Engineering
Economics
Module No. 009
Annual Equivalent Method
Introduction
Principle: Measure investment worth on annual basis
Benefit: By knowing annual equivalent worth, we can:
Seek consistency of report format
Determine unit cost (or unit profit)
Facilitate unequal project life comparison
Revenue: Alternatives include estimates of costs (cash outflows)
and revenues (cash inflows)
Cost: When only costs are involved, the AE method is called the
annual equivalent cost
Decision criteria: The alternative with the maximum annual
equivalent revenue in the case of revenue based and minimum
annual equivalent cost in the case of cost based comparison will
be selected as best alternative.
Revenue-Dominated cash flow analysis
different methodologies
Method 1: By Using Present Worth: find Present worth of
Revenue-dominated cash flow
1 2 n n
PW= P R 1 / (1 i) +R 2 / (1 i) +.. R n / (1 i) +S / (1 i)
n
PW= P R i 1 / (1 i) x
+S / (1 i)
n
x 1
(1 i ) n 1 n i (1 i )
n
PW= P R i n +S / (1 i) then. find . A PW (1 i ) n 1
i (1 i )
Method 2: By Using Future Worth
1 i
n
R 1 (1 i) +R 2 (1 i) +.. R n + S
n-1 n-2
FW= -P
n
FW= -P 1 i R i n x
n
(1 i) +S
x 1
(1
n
i) 1 i
P 1 i R i
n
FW= + S then find A = FW
n
i (1 i) 1
Cost-dominated cash flow analysis
different methodologies
Method 1: By Using Present Worth! find Present worth of cost-
dominated cash flows
1 2
PW=P C1 / (1 i) +C 2 / (1 i) +.. C n / (1 i)
n
- S / (1 i) n
(OR) PW=P C i x
1 / (1 i) - S / (1 i)
n
x 1
(1 i) 1 i(1 i)
n n
i(1 i) - S / (1 then. find . A PW
n
(OR) PW=P C i i)
(1 i) 1
n n
Method 2: By Using Future Worth
FW= P 1 i
n
C1 (1 i)
n-1
+C 2 (1 i)
n-2
+.. R n + S
n
(OR) FW= P 1 i C i (1 i) n x
n
+S
x 1
(1 i
n
i) 1
(OR) FW=P 1 i C i
n
+ S then find A = FW
i
(1 i) n 1
Evaluating Alternatives by AW Analysis
1. A contractor purchased a used crane for $11,000. His operating
cost will be $2700 per year, and he expects to sell it for $5000
five years from now. What is the equivalent annual worth of the
crane at an interest rate of 10% ?
2. Two alternatives are considered for covering a football field.
The first is to plant natural grass and the second is to install
AstroTurf. Interest rate is 10%. Cost structure for each
alternative is given below.
Natural Grass - Replanting will be required each 10 years at a cost of
$10,000. Annual cost for maintenance is $5,000. Equipment must be
purchased for $50,000 which will be replaced after 5 years with a salvage
value of $5,000.
AstroTurf - Installing AstroTurf cost $150,000 and it is expected to last
indefinitely. Annual maintenance cost is expected to be $5,000
Evaluating Alternatives by AW Analysis
HRs Cafeterias is in the process of providing meals to facilities
for the elderly, such as assisted care and long-term care centers.
Since the meals are prepared in one central location and
distributed by trucks throughout the city, the equipment that
keeps food and drink cold and hot is very important. Ali is the
manager and wishes to choose between two manufacturers of
temperature retention units that are mobile and easy to sterilize.
select the more economic unit at a MARR of 8% per year.
Hamilton Infinity Care
Initial cost (P) 15000 20000
Annual M&O (A) 6000 9000
Refurbishment cost 0 2000 every 4 years
Trade in value (S), % of P 20 40
Life, years 4 12
Evaluating Alternatives by AW Analysis
Compare the machines below using annual worth analysis at
an interest rate of 10% per year
Machine A Machine B
First cost, $ 20,000 30,000
Annual cost, $/year 9,000 7,000
Salvage value, $ 4,000 6,000
Life, years 3 6
Evaluating Alternatives by AW Analysis
A company invests in one of the two mutually alternatives.
The life of both alternatives is estimated to be 5 years with
the following investments, annual returns and salvage
values.
A B
Investment -1,50,000 -1,75,000
Annual equal return 60,000 70,000
Salvage value 15,000 35,000
Determine the best alternative based on the annual equivalent
method by assuming i = 25%.
Evaluating Alternatives by AW Analysis
A certain individual firm desires an economic analysis to
determine which of the two machines is attractive . The
minimum attractive rate of return is 15%.
Machine A Machine B
Initial cost 1,50,000 2,40,000
Life (years) 12 12
Annual Maintenance cost 0 4,500
Salvage value 0 6,000
Which machine would you choose? Base your answer on
the annual equivalent cost.
Evaluating Alternatives by AW Analysis
Two possible routes for laying a power line are under study.
Data on the routes are as follows:
Around the lake Under the lake
length 15 km 5 km
First cost 1,50,000/km 7,50,000/km
Useful life 15 years 15 years
Maintenance cost 6,000/km/yr 12,000/km/yr
Salvage value 90,000/km 1,50,000/km
Yearly power loss 15,000/km 15,000/km
If 15% interest is used, should the power line be routed
around the lake or under the lake?
