1. Comparing Mutually Exclusive Alternatives
Lecture No. 18
Chapter 5
Contemporary Engineering Economics
Copyright © 2016

2. Comparing Mutually Exclusive Projects: Basic Terminologies
Alternative vs. Project
Do-Nothing Alternative

3. Revenue Versus Service Projects
Revenue Projects
Service Projects
Project revenues depend on the choice of alternatives
Project revenues do not depend on the choice of alternatives
Revenue and cost streams vary with the choice of alternatives
Fixed (or constant) revenues for all alternatives

4. Analysis Period Versus Required Service Period
The time span over which the economic effects of an investment will be evaluated (study period or planning horizon)
The time span over which the service of equipment (or investment) will be needed

5. Road Map: A Process of Making a Choice Among Mutually Exclusive Alternatives

6. Comparing Mutually Exclusive Projects
Principle: Projects must be compared over an equal time span.
Rule of Thumb: If the required service period is given, the analysis period should be the same as the required service period.

7. Case 1 Analysis Period Equals Project Lives
What to do: Compute the NPW for each project over its life and select the project with the largest NPW.

8. Comparing Projects Requiring Different Levels of Investment
Assume that the unused funds will be invested at MARR.
This portion
of investment
will earn a 10% return on
investment.

9. Analysis Period Implied in Comparing Mutually Exclusive Alternatives
Figure: 05-13

10. Case 2 Project Lives Longer Than the Analysis Period What to do
Estimate the salvage value at the end of the required service period.
Compute the NPW for each project over the required service period.
PW(15%)A = −$362
PW(15%)B = −$364

11. Case 3A: Service Projects
Project Lives Shorter than the Analysis Period
What to do
Come up with replacement projects that match or exceed the required service period.
Compute the NPW for each project over the required service period.
PW(15%)A = −$34,359
PW(15%)B = −$31,031

12. Case 3B: Revenue Projects
Analysis Period Coincides with the Project with the Longest Life in the Mutually Exclusive Group
What to do
Compute the NPW of each project over its analysis period, assuming no cash flows after the service life for the shorter-lived project.
PW(15%)Drill = $2,208,470
PW(15%)Lease = $2,180,210

13. Case 4 Analysis Period Is Not Specified What to do
Come up with replacement projects that serve out the least common multiple period (LCM).
Compute the NPW for each project over the LCM.
PW(15%)A = −$53,657
PW(15%)B = −$48,534

14. Summary
Present worth is an equivalence method of analysis in which a project’s cash flows are discounted to a lump sum amount at the present time.
The MARR, or minimum attractive rate of return, is the interest rate at which a firm can always earn or borrow money.
MARR is generally dictated by management and is the rate at which NPW analysis should be conducted.
Two measures of investment, the net future worth and the capitalized equivalent worth, are variations of the NPW criterion.

15. The term mutually exclusive means that when one of several alternatives that meet the same need is selected, the others will be rejected.
Revenue projects are those for which the income generated depends on the choice of project.
Service projects are those for which income remains the same, regardless of which project is selected.
The analysis period (study period) is the time span over which the economic effects of an investment will be evaluated.

16. The required service period is the time span over which the service of equipment (or investment) will be needed.
The analysis period should be chosen to cover the required service period.
When not specified by management or company policy, the analysis period to use in a comparison of mutually exclusive projects may be chosen by the individual analyst.