Chapter 5: Present Value Analysis Engineering Economic Analysis Canadian Edition

5-2EECE 450 — Engineering Economics Chapter 5 … nDefines and applies criteria involving the present value (or net present value—NPV) of a project (investment). nUses present value to choose among several projects having equal, unequal, and infinite lives. nCompares multiple alternatives using the present value criterion.

5-3EECE 450 — Engineering Economics Chapter Assumptions in Solving Economic Analysis Problems nEnd-of-period convention (simplifies calculations) nViewpoint of the firm nSunk costs (past has no bearing on current decisions) nOwner provided capital (no debt capital) nStable prices nNo depreciation; no income taxes nAnnual compounding and annual cash flows

5-4EECE 450 — Engineering Economics Economic Criteria SituationCriterion Fixed inputMaximize output Fixed outputMinimize input Neither fixedMaximize difference (output-input) nProjects (or investments) are judged against an economic criterion, depending on the situation:

5-5EECE 450 — Engineering Economics Economic Criteria Restated: Present Value Techniques SituationCriterion Fixed input Amount of capital available is fixed Maximize present value of benefits Fixed output Amount of benefit is fixed Minimize present value of costs Neither fixed Neither capital nor benefits is fixed Maximize net present value of (benefits  costs)

5-6EECE 450 — Engineering Economics Economic Criteria Example: Purchasing Building Space C B A Alt Simultaneously negotiate for maximum building size & minimum cost/ft 2 $150,000 max 15-20,000 ft 2 required Neither fixed Negotiate for minimum cost/ft 2 20,000 ft 2 building available Fixed output Maximum square feet of building for the price $150,000 maxFixed input CriterionExampleSituation

5-7EECE 450 — Engineering Economics Applying Present Value Techniques nThe analysis period (sometimes called the planning horizon) must be considered. nThree possible situations exist: Useful lives of the alternatives are equal to the analysis period; Alternatives have useful lives that are different from the analysis period; The analysis period is infinite, n = 

5-8EECE 450 — Engineering Economics Useful Lives = the Analysis Period nRequire a project to last five years. nThe equipment and tooling will last five years. nCalculate the present value (NPV) over a five year span; salvage the equipment and tooling at the end of the five years. nCompare the NPVs.

5-9EECE 450 — Engineering Economics Useful Lives  the Analysis Period nA project lasts a non-integer number of life- times; equipment and tooling last one lifetime. nCalculate the present value (NPV) over a longer time: Purchase new equipment and tooling now and at the end of each lifetime. Salvage the equipment and tooling at the end of the analysis period.

5-10EECE 450 — Engineering Economics Infinite Analysis Period nA project will last longer forever (capitalized). nEquipment and tooling will last one lifetime. nCalculate the present value (NPV) over an infinite time.

5-11EECE 450 — Engineering Economics Multiple Alternatives nWe can handle more than two alternatives by extending the techniques we have developed.

5-12EECE 450 — Engineering Economics Suggested Problems n5-21, 23, 25, 31, 37, 40 ($10,000 a year beginning today), 43 (laboratory operating cost of $150,000 a year in advance), 52, 54, 56, 60, 67, 69, 73, 84.