.61
Equal-life ME Alternatives
$3,000
+
Option B
Cash
flow
0 1 2 3 Time
$500
$7,500
PWB = -7500 – 500(P/A,10%,3) + 3000(P/F,10%,3)
= -7500 – 500(2.4869) + 3000(0.7513)
= -$6489.55
PWA is better than PWB
Adam should choose option A.
Different-life Alternatives
• PW evaluation always requires equal-service between
all alternatives
• Two methods available:
o Study period (same period for all alternatives)
o Least common multiple (LCM) of lives for
alternatives
• Evaluation approach: Determine each PW at stated
MARR; select alternative with the best PW
Different-life Alternatives
Example:
A company is planning to buy a welding machine. They
have two alternatives:
Machine A Machine B
Purchase Cost $13,000 $18,000
Annual Maintenance Cost $3,500 $3,100
Salvage Value $1,000 $2,000
Life (years) 6 9
Which one should they choose at 15% interest?
1- LCM Approach
Machine A
$1,000 $1,000 $1,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
$3,500
i=15%
$13,000
$13,000 $13,000
Machine A
PWA = -13,000 – 3,500(P/A,15%,18)
–13,000[(P/F,15%,6) + (P/F,15%,12)] +
1,000[(P/F,15%,6) + (P/F,15%,12) + (P/F,15%,18)]
= -13,000 – 3,500(6.1280) – 13,000[0.4323 + 0.1869]
+ 1,000[0.4323 + 0.1869 + 0.0808]
= -$-41,798
Another method
First calculate the PW of one life cycle:
PWA,6 = -$13K – 3.5K (P/A, 15%, 6)+$1K (P/F, 15%, 6)
= -$13K – 3.5K*(3.7845) +$1K*(0.4323)= -$25,813.45
Next, notice that this repeats every 6 years until the end of 18th
year.
0 6 12 18
i=15%
-$25,813.45
PWA = -$25,813.45[1 + (P/F, 15%, 6) + (P/F, 15%, 12)]
= -$25,813.45(1 + 0.4323 + 0.1869) = -$41,797
Machine B
$2,000 $2,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
$3,100
i=15%
$18,000
$18,000
Machine B
PWB = -18,000 – 3,100(P/A,15%,18) –18,000 (P/F,15%,9)
+ 2,000[(P/F,15%,9) + (P/F,15%,18)]
= -18,000 – 3,100(6.1280) – 18,000(0.2843)
+ 2,000[0.2843 + 0.0808]
= -$41,384
You can work on the alternative method for
Machine B.
Decision: Choose Machine B, because
PWB is better than PWA
Different-life Alternatives
Study Period of length n years (periods)
• n is same for each alternative
• If life > n, use market value estimate in year n for
salvage value
• If life < n, estimate costs for remaining years
Estimates outside time frame of the study period are
ignored
Different-life Alternatives
Example:
Solve the same problem using a study period of:
a- 5 years. Assume the market values remain the same.
b- 6 years. Assume the market value of Machine B at the end of
6th year is $4,000.
Machine A Machine B
Purchase Cost $13,000 $18,000
Annual Maintenance Cost $3,500 $3,100
Salvage Value $1,000 $2,000
Life (years) 6 9
Part a – 5 years study period:
Machine A
$1,000
0 1 2 3 4 5 i=15%
$3,500
$13,000
Part a – 5 years study period:
Machine A
PWA = -$13,000 - $3,500(P/A,15%,5)
+ $1,000(P/F,15%,5)
= -$13,000 - $3,500(3.3522)
+ $1,000(0.4972)
= -$24,236
Part a – 5 years study period:
Machine B
$2,000
0 1 2 3 4 5 i=15%
$3,100
$18,000
Part a – 5 years study period:
Machine B
PWB = -$18,000 - $3,100(P/A,15%,5)
+ $2,000(P/F,15%,5)
= -$18,000 - $3,100(3.3522)
+ $2,000(0.4972)
= -$27,397
Decision: Choose Machine A, because
PWA > PWB
Part b – 6 years study period:
Machine A
$1,000
0 1 2 3 4 5 6
$3,500
i=15%
$13,000
Part b - 6 years study period:
Machine A
PWA = -$13,000 - $3,500(P/A,15%,6)
+ $1,000(P/F,15%,6)
= -$13,000 - $3,500(3.7845)
+ $1,000(0.4323)
= -$25,813
Part b – 6 years study period:
Machine B
$4,000
0 1 2 3 4 5 6
$3,100
i=15%
$18,000
Part b – 6 years study period:
Machine B
PWB = -$18,000 - $3,100(P/A,15%,6) + $4,000(P/F,15%,6)
= -$18,000 - $3,100(3.7845) + $4,000(0.4323)
= -$28,003
Decision: Choose Machine A, because
PWA > PWB
Capitalized Cost (CC)
• PW of alternatives that last ‘forever’
• Especially applicable to public project evaluation (dams,
bridges, irrigation, hospitals, police, etc.)
• CC relation is derived using the limit as n → ∞ for the P/A
factor
PW = A(P/A,i%,n) =
A
n→∞ PW =
i
Capitalized Cost (CC)
A
CC = PW =
i
• Refer to PW as CC when n is large (n → ∞). Then:
AW = CC × i
• Cash flows for CC computations are of two types:
• Recurring; and
• Non-recurring
Capitalized Cost (CC)
Recurring Costs: Costs that repeat forever with a
constant frequency; every year, every 10 years.
Nonrecurring Costs: One time Costs, or costs that
do not repeat forever.
Capitalized Cost (CC)
Procedure of finding CC
1. Draw cash flow diagram for 2 cycles of recurring cash
flows and any nonrecurring amounts
2. Calculate PW (CC) for all nonrecurring amounts
3. Find AW for 1 cycle of recurring amounts; then add
these to all A series applicable for all years 1 to ∞ (or
long life) A
4. Find CC for amount above using: CC =
i
5. Add all CC values (steps 2 and 4)
Capitalized Cost (CC)
Example:
Find CC and A values at i = 5% of long-term public project
with cash flows below. Cycle time is 13 years.
Nonrecurring costs: first $150,000; one-time of $50,000 in
year 10
Recurring costs: annual maintenance of $5000 (years 1-4)
and $8000 thereafter; upgrade costs $15,000 each 13
years
Step 1
Nonrecurring
recurring
costs
costs
It repeats
every 13 years
This cash flow can be simplified by dividing it into 4 different
cash flows as following:
$50,000
$150,000
+
+ $15,000
$5,000
+
$3,000
Step 2
$50,000
$150,000
CC of nonrecurring costs:
CC1 = ‐150,000 – 50,000(P/F,5%,10) = $‐180,695
Step 3
$15,000
$5,000
AW of recurring $15,000 upgrade:
AW = ‐15,000(A/F,5%,13) = $‐847 per year
AW of recurring maintenance costs years 1 to ∞:
AW = $‐5000 per year forever
CC for recurring upgrade and maintenance costs:
CC2 = AW/i = (‐847‐5000)/0.05 = $‐116,940
Step 4:
$3,000
CC of extra $3000 maintenance for years 5 to ∞:
CC3 =[‐3000/0.05](P/F,5%,4)= $‐49,362
A
CC =
i
Step 5:
Total CC obtained by adding all three CC components
CCT = -180,695 –116,940 –49,362= $-346,997
The AW value is the annual cost forever:
AW = CC × i = -346,997(0.05) = $-17,350
CC Evaluation of Alternatives
• For two long-life or infinite-life alternatives:
Select alternative with lower CC
• For one infinite life and one finite life:
Determine CC for finite life alternative using
AW of 1 life cycle and relation CC = AW/i
Select alternative with lower CC
CC Evaluation of Alternatives
Example:
Long-term alternative (LT): $8 million now; $25,000 renewal annual
contract .
Short-term alternative (ST): $2.75 million now; $120,000 AOC; life is n =
5 years.
Select best one at MARR = 15% per year
CCLT = -8,000,000 – 25,000/0.15 = $-8.17 million
CCST = AW/0.15
= [-2,750,000(A/P,15%,5) – 120,000]/0.15
= $-6.27 million
Select ST with lower CC of costs
CC Evaluation of Alternatives
Example:
Two sites are currently under consideration for a
bridge construction in New York City. The projected
expenses for each bridge are provided in the
following table. Compare both alternatives under a
6% interest and decide which bridge should be
chosen?
Suspension Bridge Truss Bridge
Initial Cost $30M $12M
Annual Maint. Cost $15K $8K
Resurfacing Cost every 10 $10K -
years
Painting Cost every 3 - $10K
years
Sandblast every 10 years - $45K
Purchasing right of way $2M $10.3M
Suspension Bridge
0 10 20
$15K $15K $15K
$10K $10K
$32M
CC of Nonrecurring Costs:
1. Initial investment and right-of-way cost:
-$30M initial investment
-$2M right-of-way
Both are at time 0, hence the CC of NR costs:
CCNR = -$32M
CC of Recurring Costs:
1. Annual maintenance cost:
-$15K for each year
2. Resurfacing cost every 10 years:
-$10K (A/F,6%,10)= -$3,793.5
Total Annual Equivalent of Recurring Costs:
-$15,000 -$3,793.5 = -$18,793.5
CC of the recurring costs:
CCRC = -$18,793.5 / i = -$18,793.5 / 0.06 = -$313,225
Capitalized Cost of the suspension bridge:
CCS = CCNR + CCRC
= -$32M - $313,225 = -$32,313,225
Truss Bridge
0 3 9 10 12 20
$8K
$10K $10K $10K
$45K $45K
$22.3M
CC of Nonrecurring Costs:
1. Initial investment and right-of-way cost:
-$12M initial investment
-$10.3M right-of-way
Both are at time 0, hence the CC of NR costs:
CCNR = -$22.3M
CC of Recurring Costs:
1. Annual maintenance cost:
-$8K for each year
2. Painting cost every 3 years:
-$10K (A/F,6%,3)= -$3,141.1
3. Sandblast every 10 years:
-$45K (A/F,6%,10) = -$3,414.15
Total Annual Equivalent of Recurring Costs:
-$8,000 -$3,141.1 - $3,414.15 = -$14,555.25
CC of the recurring costs:
CCRC = -$14,555.25 / i = -$ 14,555.25 / 0.06 = -$242,587.50
Capitalized Cost of the truss bridge:
CCT = CCNR + CCRC = -$22.3M - $242,587.50 = -$22,542,587.5
CCT > CCS, so choose the truss bridge.
Solved Example on capitalized cost:
Calculate the capitalized cost of a project that has an
initial cost of $150,000 and an additional investment
cost of $50,000 after 10 years. The annual operating
cost will be $5000 for the first 4 years and $8000
thereafter. In addition, there is a recurring major
rework cost of $15,000 every 13 years. Assume that
i = 5% per year.
1 4 7 10 13 16 19 22 26
$5K
$8K
$15K $15K
$50K
$150K
Nonrecurring Costs: (find CCNR)
1. -$150K at time 0
2. -$50K at the end of year 10:
PW50 = -$50K (P/F, 5%, 10) = -$30,695
The PW of the nonrecurring costs is:
CCNR = - $180,695
Recurring Costs: (find CC)
1. -$5K annuity starts at the end of 1st yr:
CC5K = -$5K/i = -$5K/0.05 = -$100K
2. -$3K annuity starts at the end of 5th yr:
CC’3K = -$3K/i = -$60K
But CC’3K is in fact at the end of 4th yr. So,
CC3K = -$60K(P/F,5%,4)=-$49,362
Recurring Costs: (find CC)
3. -$15K repeats every 13 years:
For one cycle, the annual worth of it:
AW15= -$15K(A/F,5%,13)=$-847
Then, the CC of -$15K is:
CC15 = -$847/0.05 = -$16,940
The total CC of all recurring costs is:
CCRC= -($100,000 + $49,362 + $16,940)
= -$166,302
The total CC of the project is:
CCT = CCNR + CCRC
= -$180,695 - $166,302
= - $346,997
