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I have three options. I can receive (A) $30,976 now, (B) $359.60 per month for the rest of my life, or (C) $513.80 per
month for the next 10 years . For option C if I die within 10 years, payments continue to my heirs. My interest rate is 9%.
What :should I do?" Ignore the timing of the monthly cash flows and assume that the payments are received at the end of
year.
Contributed by D .. P. Loucks, Cornell University
(a) Develop a choke table for life spans from age 66 to 100.
(b) U remaining life is 20 years and i = 9%, use an incremental rate of return analysis to recommend which option
should be chosen.
8,~37 A firm must decide which of three alternatives to adopt to expand its capacity. The firm wishes a minimum annual
profit of 20% of the initial cost of each separable increment of investment. Any money not invested in capacity expansion
can be invested elsewhere for an annual yield of 20% of initial cost.
Alt. Initial Cost Armua] Profit Profit Rate
A $100,000 $30,000 30%
B 300,000 66,000 22%
C 500,000 80,000 16%
Which alternative should be selected? Use a challenger-defender rate of return analysis. 8-38
GThe New England Soap Company is considering adding some processing equipment to the pl.am to aid in the removal
of impmities from some raw matetials. By adding the processing equipment, the firm can purchase lower-grade raw
material at reduced cost and upgrade it for use in its products.
Four different pieces of processing equipment with 15-year Jives are being considered:
A B C D
Initial investment $8,500 $18,500 26,500 $30,000
Annual saving in mate1ia]s costs 3,500 6,000 7,400 9,000
Annual operating cos t 2, 100 3,000 3,200 4, 100
The company can obtain a 13% annual return on its investment in other projects and is wil1ing to invest money on the
processing equipment only as long as it can obtain 14% annual return on each increment of money invested. Which one, if
any, of the .alternatives should be selected? Use a challenger-defender rate of rerum analysis.
Cash vs. Loan vs. Lease

8- Frequently we read in the newspa.p er that one should lease a car rather than buying it For a typical 24-month lease on a ca.r costing
39 $9400, the monthly lease charge is about $267. At the end of the 24 months, the car is returned to the lease company (which owns
th,e car). As an aJtemative, the same car could be bought with no down payment and 24 equal monthly payments, with interest at a
12% nom inal annua.l percentage rate. At the end of 24 months the car is fully paid for. The car would then be worth about half its
original cost.
(a) Over what range of nominal before-tax interest rates is leasing the preferred altemative?
(b) What are some of the reasons that wouJd make leasing more desirable than is indicated in (a)?
3- The Financial Advisor is a weekly co]um11 in the local newspaper. Assume you must answer the foUowing question. ' I need a new
40 car that I wrn keep fo r 4 years. I have three options. I can (A) pay $32,999 now, (B) make monthly payments for a 7% 4-year loan
O with 0% down, or (C) make lease payments of $425 per month for the next 4 years. The lease option a.lso req ui11es an up-front
payment of $3500. What should I do?"
Assume that the number of miles driven matches the assumptions for the lease, and the vehicJe' s value after 4 years is $14,500.
Remember that lease payments a11e made at the beginning of the mon th, and the salvage value is received onJy if you own the
vehide.
(a) Develop a choice table for nominal interest rates from 0% to 50%. (You d o not know what the reader's in terest rate is .)
(b) If i = 8%, which option shou]d be chosen?
3- The F.inancia/ Advisor is a weekly column in the local newspaper. Assume you must answer the foUowing question. " I need a new
41 car that I wm keep for 5 years. I have three options. I can (A) pay $25,999 now, (B) ma.ke monthly payments for a 9% 5-year loan
with 0% down, or (C) make lease payments of $470 per month for the next 5 years. The lease option also requires a secmity
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deposit of $1500. Wha t shouJd I do?'

Assume that the numbe.r of miles d1iven matches the assumptions fo r the lease, and the vehicle's value after 5 years is $7000.
Remember that lease payments are made at the beginning of th,e month, and the salvage value is received only if you own the
vehlde.
(a) Develop a choice table for nominal interest rates from 0% bo 50%. (You do not know what the reader's interest rate is.)
(b) If i = 9%, use an incremental rate of return analysis to recommend which option should be chosen.
Minicases
3- Contact a car dealer and choose a car to evaluate a buy-versus-lease decision (keep it reasonable-no Larnborghinis). Tell the
4.2 people at the dealership that you a11e a student working on an assignment. Be truthful and don't argue; if they don' t want to hel p
you, leave and find a friendlier dealer. For both buying and leasing, show al.I assumptions, costs, and calculations . Do not include
the cost of main tenance, gasoline, oil, water, fluids, and other routine expenses in your calculations.
Determine the car's sales price (no need to negotiate) and the costs fo r sales tax, hcense, and fees. Estimate the "Blue Book
value' in 5 years. Determine the monthly payment based on a 5-year loan at 9% interest. Assume that your down payment is .large
enough to cover only the sales tax, license, and fees. Cakulate th.e equivalent unifmm monthly cost of owning the car.
1dentify the rnsts to lease the car (if available assume a 5-yea.r lease). This includes the monthly lease payment, required dowil
payments, and any return fees that are required. CalcuJate the equivaJent unifo rm monthly cost of leasing the car.
The salespe1'5on probably does not have the answers to many of these questions. Write a one-to two~page memo detailing the
costs. _ ake a rernmmendation : Should you own or lease your car? Include nonfinancial items and potential financial items in your
condusions, such as d1iving habits and whether you are likely to d1ive more than the aJJowed number of miles dictated in the leas.e.
3- Devel.op the costs and benefits to compare owning a car versus depending on publi.c transit, ftiends, and/or a. bicycle. Place a
43 monetary value on each advantage or disadvantage.
(a) Develop a choke table for in terest rates between 0% and 25%.
(b) Since costs a.re Jikely to be similar for most peop.le, how sensitive are your results to environmental concerns? vVhat external
costs did you omit? How does inducting them and increasing their importance change your resul ts?
3- Devel op the costs and benefits to compare owning a new car with one that is 2 years old. Place a monetary value on each
44 advantage or disadvantage. Develop a choice table for interest rates between 0% and 25%.
3- For a vehide that you or a friend owns, determine the number of miles driven per year. Find three alternative sets of 4 tires that
45 differ in their tread warranty. Assume that the life of the ti11es equal.s the tread warranty divided by the number of mUes driven per
y,ear. Compare the EUACs of the tires.
(a) For what interest rates is each choke the best?
(b') Develop a graph equivaJen t to Figure 8--4 to mustrate th.e results.
(c) For the interest rate that is in the "middle" of your range, how low and how high can the number of miles each year be
with.out changing the best choice?
CASES
The following cases from Cases in Engineering Economy (www.oup.com/us/newnan) are suggested as matched with
this chapter.
Lease a Lot
CASE6
Compares leasing and owners hip. Results show importance of separating financing and investing decisions .
The Cutting Edge
CASE rn ake vs. buy and machine se1ection.
Harbor Delivery Service
CASE 11
Annual comparison of diesel versus gasol.ine engines.
I The cost t.e rm in the equatio n has a min11S S-ign because it is a cost and we are ralrulating a preseal worth. Thi, ann ual. benefit term has a minus sign because of (he s ign amvention for ihe
PV functio n.
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CHAPTER9
OTHER ANALYSIS TECHNIQUE,S
1
Clean, Lower Cost Space Travel
Since 1960 there have been over 5000 orbital launches. Each launch has the potential to leave pieces of debris behind.
NASA currently tracks more than 500,000 pieces of space debris in orbit. Space debris is defined as any man-made object
in Eatth's orbit that does not serve a useful function . When companies launch satelHtes into space or deliver payloads to
the International Space Station, the rockets used to get them into orbit are either left floating in space or drop back
through Earth's atmosphere, landing in their final resting place at the bottom of the ocean. About 24% of space debris
consist of satellites, while 18% are spent rockets and other mission-specific objects. AU of this debris is orbiting at speeds
up to 17,000 mph, posing catastrophic threats to other spacecraft and sateUites.
In addition to polluting space, the "disposable rocket" model is expensive. In 1969, ASA spent approximately $350
million for each launch of the Saturn V rocket as patt of the Apollo space program. That is over $6.5 billion, adjusted to
today's dollars. In fact, the high cost of producing and launching these rockets was the main reason for the cancellation of
the last three Apollo flights. Simiiarly, the average cost to design, build, prepare, and launch a Space Shuttle was close to
$920 mi.llion per mission (adjusted for inflatfon).
We are entering the era of the reusable rocket. Private companies such as SpaceX and Blue Origin believe the future of
space travel will be powered by reusable rockets. On October 7, 2018, SpaceX launched the Falcon 9, which successfully
delivered an eanh-observation satellite into orbit. Less than 10 minutes after liftoff, as seen in a widely viewed video,
Falcon 9's first stage safely returned to Earth at Vandenberg Air Force Base in California to be refurbished and reused in
another launch. Falcon 9's first-stage engines provide liftoff power and boost the rocket to the edge of space. The second
stage carries the payload into orbit while the first stage returns back to Earth for reuse.
According to SpaceX, the first stage engine can be reused up to 15 times. By refurbishing rockets, the cost of each launch
can be reduced from $62 million to $40 million. SpaceX's chief operating officer Gwynne Shotwell suggests the reusable
first stage reduces production costs by half. The first stage is estimated to be 75% of the total direct cost of each rocket.
Much of these savings will be passed on to SpaceX customers-private firms launching satellites for commercial use or
for government entities such as NASA. SpaceX hopes to decrease the overall cost of commerciaUzing and exploring the
solar system while having a positive impact on the environment-on Eatth and in space! ■ ■ ■
Contributed by Christy Bozic, University of Colorado Boulder
QUESTIONS TO C ONSIDER
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1. What has happened more recently with reusable launches?

2. What are the potentla] costs and benefits of reusable rockets to producers such as SpaceX? To a satellite
company?
3. Which measures of economic va]ue would be the most usefuJ in evaluating reusable rockets? Why?
4. What ethical questions arise from companies who allow single-use rockets to land in the ocean or become space
debtis?
After Completing This Chapter ...

The student should .be a.ble to:
• Use future worth, benefit-cost ratio, payback period, and sensitivity analysis methods to so]ve engineering
economy problems.
• Link the use of furure worth analysis to the present worth and annual worth methods developed earlier.
Mathematically develop the benefit-cost ratio, and use this model to select alternatives and make economic
• choices.
• Understand the concept of the payback period of an investment, and be able to calculate this quantity for
prospective projects.
• Demonstrate a basic understanding of sensitivity and breakeven analyses and the use of these too]s in an
engineering economic analysis.
• Use a spreadsheet to perform sensitivity and breakeven analyses.
• Consider expected returns and risks when investing or saving. (Appendix 9A)
Key Words
benefit-cost ratio
breakeven chart
discounted payback period
future worth analysis
liquidity
payback period
profitabiHty
sensitivity analysis
staged construction
what-if ana]ysis
Chapter 9 examines four topics:

• Future wmth ana]ysis
• Benefit-cost ratio or present wmth index analysis
• Payback period
• Sensitivity, breakeven, and what-if analysis
Future wmth analysis is very much like present worth analysis, dealing with then (future wmth) rather than with now
(present worth) situations.
Previously, we have written economic analysis re lationships based on either
PW of cost = PW of benefit or EUAC = EUAB
Instead of writing it in this fmm, we could define these relationships as
PW of benefit EUAB
-----= 1 or -- = 1
P\V ofco t EUAC
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I. 1'1' VI ..,_.V,'.H.
When economic analysis is based on these ratios, the calculations are called benefit-cost ratio analysis. The PW ratio is
also known as a present wmt h index.
Payback period is an approximate analysis technique, genernUy defined as the dme required for cumulative benefits to
equal cumulative costs.
Sensitivity desc1ibes how much a problem element must change to reverse a particuiar decision. C]osely related is
breakeven analysis, which determines the conditions under which two alternatives are equivalent What-if analysis
changes one or all variables to see how the economic value and recommended decision change. Thus, breakeven and
what-if analysis are forms of sensitivity analysis.
FUTURE WORTH ANALYSIS

In present wotth analysis, alternatives are compared in terms of the ir present consequences. In annual cash flow analysis,
the comparison was in terms of equivalent uniform annual costs (or benefits). But the concept of resolving alternatives
into comparable units is not restricted to a present or annual comparison. The compatison may be made at any point in
time. In many situations we would like to know what the future situation will be, if we take some particular course of
action now. This is called future worth analysis.
Example 9- 1 illustrates how much impact seemingly small decisions can have on long-term objectives. A common
variation of Example 9- 1 defines a future worth goal inn years for an expensive vacation, a dm'!ITI payment on a house, a
child's college fund, or for retirement. In these cases the question is how much must be saved each month to meet the
goal. This type of savings and investing is the subject of Appendix 9A, which focuses on retirement because of its long
horizon and .importance. Appendix 9A can be applied to any future wmth savings goal. Example 9-2 illustrates how to
calculate the future wmt h at statt-up of projects with multi-year construction periods.
EXAMPLE9-l
A college student spends $35 a week on lottery tickets. He wonders how much money he could accumulate before
retili ng at 65 if he stopped buying lottery tickets and instead put the money into a savings account. The savings account
would eam 5% interest, compounded semiannualJy. Compute the future worth of the savings at age 65.
Assume that the week]y $35 is from a 5-day per week habit where this makes sense, and that there is a $2 per day
alternative. Possibie examples include lattes, breakfasts from a drive-through, and lunches not brought from home.
What are the week]y savings and the future wmth of the savings account?
TABLE SOLUTION
Stop and Save
Semiannual aving = 35/week)(26 wee ks) = $910

FW = A(F/A, 21/ 2%, 90) = 910(329 .2) = $299.572
Daily Habit to Weekly Treat 1

A weekly $35 from a 5-day per week habit is $7 per day. Substituting a $2 per day alternative on 4 days per week
would save $20 weekly(= 4 x $5). Th.is would be $520 every 6 months.
FW = 520(F /A, 2 1/ 2 %, 90) = 520(329.2 , = $171 , 184

5 BUITO SOLUTION
A B C D E F G H I
1 Problem i n PMT PV FV Solve for Answer Form ula
2 Stop & save 2.5% 90 -910 0 FV $299,530 FY =FV(B2,C2,D2,E2)
3
4 Weekly treat 2.5% 90 -520 0 FV $171,160 =FV(B2,C2,D2,E2)
I EXAMPLE 9-2
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An East Coast firm has decided to establish a second plant in Kansas City. There is a factory for sale for $850,000 that
could be remodeled and used. As an alternative, the firm could buy vacant land for $85,000 and have a new plant
constructed there. Either way, it will be 3 years before the firm will be able to get a plant into production. The timing of
costs for the factory are:
Year Construct 'ewPlant Remodel Available Factory
0 Buy land $85,000 Purchase factory $850,000
1 Design 200,000 Design 250,000
2 Construction 1,200,000 RemodeUng 250,000
3 Prod uction equipment 200,000 Production equipment 250,000
If interest is 8%, which alternative has the lower equivalent cost when the firm begins production at the end of Year 3?
SOLUTION
New Plant
0- -1- -2- -3 = 0----1- -2- -3
85.k L___ _____ _! }200.(00

1.000,000
1,200;000 FW
Cash flow in year 2 can be viewed as $1,000,000 plus $200,000, creating a uniform cost of $200,000 in years 1, 2, and
3 plus a one-time cost of $1,000,000 in year 2.
FW of cost = 85 ,000(F/ P 8%,3) 200000(F/ A 8%,3

1,000 000 F / P, 8% 1 , = .1,836,000
Remodel Available Factory
0- -1- -2- -3 = 0------3

I t t t
t 50,000
FW
FW of cost = 850,000(F / P, 8%, 3) + 250 OOO(F/ A 8% 3)

= I 882,00CI
The total cost of remodeling the available factory ($1,600,000) is smaller than the total cost of a new plant
($1,685,000). However, the timing of the expenditures is helter with the new plant. The new plant is projected to have
the smaller future wmt h of cost and thus is the prefem~d alternative.
BENEFIT-COST RATIO ANALYSIS

At a given minimum attractive rate of return (MARR), we would consider an alternative acceptable, provided that
PW of benefi ts - PW of costs ~ 0 or EUAB - EUAC ~ 0
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ThltJle 9-1 Benefit-Cost Ratio Analysis

Input/Output Situation Criteri1m
either input nor either amount of money or other inputs nor amollnt One alternative: BIC :c: 1 Two or more altematives: So]ve by
output fixed of benefits or other outputs are fixed incrementaJ analysis of benefi t-cost ratios
Fixed input Amount of money or other input resources are fixed axi.mize B/C
Fixed task, benefit, or other output to be
Fixed output axi.mize B/C
accomplished
These could also be stated as a ratio of benefits to costs, or

. PW of benefit E AB
Be11efit- o f ra, 10 = . = -- > 1
PW ofco ts E AC -
Rather than using present worth or annual cash flow analysis to solve problems, we can base the calculations on the
benefit-cost ratio, B/C. The c1iteria are presented in Table 9'---1. In Table 9-1 the two special cases where maximizing the
B/C ratio is correct are listed below the more common situation where incremental analysis is required. ln Chapter 16 we
will detail how this measure is applied in the public sector. Its use there is so pe1vasive that the te1m presenc worth index
is sometimes used to distinguish private-sector applications.
Present worth, annual cash flow, rate of return, and benefit-cost ratio approaches all require a common horizon when
comparing alternatives. Example 9- 3 shows that incremental analysis is required for rnutuaJly exclusive alternatives to
correctly apply the benefit-cost ratio, just as it was required to use rate of return. The intuitively appealing approach of
maximizing the B/C ratio does not work. Example 9-4 applies incremental analysis to a six-alternative problem.
EXAMPLE 9-3 Examples 5-1, 6-5, and 7-13 Revisited

A firm is ttying to decide which of two devices to install to reduce costs. Both devices have useful Uves of 5 years and
no salvage va]ue. Device A costs $10,000 and can be expected to result in $3000 savings annua1ly. Device B costs
$13,500 and will provide cost savings of $3000 the first year, but savings wilJ increase by $500 annually, making the
second-year savings $3500, the third-year savings $4000, and so forth . With interest at 7%, which device should the
firm purchase?
SOLUTION
We have used three types of analysis thus far to solve this problem: present worth in Example 5-1, annual cash flow in
Example 6-5, and rate of return in Example 7-13. First we correctly analyze this incrementally, then we look at each
device's benefit-cost ratio.
Incremental B- A
PW of incremental cost = 3500
PW of inc,cemental benefit = 500(P/ G 7%, 5 ,
= 500(7,647) = 3820
B PW of benefit 3820
---- = - = 1.09
C PV·{ of costs 3500
The increment is justified at the MARR of 7%. Device B should be purchased.

Device A
PW of cost = ,10000
PW of benefits = 3000(P/ A, 7o/, .5)
= 3000 4 .100) = 12.300
B PW of benefit 12,300
- - - - = - - = 1.23
C PW of co 10,000
DeviceB
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PW of cost = 13,500
PW of benefit = 3000(P/ A 7%, 5 + 500(P/ G, 7%, 5)
+ 500(7.647) = 12,300 + 3820 =
= 3000(4.100) 16 120
_!! = PW of benefit = 16, 120 = 1. l 9
C PW of costs 13,500
Maximizing the benefit-cost ratio indicates the wrong choice, Device A Incremental analysis must be used.
EXAMPLE 9-4 Examples g:.....6 and B- 7 Revisited

Consider the five mutuaJly exclusive alternatives from Examples 8-6 and 8-7 plus an additional alternative, F. They
have 20-year useful lives and no salvage value. If the minimum attractive rate of return is 6%, which aJtemative should
be selected?
A .B C D £ F
Cost $4000 $2000 $6000 $1000 $9000 $10,000

PW of benefit 7330 4700 8730 1340 9000 9,500
B PW of benefit
1.83 2.35 1.46 1.34 1.00 0.95
C PW ofco t
SOLUTION
Incremental analysis is needed to solve the problem. The steps in the solution are the same as the ones presented in
Example 8-7 for incremental rate of return, except here the c1iterion is iiB/&C, and the cutoff is 1, rather than LlIRR
with a cutoff of MARR.
1. Be sure all the alternatives are identified.
2. (Optional) Compute the B/C ratio for each alternative. Since there are altematives for which B/C ~ 1, we wiU
discard any with B/C < 1. Discard Alt. F.
3. Arrange the remaining alternatives in ascending order of investment.
D 8 A C E
Cost ( = PW of cost) 1000 2000 4000 $6000 9000

PW of benefits 1340 4700 7330 8730 9000
B/ C 1.34 2.35 1.83 1.46 1.00
8- D A- 8 C-A
Increment Increment Increment
ti.Cost 1000 $2000 2000

ti. Benefits 3360 2630 1400
ti.B / C 3.36 1.32 0.70
4. For each increment of investment, if 11B/~C~ l the increment is attractive. If ~B/~ C < 1 the increment of
investment is not desirable. The increment B - D is desrrable, so B is prefe.1Ted to D. The increment A - B is
desirable. Thus, Alt. A is prefe11"€d. Increment C - A is not amactive since iiB/~C = 0 .70. Now we compare A
andE:
E-A Increment
llCost $5000
llBenefit 1670
11B/tlC 0.33
The increment is undesirab]e. We choose Alt. A as the best of the six alternatives. [Note.' The best aJternatJve does
not have the highest B/C ratio, nor is it the largest project with a B/C ratio ;_, 1. Alternative A does have the largest
difference between the PW of its benefits and costs(= $3330).]
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Benefit-cost ratio analysis may be graphically represented. Figure 9- 1 is a graph of Example 9-4. We see that F has a
B/C < 1 and can be discarded. Alternative D Is the statting point for examining the separable .increments of investment.
The slope of line B-D indicates a ~B/L1C ratio of >1. This is also true for hne A-B. Increment C-A has a slope much
flatter than B/C = 1, indicating an undesirable increment of investment. Altemative C is therefore discarded and A
retained. Increment E-A is similarly unattractive. Alternative A is therefore the best of the six alternatives.
SIO;OOO
BIC = 2.0 BIC = l.5 B/C = 1.0
9000
!!l $8000
,.;:
dl
~ $7000
oil
.....C $6000
'€ $-000
~~
$4000
C
dl
$3000
~
p..
$2000
$ 1000
$4000 $6000 8000 .$ I0,000

Pre.sent Worth of Cost
FIGURE 9-1 Benefit-cost ratio graph of Example 9-4.
Note three additional things about Figure 9- 1: first, even if alternatives with B/C ratio < 1 had not been initially
excluded, they would have been systematicaJly eliminated in the incremental analysis. Second, Alt. B had the highest B/C
ratio (B/C = 2.35), but it is not the best of the six alternatives. We saw the same situation in rate of return analysis of three
or more alternatives. The reason is the same in both analysis situations. We seek to maximize the total profit, not the
profit rate.
Third and most important. the total profit or B - C for each alternative is the ve11ical distance from the point to the B/C
= 1.0 Une. A maximizes that distance .
Variations on the Theme of the Benefit- Cost Ratio

The basic benefit-cost ratio has been defined as placing all benefits in the numerator of the ratio and all costs in the
denominator. One variation of the ratio considers the salvage values as reducing the costs rather than as increasing the
benefits.
In the public sector, it is common to define the benefit-cost ratio so that the numerator includes all consequences to the
users or the public and the denominator includes all consequences to the sponsor or government. For example, the
numerator might include the positive benefits of improved highway traffic flow and the disbenefits of congestion during
construction, since both accrue to the public or users. The denominator in this case includes consequences to the
government. such as the costs of construction and the reduced maintenance cost for the new highway. Example 9~5
illustrates this for a public project.
In Example 9-6 exactly the same numbers are put in a private context. Here the benefit-cost ratio is typically called a
present worth index. The calculation is modified so that the denominator is the project's first cost, and all other
consequences are placed in the numerator. This formulation of the benefit~cost ratio emphasizes the "bang for the buck"
of how much return is gained for each dollar of investment.
We will examine the public-sector application of the benefit-cost ratio in more detail in Chapter 16, and the present
worth index will be used in Chapter 15. Here and in those chapters, the same standard applies for all versions of the ratio.
Is the ratio 2': l? ore impmtantly, if one version of the ratio is 2': l, then all versions are ~1. As shown in Examples 9-5
and 9- 6, the values of the ratios may differ, but whether they are above or below 1 and the recommended decisions do not
change.
EXAMPLE 9-5
Traffic congestion on Riverview Boulevard has reached a point where something must be done. Tuo suggested plans
have a life of 15 years, because that is the scheduled time for completion of the new Skyway Highway. After that time
traffic will faU well below current levels.
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Adding right-tum lanes at key intersections will cost .$8.9M (million) with annual maintenance costs for signals and
lane painting of $150,000. Added congestion dming constmction is a disbenefit of .$900,000, but the reduced
congestion after construction is an annual benefit of $1.6M. This benefit actually statts lower and increases over time,
but for a simple initial ana]ysis we are assuming a uniform annual benefit.
Adding a second left-tum fane at a few key intersections will cost an additional $3 with an added annual
maintenance cost of $75,000. This construction is more disruptive, and the total disbenefit for congestion dmi.ng
construction is $2.1 . Upon completion, the total benefit for reduced congestion will be $2.2M annualJy.
Which alternative is preferred i.f the interest rate is 10%? Analyze using a government B/C ratio (public in
numerator and government in denominator).
SOLUTION
Since something must be done and we have only two identified alternatives, we could simply analyze the difference
between the alternatives to see which is better. But we are going to start by analyzing the Jess expensive "1ight-tums"
alternative to check that this is a reasonable choice for what must be done.
The user consequences include an annual benefit for reduced congestion and a first "cost" that is the disbenefit of
increased congestion during constmction .
PW-benefitSright tllflls = - 900,000 + 1,600,000(P /A, 10%, 15)

= - 900,000 + 1,600,000(7.606) = 11 .27M
The government costs include a first cost for constmction and annual maintenance costs. Note that these are
calculated as present costs .
PW-cos.tsrlght tums = 8,900000+ 150,000 P/A, 10%, 15)

= 8,900 000 + 150,000 7.606) = 10.04M
The benefit-cost ratio for public divided by government consequences is
B/ C ratio = $11.27M/ $10.04M = 1.122

Thus, the right-turns-only alternative is better than doing nothing.
Now we evaluate the incremental investment for also doing the left-tum improvements. Because we are using a
benefit-cost ratio, this evaluation must be done incrementally. The user consequences include an incremental annual
benefit for reduced congestion and an incremental first "cost" that is the disbenefit of increased congestion during
construction.
PW-benefit leH turns - rigllt 1u1:ns = - 2,100 000 - (- 900 000 + (2,200 000 - 1 600,000)(P/ A, 101½, 15
=- 1,200,000 + 600,000(P / A 10% 15
=- 1,200 000 + 600,000(7 .606 , = $3.364M
The government costs include a first cost for construction and annual maintenance costs.
PW-costs1eft mums - right turns = 3,000,000 + 75,000(P/ A 10%, 15

= 3,000.000 + 75.000(7.606) = $3.570M
The benefit-cost ratio for public divided by government consequences is
B/ C ratio = $3 .364M/ $3.570M = 0.942
Thus, the right--l mns-only alternative is better than adding the left-tum increment..
EXAMPLE9-6
The industrial engineering department of Amalgamated Widgets is considering two alternatives for improving material
flow in its factory. Both plans have a life of 15 years, because that is the estimated remaining life for the factory.
10 of 48 1/25/2020, 11:08 AM
A minimal reconfiguration will cost $8.9 (milUon) with annual maintenance costs of $150,000. Dming
construction there is a cost of $900,000 for extra material movements and overtime, but more efficient movement of
materials will save $1.6M annually. The cost savings acruaUy start lower and increase over time, but for a simple initial
analysis we are assuming a uniform annual cost savings.
Reconfiguring a second patt of the plant will cost an additional $3 w:i.th an added annual maintenance cost of
$75,000. This constmction is more disruptive, and the total cost for material movement and overtime congestion during
construction is $2.lM. Once complete, the total cost savings for more efficient movement of materials is $2.2
annually.
Which alternative is preferred if the interest rate is 10%? Analyze using a present wmth index (all consequences 1n
Years 1 ton in numerator and all first costs in denominator).
SOLUTION
Since something must be done and we have only two identified altematives, we could simply analyze the difference
between the alternatives to see whilch is better. But we are going to start by analyzing the less expensive minimal
reconfiguration alternative to check that this is a reasonable choice for what must be done.
The consequences in Years 1 ton include an annual cost savings for more efficient flow and annual maintenance
costs.
PW-benefit Ye.ars 1 to 11 = (1 600 000 - 150,(X}O)( P / A, lOo/t , 15)

= (1600000 - l 0,000)(7.606) = 11 .03M
The first costs include a first cost for construction and the cost for d1sruption dming construction.
P\V-cost = 8,900,000 + 900,000 = $9.8M

The present worth index is
PW-index = $11.03M/ $9.8M = 1.125
Thus, the minimal reconfiguration is better than doing nothing.

Now we evaluate the incremental investment for also reconfiguring the second part of the plant. Because we are
using a present worth index, this evaluation must be done incrementally. The annual consequences include an
incremental annual cost savings and incremental maintenance costs.
PW-benefi tsYear. 1 ton = 600,000 - 75 000 P/ A, 109.: , 15)

= 525,000(7 .606) = $3.993M
There is a first cost for constmction and for the associated dismption.
PW-costs = 3 000,000 + 1,200,000 = $4.2M

The present worth index is
PW-index = $3.993M/ $4.2M = 0.951

Thus, the minima] reconfiguration is better than reconfiguring the second part of the plant.
In Examples 9-5 and 9-6, the numhers that appeared in the numerator and denominator were changed, and the exact
values of the B/C ratio and present worth index also changed. However, the conclusions did not. The ratios were above
1.0 for the minimal investment choice. The ratios were below 1.0 for the incremental investment. It was always best to
make the minimal investment.
These examples demonstrate that present worth analysis and incremental benefit-cost ratio analysis lead to the same
oplimaI decision . We saw in Chapter 8 that rate of retum and present worth analysis led to identical decisions. Any of the
exact analysis methods--present worth, annual cash flow, rate of return, or benefit-cost ratio-will lead to the same
decision. Benefit-cost ratio analysis Is extensively used in economic analysis at all levels of government.
11 of 48 1/25/2020, 11:08 AM
PAYBACK PERIOD
Payback period measures the time required for the profit or other benefits from an investment to equal the cost of the
investment. This is the general definition for payback period. Other definitions consider depreciation of the investment,
interest, and income taxes; they, too, are simply called "payback period." We will limit our discussion to the simplest
form.
Payback period is the period of time required for the projecfs profit or other benefi ts. to equal the project's cost
The ctiretion in alJ situations is w minimize the. payback petiod. The computation of payback period and its weaknesses relative. to time
value of money measures are illl.15trated in Examples 9-7 and 9-8.
EXAMPLE9-7
The cash flows for two alternatives are as follows:
Year A B
0 -$1000 -$2783
1 200 1200
2 200 1200
3 1200 1200
4 1200 1200
5 1200 1200
You may assume the benefits occur throughout the year rather than just at the end of the year. Based on payback
period, which alternative should be selected? For what interest rates is this the correct choice?
PAY BACK PERIOD SOLUTION

Because benefits occur throughout the year (like most engineering projects), fractional years have meaning.
Alter-native A
Payback period is how long it takes for the profit or other benefits to equal the cost of the investment. In the first 2
years, only $400 of the $1000 cost is recovered. The remaining $600 cost is recovered in the first half of Year 3. Thus
the payback period for Alt. A is 2..5 (= 2 600/1 200) years.
Alter-native B
Since the annual benefits are uniform, the payback period is simply
$2783/$1200 per year = 2.3 years
To minirni1.ie the payback period, choose Alt. B.
TIME VALUE OF MONEY SOLUTION

Previous chapters have shown that incremental analysis is needed to analyze mutuaUy exclusive alternatives with rate
of return. Since both alternatives have cash flows of $1200 in years 3 through 5, the incremental cash flows are zero,
and the incremental analysis can focus on the cash flows for the first 2 years.
Year B-A
0 -$1783
1 1000
2 1000
The incremental IRR is 8.0%, so for interest rates below 8% Alternative B will be prefen-ed (matching the payback
period solution). For interest rates above 8% Alternative A will be prefen-ed. The easiest way to check this is to ask,
which is prefen-ed at 0% interest? By adding the cash flows we see that PW B-A = $217 (= 2000 - 1783). So the PW of
12 of 48 1/25/2020, 11:08 AM
Bis $217 higher than the PW of A at 0%. At 10% the PW of the increment is -$47, so A is preferred.
A B C D E p G H I
1 Problem i n PMT PV FV Solve for Answer Pornrnla
2 lRRa-A 2 1000 -1733 0 RATE 3.011% =RATE{C2,02,E2,F2)
3 PW10% 10% 2 1000 PV 1736
4 -1733
5 PWB-A 10% -47
EXAMPLE 9-8
A product wilI be phased out in 5 years, but it currently has a quality problem that is costing $4000 per year. achines
A and B will both solve the quality problem. Machine A costs only $10,000 but it will have no salvage value in S years.
Machine B costs $15,000 but in 5 years it will have a salvage value of $9000. Based on payback period, which
alternative should be selected? For what interest rates is this the correct choice?
PAYBACK PERIOD SOLUTIO

As long as payback does not depend on the salvage value (usually true), the payback pe1iod for uniform cash flows is
simply the first cost divided by the annual benefit. In this case.:
PaybackA = 10,000/($4000/year) = 2.5 years
Paybacks = 15,000/($4000/year = 3.75 years
So choosing to minimize the payback period would result in choosing Machine A
TIME VALUE OF M ONEY SOLUTION

Previous chapters have shown that incremental analysis is needed to analyze rnutual1y exclusive alternatives with rate
of return. Since both alternatives have cash flows of $4000 in years 1 through 5, the incremental analysis can focus on
the cash flows for the first cost and the salvage value.
Y:ear B-A
0 -$5000
5 9000
A B C D E p G H I
1 Problem i n PMT PV FV Solve for Answer Form ula
2 IRRa-A 5 -5000 9000 RATE 12.5% =RATE(C2,D2,E2,P2)
3 PW10% 15% 5 1000 PV 4475
4 -5000
5 PW&A 15% -525
The 1ncremental IRR is 12.5%, so for interest rates beiow 12.5% Alternative B will be preferred (matching the
payback period solution). For interest rates above 12.5% Alternative A will be preferred. The easiest way to check this
is to ask, which is preferred at 0% imerest? By adding the cash flows we see that at 0% PWB- A = $4000 ( = 9000 -
5-000). So the PW of B is $4000 higher than the PW of A at 0%. Ar 15% the PW of the increment is -$525, so A is
preferred.
There are four important points to be understood about payback period cakulations:
11 l"'T"11- "- • - __ - - - ·· -- ·• -_,.__ · · · ' - - - ... L __ - - _ __ __ .._ - - - - - - • - _ __ 1_ __ , __ _ ·1 - . • l -••· - -
13 of 48 1/25/2020, 11:08 AM
1. This is an approximate, rather than an exact, economic ana]ysis calculation.
2.. All costs and all profits or savings of the investment before payback are included without considering differences in
their timing.
3. All the economic consequences beyond the payback period are completely ignored.
4. Being an approximate calculation, payback period may or may not select the correct altemative.
This last pojnt-that payback period may select the wrong alternative-was illustrated by Examples 9- 7 and 9- 8. But if
payback period calculations are approximate and may lead to selecting the wrong alternative for some or aU interest rates,
why are they used? First, the calculations can be readily made by people unfamiliar wJth economic analysis. Second, good
projects and alternatives are usually clearly superior by all measures. Third, payback petiod is easily understood. Earlier
we pointed out that this is also an advantage to rate of retum. The vignette in Chapter 3 described a high payout project.
The PV was about $8.6M and the IRR was over 11,000%. Both of these can be confusing to management, but the idea
that the project paid out in one day was very dear.
Moreover, payback period does measure liquidity-how long it will take for the cost of the investment to be recovered
from its benefits. Films are often very interested in this time period: a rapid return of invested capital means that the funds
can be reused sooner for other purposes. But one must not confuse the speed of the return of the :investment, as measured
by the payback period, with profitability. They are two distinctly separate concepts.
There is a refinement of the payback petiod that does include interest-the discounted payback period. The
discounted payback period is longer than the payback period, because the benefits must also cover the interest on the
capital invested in the project. If the annual benefits are uniform and the salvage value is $0, then PER can be used to
calculate the discounted payback period-as long as that period is less than the altemative's life. If the sa]vage value
becomes involved in achieving payback, then the horizon Is the payback period.
The discounted payback period includes some considerntion of the time value of money, so it is a better measure than
payback petiod, but discounted payback period is still not a vaUd time va]ue of money measure that includes aU cash
f1ows . In Example 9- 9, there are clearly salvage values that would make either alternative the preferred choice. Payback
periods, whether discounted or not, ignore cash flows that occur after payback.
EXAMPLE9-9
Two alternatives have been identified. Alternative A has a first cost of $10,000 and benefits of $3000 annually.
Alternative B has a first cost of $12,000 and benefits of $3500 annually. The salvage values of each alternative are
currently unknown. Using discounted payback petiod, which alternative is prefem~d at an interest rate of 10%?
SO LUTION
Even if the salvage values were known, they must be ignored for the NPER calculation. If they are included, then
NPER assumes that the salvage value occurs at time of payback- which may dramatically shorten the cakulated time
period.
A B C D E F G H I
1 Exp. 9-9 i n PMT PV FV Solve for Answer Formula
2A 10% 3000 -10,100 0 PER 4.25 = PER(B2,D2,E2,F2)
3B 10% 3500 -12,000 0 PER 4.41
Alternative A has a discounted payback period of 4.25 years versus 4.41 years for Alternative B. So A is prefen"ed
using the discounted payback period. Whether or not this is cmTect can only be determined by a valid time value of
money computation that includes the unknown salvage values. We do not yet know which alternative has the better
present worth at 10% .
From the discussion and the examples, we see that payback period can measm"€ the speed of the return of the
investment. This might be quite impmtant, for example, for a company that is short of working capital or for a firm in an
industry experiencing rapid changes in technology. Calculation of payback period alone, however, must not be confused
with a careful economic analysis. Ignoting all cash flows after the payback period is seldom wise. We have shown that a
shmt payback period does not always mean that the associated investment is desirable. Thus, payback period is not a
suitable replacement for accurate economic analysis calculations.
14 of 48 1/25/2020, 11:08 AM
SENSITIVITY AND BREAKEVEN ANALYSIS

Since many data gathered in solving a problem represent projections o f future consequences, there may be considerable
uncettainty regarding the data's accuracy. Since the goal is to make good decisions, an appropriate question is: To what
extent do variations in the data affect my decision? When small variations in a pa1ticular estimate would change which
alternative is selected, the decision is said to be sensitive to the estimate. To better evaluate the impact of any particular
estimate, we compute "how much a pa11icular estimate would need to change in order to change a particular decision."
This is called sensitivity analysis. Chapter 8 compared economic values at different interest rates with graphs and choice
tables. That was also a form of sensitivity analysis.
An analysis of the sensitivity of a problem's decision to its various parameters highlights the impmtam aspects of that
problem. For example, estimated annual maintenance and salvage values may va11r substantially. Sensitivity analysis
might indicate that a certain decision is insensitive to the salvage-value estimate over the full range of possible values.
But, at the same time, we might find that the decision is sensitive to changes in the annual maintenance estimate. Under
these circumstances, one should place greater emphasis on improving the annual maintenance estimate and less on the
salvage-value estimate.
As indicated at the beginning of this chapter, breakeven analysis is a form of sensitivity analysis that is often presented
as a breakeven chart. Another nomenclature that is somerimes used for the breakeven point is point of indifference. One
application of these tools is staged construction. Should a facility be constructed now to meet its future full-scale
requirement? Or should it be constructed in stages as the need for the increased capacity arises? What is the breakeven
point on how soon the capacity is needed for this decision? Three examples are:
• Should we install a cable with 400 circuits now or a 200-drcuit cable now and another 200-circuit cable later?
• A 10-cm water main is needed to se1ve a new area of homes. Should it be installed now, or should a 15-cm main he
instaUed to ensure an adequate water supply to adj oining areas later, when other homes have heen built?
• An industrial firm needs a new warehouse now and estimates that it wil] need to double its size in 4 years. The finn
could have a warehouse built now and later enlarged, or the firm could have the larger warehouse built 1ight away.
Examples 9-10 and 9-11 illustrate sensitivity and breakeven analysis. These examples have focused on the breakeven
project life, because that value of n is often one of the most uncertain values in an economic analysis. How long will that
bridge, machine, or product function and meet the need?
EXAMPLE 9-10
Consider a project that may he constructed to full capacity now or may be constructed in two stages.
Construction A1ter native Costs

Two-stage construction
Construct first stage now $100,000
Construct second stage n years from now 120,000
Pul.1-capacity consnuction
Construct full capacity now 140,000
After 40 years all facilities will have zero salvage value. The annual cost of operation and maintenance is the same
for hoth altematives. With an 8% inrerest rate, what is the breakeven n?
5-BUITON SOLUTION
As emphasized previously, the choice between two mutually exclusive alternatives can be made hy analyzing the
incremental difference between them. For rate o f return and benefit-cost methods, incremental analysis is required. In
this case, building the full capacity now costs $40,000 more than the inHial cost of the two-stage alternative. This will
save the $120,000 required whenever the second stage would be built. PE R can be used to solve for the life that gives
these cash flows the same worth at an interest rate of 10%.
A B C D E F G H l
1 Exp. 9-9 i n PMT PV FV Solve for Answer Fommla
15 of 48 1/25/2020, 11:08 AM
2 Pull-staged 8% 0 -40,000 120,000 PER 4.27 = PER(B2,D2,E2,F2)
Example 9-12 will revisit this examp]e m create and improve the graph of each aJternative's present worth.
TABLE SOLUTION
Since we are dealing with a common analysis period, the calculations may be either annual cost or present wmth.
Present worth ca]culations appear simpler and are used here. Incremental analysis with a simple factor equation
matching the 5-BUTfON SOLUTION wilJ be presented, but starting with a graphica] approach (like Chapter 8) seems
likely to support a better understanding.
Construct Fu11 Capacity Now
PW of co t = $140,000
Tuo~Stage Construction
U the first stage is to be constructed now and the second stage n years hence. compute the PW of cost for several values
of n (years).
P\V of cost = 100 000 + 120,000 P/ F . 8%, n ,
n=S PW= 100, 000 + 120, 000(0.6806} = $181, 700

n= 10 PW= 100, 000 + 120, 000(0.4632} = 155, 600
n= 20 PW= 100, 000 + 120, 000(0.2145} = 125, 700
n= 30 PW= 100,000 + 120, 000(0.0994} = 111,900
These data are p]otted in the fmm of a breakeven chatt in Figure 9-2.
$250.000
;,,,,_,
Q\S)
200.000 I,~
.,: eC'o,J,
C
u '1j lrf,C f/0/J
'a ]50.000
-5
!-
iC: 100,000 &

C:
~ :,cc~
C:
ll
A. j,; II"\
50.000 :,
di
0 5 IO ]5 20 25 30
Year
Age WheJJ Seoond Stage ConsU-ucled
FIGURE 9-2 Breakeven chatt for Example 9-10 .
In Figure 9-2 we see that the PW of cost for t\.vo-stage construction namrally decreases as the second stage is
defe1Ted. The one-stage constmction (full capacity now) is unaffected by the x-axis variable and, hence, is a horizontal
line.
The breakeven point on the graph JS where both altematives have the same PW. Thfa is about 15 years. If the second
stage were to be needed prior to Year 15, then one-stage construction has the lower cost. On the other hand, if the
second stage would not be required until after 15 years, two-stage construction has the lower cost.
This breakeven point can be more accurately calculated by setting the two alternatives equal to each other.
PW = 140,000 = 100,000 + 120,000(P/ F, 8i n)
40000
P/ F &%, n) = ' = 0.3333
120.000
From the tables
n = 14 + H5 - 14)(0.3405 - 0.3333)1(0.3405 - 0.31.52

16 of 48 1/25/2020, 11:08 AM
n = l'J +lD - 14)lU. j'JU) - U, j j j jJ/ lU',J4ill - U.jlJ.lJ
n = 14.3 years
SENSITIVITY DISCUSSION
The decision on how to construct the project is sensitive to the age at which the second stage is needed only if the range
of estimates indudes 15 years. For example, if one estimated that the second-stage capacity would be needed between
5 and 10 years hence, the decision is insensitive to that estimate. For any value within that range, the decision does not
change. But. if the second-stage capacity were to be needed sometime between, say, 12 and 18 years, the decision
would be sensitive to the estimate of when the full capacity would be needed.
EXAMPLE 9-11 Examples 9,_5, and 9--6 Revisited

In both Examples 9-5 (traffic congestion on Riverview Boulevard) and 9.....:6 (reconfiguring the plant of }\..malgamated
Widgets), the Ufe of 15 years is dearly subject to some uncertainty. WhUe holding the other data constant, analyze the
sensitivity of the recommended decisions to the project life. Use the present worth measure, since it is the same for
both examples.
SOLUTION
The two alternatives have the following present worth values.
PW rigl:IL Hims or minimal = - 900,000 - 8,900,000 + (1 .600 000 - 150 OOO)(P / A, I091:, n)
= - 9,800 000 + 1 4.50,000(PJA, 10 n)
PW1e1t turns or 2nd part of pl :mt = - 2.100 000 - 8,900,000 - 3,000 000
+ (2 200,000 - 225,000 (P / A, I 0%, n
= - 14,000,000 + 1,975 000 P/A, 10% n
These could be analyzed for breakeven values of n. However, it is easier to use the graphing technique for multiple
alternatives that was presented in Chapter 8. Instead of using the interest rate for the x axis, use n.
As shown in Figure 9- 3, the right-turn or minimal alternative is the best one for lives of 12 to 16 years. The left-tum
increment or 2nd patt of the plant. is the best choice for lives of 17 or more years. If the life is 11 years or less, doing
nothing is better. To keep the graph readable, Figure 9- 3 indudes only Years 10 through 20.
S3000
1.r oo:akrn:o for right-turns ill minimal = I 1.8 ye.ars
2500
Riglll-lurn or
2000 +-- mini mal --+
Do
------f> Add tefl-lurn
1500 nothtng
orrellllOdel
~ rnoo
P-. n bccakcm, for teft-turm.s ill
500 remodel _ nd pal"I = 16. 9 years
- 500
,.
- HIOO
IO 12 14 16 Jg 20
U fe of Project (ye.ars)
FIGURE 9-3 Breakeven cha11 for Example 9- 11.
Breakeven points can be estimated from graphs or caJculated with formulas or GOAL SEEK. Sensitivity analysis and
breakeven point calculations can be very useful in identifying how different estimates affect the calculations. It must be
recognized that these calculations assume that al1 parameters except one are held constant, and the sensitivity of the
decision to that one variable is evaluated. The next section presents ways to modify your Excel chart to make it more
effective.
17 of 48 1/25/2020, 11:08 AM
euecuve.
GRAPHING WITH SPREADSHEETS FOR SENSITIVITY AND

BREAKEVEN ANALYSIS
Chapter 4 introduced drawing xy plots with spreadsheets, and Chapter 8 relied on pfots of PW, EUAW, and EUAC versus
i. This section will present some of the spreadsheet tools and options that can make the xy plots more effective and
attractive .
The spreadsheet tools and options can be used to:
• Modify the x or y axes
Specify the minimum or maximum value
Specify at what value the other axis intersects (default is 0)
• Match line types to data
Use line types to distinguish one curve from another
Use markers to show real data
Use lines without markers to plot curves (straight segments or smooth rnrves)
• Match chart colors to how displayed
Color defaults are fine for color computer screen
Color defaults are OK for color printers
Black-and-white printing is better with editing (use line types not cofors)
• Annotate the graph
Add text, arrows, and lines to graphs
Add data labels
In most cases the menus of Excel are self-explanatory, so the main step is deciding what you want to achieve. Then
you just look for the way to do it. Left dicks are used to select the item to modify, and right clicks are used to bring up the
options for that item. Example 9- 12 illustrates this process.
EXAMPLE 9-12 Example 9- 10 Revisited

The staged construction choice described in Example 9-10 used a broad range of x values for the x axJS. Create a graph
that focuses on the 10- to 20-year petiod and is designed for ptiming in a report. The costs are:
Year Full Capacity Two Stages

0 $140,000 $100,.000
n 0 120,000
SOLUTION
The first step is to create a table of values that shows the present worth of the costs for different values of n = the
length of time until the second stage or fuU capacity is needed. Notice that the full capacity is calculated at n = 0. The
only reason to calculate the cmTesponding value for staged constrnction is to see if the formula is properly entered,
since building both stages at the same time will not really cost $220,000. The values for staged construction at S, 10,
20, and 30 years check with the values in Example 9-10.
The next step is to select cells A8:Cl 3, which includes the x values and two series of y values. Then the
ChartWizard tool is selected. In the first step, the xy (scatter) plot is selected with the option of smoolhed lines without
markers. In Step 2 no action is required, since the cells A8:Cl3 were selected first. In Step 3 labels are added for the x
and y axes. In Step 4 the chart is moved around on the worksheet page, so that it does not overlap with the data. The
result JS shown in Figure 9-4.
18 of 48 1/25/2020, 11:08 AM
A B C D
I Time Full Oipacity Two Stage
2 0 140.()00 100,000
3 n 120,000
4
j Li ~e 40
6 i 8%
7 Pres&1t Worth of
8 II Full Cav.tcity Two Stage
9 0 140,000 220,000 =$C$2+PV($BS6,A9;0,-$CS3)
I.O j 140,000 I Sl ,670
1.1 10 140,000 155583
12 2.0 140,000 U.746
13 30 140,000 11 1,925
- 14[ j -
ti
250.000
1- FuH Capacr1y
~
- ~ 200,000 - TwoS tage
-
16
-
u
4-
C •
17 _ ~
- 18
150,000
- 19
C
- ~ 100,000 -
~
- 20 - iC
~ 50000 -
- - ~
I'-,
21
- - I I
22
- 23
- 0 10 20
Years until Capacity Needed
30
24
FIGURE 9-4 Automatic graph from spreadsheet.
Our first step in cleaning up the graph is to delete the formula in cell C9, since two-stage construction will not be
done at Time 0. We also delete the label in the adjacem cell, which explains the fonnula. Then we create a new label
for cell ClO. As shown in Appendix A, the easy way to create that label is to inse11 an apostrophe or space, as the first
entry in cell ClO. This convetts the formula to a label that we can copy to D lO. Then we delete the apostrophe or space
in cell ClO.
The ax.is scales must be modified to focus on the area of concem. Select the x ax.is and change the minimum from
automatic to 10 and the maximum to 20. Select they axis and change the minimum to 125,000 and the maximum to
160,000.
Left-click on the plot area to select it. Then right-dick to bring up the options. Select Fmmat Plot Area and change
the area pattern to "none." This will eliminate the gray fill that made Figure 9-4 difficult to read.
Left-dick on the two-stage curve to select H. Then right-click for the options. Format the data series using the
Patterns tab. Change the line style from solid to dashed, the line color from automatic to black, and increase the line
weight Similarly, increase the line weight for the fuU-capacity line. Finally, select a grid line and change the line style
to dotted . The result is far easier to read in black and white.
19 of 48 1/25/2020, 11:08 AM
A B C D
I Time Full C.apacity Two SI.age
2 0 140,000 100,000
3 n 120,000
4
s lire 40
6 i 8%
7 Present worth of
s I! Full Capacity Two SI.age
9 0 140,000
10 5 140,000 18 1,670 =SC$2 +PV($B$6,A IO,0, -$C$3)
II IO 140,000 155,583
,_ 20 140,000 125,746
13 30 140,000 111 ,925
- 14
15
16
-
.,,
Ja
155,000 ......... Two-St.age
... ......
... ...Conslrucl:ion
-
-
C
........ ... ... -
- 17
IS
-
u
....
C
-5
....
14-,000 -
... .......
I
I
I
I
,...
Full-Capacity
Construction
-
-
- 19
2.0
21
- ~
C
~ 13 -,000 -
C
<!)
~
I
I
I
I
I
I
I
',
~
...... ...
- ........ _
_
... ...
-
...... _ --
-
0.. I
12-,00010
22 15 20
- -
23 Ye:i.rs unlil Capacity Need d
24
FIGURE 9-5 Spreadsheet of Figure 9-4 with improved graph.
To frnther improve the graph, we can replace the legend with annotations on the graph. Left-click somewhere in the
white area around the graph to select "chart area." Right-click and then choose the chart options on the menu. The
legends rab will let us delete the legend by turning "show legend" off. Similarly, we can turn the x-axis gridlines on.
The line style for these gridJines should be changed to match the y-axis gridlines. This aUows us to see that the
hreakeven time is between 14 and 15 years.
To make the graph less busy, change the scale on the x axis so that the interval is 5 years rather than automatic. Also
eliminate the gridlines for they axis (by selecting the Chatt Area, Chatt Options, and Gridlines tabs). The graph size
can be increased for easier reading as well. This may req uire specifying an interval of 10,000 for the sca]e of they ax.is.
Finally, to add the labels for the full-capacity cmve and the two-stage curve, find the toolbar for graphics, which is
open when the chmt is selected (probably along the bottom of the spreadsheet). Select the text box icon, and click on a
location dose to the two-stage cha11. Type in the label for two-stage constmction. Notice how including a return and a
few spaces can shape the label to fit the slanted line. Add the label for full constmction. Figure 9-5 is the result.
DOING WHAT-IF ANALYSIS WITH SPREADSHEETS

Breakeven cha11s change one variable at a time, while what-if anallysis may change many of the variables in a problem.
However, spreadsheets remain a very powerful tool for this fom1 of sensitivity analysis. In Example 9-13 a project
appears to be very promising. However, what-if analysis indicates that a believable scenario raises some questions about
whether the project should be done.
EXAMPLE 9-13
You are an assistant to the vice president for manufacturing. The staff at one of the plants has recommended approval
for a new product with a new assembly line to produce it. The VP believes that the numbers presented are too
optimistic, and she has added a set of adjustments to the original estimates. Analyze the project's benefit-cost ratio or
20 of 48 1/25/2020, 11:08 AM
U 'f -'LI.U . .1.l U'I..J.'L, U.IIU 0::, 1 1'\.. .lJIU_.,:J, UUU '\..U U J\... L 'U.l. U.UJU.:iLl..l .l\....ll L .::J l.'U LI.I'\.. 'U.l .l.5.l.UU.J. L .:J,Ul. .l lU LL J , L .l...flUI.JLI.'-- UI'\.. ptVJL'\..'-.:, ULJ.I\...J.l'L~V.:>t.. I.U L.LU ILJI.
present worth 1ndex as originally submitted. Reanalyze the project, asking "What if the VP's adjustments are conect?"
IInitia] Estimate IAdjustment I

Initia] Estimate Adjustment
First cost $70,000 +1 0%
Units/year 1,200 -20%
Net unit l'evenue $25 - 15%
Life, in years a -3
Interest rate 12% one
SOLUTION
Figure 9--6 shows that the project has a 2.13 benefit-cost ratio with the initial estimates, but only a value of 0.96 with
the what-if adj ustments. Thus we need to determine which set of numbers is more realistic. Real-world experience
suggests that in many organjzations the initJal estimates are too optimistic. Auditing of past projects is the best way to
develop adjustments for future projects.
A B C D
I Adjust- Adjusted
luil.ial Estimate ment Values
2 First cost 70,000 100. $77 , 000
3 Un.its/year 1.200 -20% 960
4 Net 11nit re,•emre 52. - -15 % $21
5 Life (years) 8 -3 5
6 lolere.s t me 12% none 12%
7
8 Benefits I 149;029 73,537
9 Cost I 70,000 77,000
JO B/C Ratio I 2.1 3 0.96
I. I I
12 =PV(B6.B5,-B3*B4)
FIGURE 9-6 Spreadsheet for what-if analysis.
SUMMARY
In this chapter, we have looked at four new analysis techniques.
Future worth: When the comparison between altematives will be made in the future, the calculation is called future
worth. This is very similar to present worth, which is based on the present, rather than a future point in time.
Benefit-cost ratio analysis: This technique is based on the ratio of be nefits to costs using either present worth or
annual cash flow calculations. The method is graphically similar to present worth analysis. When neither input nor
output is fixed, incremental benefit~cost ratios (llB/ti.C) are required. The method is similar in this respect to rate
of return analysis. Benefit- cost ratio analysis is ofien used at the various levels of government.
Payback period: Here we define payback as the period of time required for the profit or other benefits of an
investment to equa] th e cost of the investment. Although simple to use and understand, payback is a poor analysis
technique for ranking aJtematives. While it provides a measure of the liquidity or speed of the return of the
investment, it is not an accurate measure of the profitability of an investment.
Sensitivity, breakeven, and what-if analysis: These techniques are used to see how sensitive a decision is to
estimates for the various parameters. Breakeven analysis is done to locate conditions under which the alternatives
are equivalent. This is often presented in the form of breakeven charts. Sensitivity analysis examines a range of
values of some parameters to detennine the effect on a pamcular decision. What-if analysis changes one or many
estimates to see what results.
21 of 48 1/25/2020, 11:08 AM
STUDENT STUDY GUIDE
These questions are intended for self-study. Click the [solution] box to reveal a detailed solution.
FUTURE WOR'IH
9-- A new automobile offers free maintenance during the first year of ownership. T he maintenanece costs the second year will be $100,
1 increasing by $100 ea,ch year thereafter. Assume that you will own the automobile for 5 years and that your cos t of money is 8%.
Find the future worth of the maintenance costs.
Wi•1••dM§1
9-- Detennine the future worth of 20 qua1terly lease payments of $500 at an .interest r-ate of 8%.
2.
Wffi•!ii0ii
9-- acoupin Minjng Inc. must purchase a new coring machine that costs $60,000 and will last 15 years wi th a saJvage value of
3 $12,000. The annuaJ operating expenses will be $9000 the first year, increasing by $200 each year thereafter. T he annual income is
$15,000 per year. If Macoupin 's ARR is 8%, dete1mine the net futu11e wmth of the machine purchase.
WM•!iiM§i
9-- Zap Bug Killers, Inc. 11ecently purchased new electricaJ shock equipment. The equipment cost $16,250 and has a us.eful life of 4
4 years. Each year the equipment will produece income of $5500. The costs to operate the equipment are $500 the first year,
increasing by $250 year thereafter. The equipment should have a salvage value of $800. If ZAP 's ARR is 8%, what is the net
future worth of the equipment? Was the purchase a wise investment?
Wi•1•1d0S1
9-- Salty Nuts, Inc. must buy a new nut-shelUng machine. The industri al engineer has collected the fo]1owing information concemjng
5 the apparent best altemative. CaJculate the net fu ture wmth of the alternative if the ARR is 6%.
First cost $250,000
Armual benefits 73,000 the first year, decr-easi.ng by $1200 each year thereafter
Annual O & M cos.ts 28,000 the first year, increasing by $1600 each year thereafter
Salvage value 42,000
Useful life 6 year.;
9-- An engjneer is considering the purchase of a new set of batteries for an electric pallet jack. Given the cost, annuaJ benefit, useful
G life, and i = 5%, conduct a net future worth anaJysis to decide which aJtemative to pU11Chase .
A B
Cost $19,000 $11,000
Annual bt-nefit 4,000 4,250
Useful life 6 years 3 years
9-- Lucky Luis has just won $20,000 and wants to invest it for 12 years . There are three plans avaHable to him.
7
a. A savings a.ccount that pays 3¾% per year, compounded daily.
b. A money market certificate that pays 6¾% per yea1~ compounded semiannuaJJy.
c. An investment account that, based on past experience, is likely to pay 8½% per year,. compounded annually.
If Luis did not withdraw any interest, how much would be in each of the three investment plan s at the end of 12 years?
Wi11 ••Pi 0S1
9-- The following investment oppmtunities are avaHable. se fu ture worth analysis and a MARR of 6% to determine which, if either,
B al.temative should be selected.
A B
First cost $22,000 $30,000
Annual benefits 6,000 10,000
Annual co:.t 1,000 3,.500
ll..t ii"4l i f ·.i: 1o n.u,ci,d,::u 1.I A nn,n '7 c:;n,n
22 of 48 1/25/2020, 11:08 AM
Midlife overhaul 4,000 7,500
Salvage value 3 ,000 8,000
WMl!ii0ii
BE EFIT/COST RATIO
9- Rash, Riley, Reed, and Rogers Consulting has a contract to design a major highway project that win provide service from Memphis
9 to Tunica, Mississippi. R4 has been requested to provide an esti.mated B/C ratio for the project, summa1ized as foIJows.
lnjtial cos t 25,750,000
Right-of-way maintenance 550,000
Resurfacing (every 8 years) 10% of first cost
Shoulder grading and rework (every 6 years) 1,000,000
Average number of road Uf>ers per year 1,950,000
Average time savings value per road user $2
Detennine the B/C ratio if i = 8%.
9- A proposed bridge on the interstate highway system is being consjdered at the cost of $12 mmion. It is expected that the blidge
10 will last 20 years. Construction costs wm
be pajd by the federal and sta.~e governments. Operation and maintenance costs will be
$180,000 per year. Benefits to the public will be $1, 00,000 per year. The building of the b1idge will result in a cost of $200,000
per year to the general public. The project requires a 6% return . DetermJne the B/C ratio for the project. State any assumptions
made about benefits or costs.
Wi■,i!iihii
9- The town of Podunk is considering building a new downtown parking lot. The fand wiJJ cost $25,000, and the construction cost of
11 the lot wiU be $150,000. Each yea1~ costs associated with the lot will be $17,500. The income from the lot is $18,000 the first year,
increasing by $3500 ,each year for the 12-year expected life of the l.ot. Determine the B/C ratio if Podun k uses a cost of money of
4%.
Wi•ji!iiM§i
9- Ttres-R-Us is conside1i ng the purchase of new tire-balancing equipment. The machine, which will cost $12,699, wm result in
12 annual savings of $1500 with a salvage value at the end of 12 years of $250. For a ARR of 6%, use B/C analysis to detennine
whether the equjpment should be purchased.
Wiij•Qic■ii
9- Dunkin City wants to build a new bypass between two major roads that wiJJ cut travel time for commuters. The road will cost
13 $16,000,000 and save 17,500 people $100/year on gas. The road will need to be res urfaced every year at a cost of $10,000. The
road is to be used for 20 years. Use B/C analysis to determine whether Dunkin City should build the road. T he cost of money is
8%.
PAYBACK PERIOD
9- Por calcuJating payback period, when is the foHowing formula valid?

14
". d First Cost
Payback pen o = - - - - - -
Annua] Benefits
9- Is the following statement true or false?

15 If two investors are considering the same project, the payback period will be longer for the investor with the higher minimum
attractive rate of retum (MARR).
Wi•1i!iiM§i
23 of 48 1/25/2020, 11:08 AM
9- What is the payback period for a project with the following characteristics, given a MARR of 10%?
16
First cos,t $20,000
Animal benefits 8,000
Annual ma.i11temmce 2,000 in Year 1, then increasing b}• $500 per ye11r
Salvage va.lue 2,.000
Useful life 10 years
9- Determine the payback period (to the nearest year) for the foUowi ng project if the MARR is 10%.
17 First cost $10,000
Annual ma.i11tena11ce 500 in Year 1, increasing by $200 per year
Annual income 3,.000
Salvage value 4,000
Useful li fe 10 years
9- Detenn ine the payback period (to the nearest year) for the foUm,dng project
18
Investment cost $22,000
Annual ma.i11tena11ce costs 1,000
Annual benefits 6,000
Overhaul costs 7,000 every 4 years
Salvage value 2 ,500
Useful life 12 years
MARR 10%
9- A cannery is considering different modifications to some of their can filJers in two plants that have substantially differe nt types of
19 equipment These modifications will allow better control and efficiency of the lines. The requked investments a.mount to $135,000
in PfantA and $2 12,000 for Plant B. The expected benefits (which depend on the number and types of cans to be filled each year)
are as follows.
Plant A Plant B
Year
Benefi ts Benefits
1 $ 73,.000 $52,000
2 73,000 85,000
3 80,000 135,000
4 80,000 135,000
5 80,000 135,000
a. Assuming that MARR= 10%, whkh alternative is should be c.hosen?

b. Which alternative should be chosen based on payback period?
Wffi•!iiM§i
9- In this problem the minimum attractive rate of return is 10%. Three proposals are being considered.
2.0
Proposal A ProposalB Proposal C
A = $1000 A = $1000 A = $1000
ll J_LJ
E l
$1 700
lo 1 2 3 0 2 3 4 5 6
$2100
$3750
24 of 48 1/25/2020, 11:08 AM
a. Whic-h proposal would you choos,e using future value analysis?

b. How many years fo r payback fo r each alternative?
BREAKEVEN
9- A road can be paved with either asphalt or concrete. C-0nc:rete costs $20,000/miJe and lasts for 20 years. What is the maximum that
21 should be spent on aspha]t, whi.ch lasts only 10 years? The annual maintenance costs a.re $500/mile for both pavements. The cost
of money = 8 %.
►i-,•GiM§i
9- What is the minimum acceptable annual income from a project that has a $70,000 investment cost and a $14,000 salvage value if
2.2 the life is 15 yea.rs and the mini.mum attractive rate of return (MARR) is 9%?
9- Junker Rental Car has a contract with a garage for major repair service for $450 per car, every 6 months. Management estimates
23 that for $350,000, the company could have its own faciHty, financed at 8% interest for 20 years, and a salvage vaJue of $20,000.
They will do their own car repairs at a cost of $200 per ca1~ every 6 months. Ignoring taxes and other economic facto rs, what is the
m inimum number of cars needed to make the change feasible?
9- The annual income from an apartment house is $33,.600. The annual expense is estimated to be $8000. If the apartment house can
2.4 be bought today for $349,000, what is the breakeven resale pd ce in 10 years wi th a 6% interest rate?
►i• 1 ••,im,! 1
9- A mach ine, costing $16,000 to buy and $1200 per year to operate, wiJJ produce savings of $2500 per yea.r for 8 years . If the
25 interest rate is 8%, what is the minimum salvage value that would ma.ke the machine an attractive investment?
►W•GiM\!i
9- ABC Manufacturing has a ARR of 12% on new investments. What unifonn annual benefit would Investment B have to generate
2.6 to make it preferable to Investment A?
Year Investment A Investment B
0 -.$60,000 -.$45,000
1-6 +1s,ooo ?
9- Over the next 6 years investment in a crane is expected to produce profit from its rental as shown. Assume that the salvage va.Jue
2.7 is zero. Assuming 12% interest, what is the breakeven cost of the crane?
YeaJ Profit
1 $15,000
2 12,500
3 10,000
4 7,500
5 5,000
6 2,500
4W•Gi0ii
9- A proposed buildjng may be roofed in either composition roofing (C) or galvan ized steel sheet (S). The composition roof costs
2.8 $56,000 and is replaced every 5 years (assume at the same cost). The steel roof costs $68,000 but the useful life is very long.
either roof has any salvage value, nor is maintenance needed. If the ARR is 10%, what minimum life must the steel roof have
to make it the better a.ltemative? (Report to the nearest who.le year; don't bother inte·rpolating.)
9- What is th,e brea1 even cost for Project B if in terest equals 10%?
2.9 Year A B
0 -10,000 ?
1_,; +~ <;fl() +? Mn
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1 •-S 1 +3,soo 1+2,soo 1
►M•Git•ii
9- The PARC Company can purchase gizmos to be used in building whatsits for $90 each. PARC can manufacture their own gizmos
30 for $7000 per year overhead cost plus $25 dkect cost for each gizmo, provided they purchase a gizrno maker for $100,000. PARC
,e xpects to use g,izmos for 10 years . The gizmo maker shouJd have a saJvage value of $20,000 after 10 years. PARC uses 12% as its
minimum attractive rate of return. At what annuaJ production rate N should PARC make its own gizrnos?
►i•1 •Gi 0ii

9- Oliver Douglas decides to install a fuel :storage system for his fa1m tha t wilJ save rum an estimated 6.5 cent:s/gaUon on his fuel cost.
31 Initial cost of the sys~em is $10,.000, and the annuaJ maintenance is $25 the first year, increasing by $25 each year thereafter. After
a period of 10 years the estimated saJvage is $3000. If m oney is worth 12%, what is the breakeven quan tity o f fuel?
►i•jiid 0 R•
9- Given the foJJowing:
32 AWA= -23,000(A/P, 10%, 10) 4000(A/F, 10%, 10)- 3000- 3X
AWB = -8000(A/P, 10%, 4)-2000-GX
Por these t\<,'O AW relations, find the breakeven poin t X in miles per year.
9- To produce an item in-house, equipment costing $250,000 must be purchased. It will have a life of 4 years and an annual cost of
33 $80,000; each unit wm cos t $40 to manufacture. Buying the item externally will cost $100 per unit. At i = 12%, determine the
breakeven production number.
►-W•Git•ii
9- Data for two d riJJ presses under consideration are listed. Assuming an interest rate o f 12%, what salvage value of Press B will
34 make the two altematives equal?
A B
First cost $30,000 $36,000
Annual ma.i11tena,11ce 1,500 2,000
Salvage value 5,000 ?
9- A fmit processing company is considering the pu11Chase of new equipment. The data are as follows.
3,5
First cost $78,750
Annual income $25/ton of processed fruit
Annual operating costs $5500 the first year, increasing $800 each year thereafte r
Annual property taxes 8% of first cost
Annual insurance 4% of first cost, payable at the beginning of each year
Salvage value 15% of first cost+ $1000
Useful Ufe 10 years
The MARR is 4%. Determine the number of tons of fruit that must be proC'essed annually to justify purchasing the m achine.
►i■i•Gi 0ii
9- The state Department of Highways is n-ying to decide whether it should "hot-patch" a short stretch of an existing highway or
3G resurface it. If the hot-patch method is chosen, approximately 300 cubic meters of material would be required at a cost of
$600/cubic meter (in place). The shoulders would have to be improved at the same time, at a cost of $24,000. These shoulder
jrnprovements must be redone every 2 years (assume the same cost). The annual cost of routine maintenance on the patched road is
estimated to be $5000. Alternatively,. the state can resmface the road . This :su rface win last 10 years if maintained prop erly at a cost
of $2000 per year. The shoulders would re;quire reworking at th e end of the fifth year at a cost of $5000. Regardless of the method
selected, the road will be completely rebuilt in 10 years. At an interest rate of 8%, wha t is the maximum amount that shouJd be
paid for resurfacing the road?
►i•1 •Git•ii
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PROBLEMS
Key to icons: C, = click to reveal answer; CD = Green, which may include environmental ethics; CJ = Ethics other than
green; = autograded problems that are available online in Dashboard; = The icon indicates that a spreadsheet is
recommended.
Future Worth
9- Pick a discretionary expense that you incur on a regular basis, such as buying premium coffees daily, b uying fas hion .items
1 monthJy, buyin g sports tickets monthly, or going to movies weekly. Assume that you ins~ead place the money in an investment
account that earns 6% annually. After 40 y,ears, how much is in the account?
9- Sally de-posi ~ed $250 a month in her savings account for 36 months. For the next 6 years she made no deposits. What is the future
•
2 worth in Sally's savings accoum at the end of the 9 years, if the account eamed 2% annual in terest, compounded monthly?
9- A new engineer is conside-ring investing in an individual ret i.rement account (IRA) with a mutua.l fund tha t has an average annual
3 return of 8%. What is the fu ture worth of her IRA at age 70 if she makes annual inve•s tments of .$2000 into the fund begin ning Oil
her 22 nd birthday? Assume that the fund continues to earn an annual return o f 8% .
9- You can buy a piece o f vacant land for $40,000 cash . You plan to hold it for 20 years and then sell it at a profi t. Dwing thjs period,
4 you wouJd pay annual property taxes of .$815. You would have no income from the property.
I (a) Assuming that you want an 8% rate of retum ,. at what net price wouJd you have to sell tlle land 20 years hence?
C9 (b) What is op.en span• conservation and why is it important? What options would you have in selling your property wi th this in
mind?
9- Compute the future wo rth for the fo11owing cash flows .
5
800
725
iT
0 - -1- -2- -3- -4- -5
i=8%
1 1
9- An ind.ividuaJ who makes $32,000 per y ear anticipates reti1ing in 30 years. ]f his salary is increased by .$600 each year and he
•
6 deposits 10% of his yearly salary into a fund that earns 7% in terest, w hat is the future· worth at retirement?
9- Por the foUowi.ng cash flows, com pute the future worth.
7
4x
3x
2x
1 1 t
0----1- -2- -3- -4
X
~
i = 10%
9- The in terest rate is 6% per y ear and there are 24 compounding periods per yea r. The principal is $30,000. What is the fu ture worth
•
8 in 4 years?
9- A company deposits $10,000 in a ban k at the beginnjng of each year for 20 years. The account earns 4% jnterest, com pounded
9 every 6 months. Wha t is in the account at the end of 20 y ears?
9- In the early 1980s, planners were exam ining alternate sites for a new London airport. Al one p otential site, the n ..e!fth-century
10 orman church of St. Mic.hae]s, in the vil1age of Stewkley, would have had to be dem olfr,hed. The planners used the value of the
I fire insurance policy 0 11 th,e church-a few thousand pounds sterJing-as the church's value.
An outraged antiquarian wrote to the London Times that an equally plausjble computation wou ld be to assume that the original
cost o f the church (estimated at 150 pounds sterling) be increased at the rate of 8% p er year for 750 years. Based Oil his p roposal,
11 ... rh ... r h 1.n·11I .-I !h.n th n f -ut-11 r.n 1-4 r,.,,rth n'f. 'Ct l\A;,...h ., n l o:-? ( ATro_f..-. • T lhnrn h 7"\,r, n '...,n"'\t" nu:hlli;I"" ,l"\.' h ;n,,..,r;,.n.,,., t"n t,.._..,,..;n.-,· ..-:l n.11 ... , n 't~ n rh H ,..,,..,h ..,, T'H -1 1t 11 .a.1,,r-,
27 of 48 1/25/2020, 11:08 AM
L Printed by: [email protected]. Printing is for personal, private use only. No part of this book
what would be the future worth of St. Mi chaels? (Note: There was great pub]ic objection to tearing down the church, and it was
J
spared.)
9- If you invested $5000 in a 24-month bank certificate of deposit (CD) payin g 3%, compounded monthly, what is the future worth
11 of the CD when it matures?
9- Pora 12% interest rate, compute the val ue of F so the following cash flows have a fu ture worth of 0.
•
12
S.00
650
t 1
0- -1- - - - - 3 - - -4- -:'i
1L j
F
9- CaJculate the present worth and the future worth of a series of 15 annual cash flows with the first cash flow equal to $15,000 and
13 each successive cash flow increasin g by $ 750 . The interest rate is 6%.
9- A 20-year-old student ded ded to set asi.de $100 on his 21st bi:rtilday for investment. E:ach subsequent year through his 55th
14 birthday, he plans to increase the investment on a $100 arithmetic g radient. He wiJJ not set as.ide additional money after his 55 th
0 bi.rthday. If the student can achieve an 8% rate of return, what is th e future worth of th.e investments on his 65 th bi.rthday?
9- For the foUowing cash flows, compute the future worth.
15
600 600 600 600 600 600
50 0
O-
rt
1
l-
200
2-
Tl' I
3- 4- 5- 6- 7- 8- 9- lO- ll
i = l0%
9- Stamp collecting has become an increasingly and popular hobby, and stamps have been a good place to invest money over the last
16 10 years, as demand has caused resale prices to increase 18% ea.c h year. Suppose a collector purchased $100 worth of stamps 10
O years ago and inc11eased his purchases by $ 50 per year in each subsequent year. After 10 years of stamp collecting, what is the
cur11ent worth of the stamp co.lJection?
9- After receiving an inheritance of $50,000 on her 21 st birthday, Katlyn deposited the inhe1itance in a savings account with an
17 effective annual imerest rate of 3%. he dedded to make regular deposits, beginning with $1000 on her 22nd bi.rthday and
increasing by $200 each year (i.e., $1200 on her 23 rd birthday, $1400 on her 24di birthday, etc.). What was the fu ture worth of
Katlyn 's deposits after her deposit on her 66di birthday?
9- Bill made a budget and planned to deposit $350 a month in a savings account, beginning September 1. He did this, but on the
18 following January 1, he reduced the month]y deposits to $100. He made 20 deposits, 5 at $350 and 15 at $150. If the savings
O account paid 3% interest, compounded monthly, what was the fu ture worth of his savings immediately after the last deposit?
9- Compute F so the following cas.h flows have a future worth of 0.
19
500 500 :'iOO
t
0- -1- -2- -3- -4- -5- -6
t t
i = 12% t
500
t
500
+
F
9- A family starts an education fund for their son Patrick when he is 8 yea.rs old, investing $500 on his eighth birthday, and inneasing
20 the yearly in vestmen t by$ 00 per year until Patrick is 21 years old. The fund pays 6% annual in terest. What is the fund's fu ture
O worth after the deposit when Patrick is 21?
9- IPS Corp. will upgrade its pa ckage-labeling machinery. ]t costs $8 50,000 to buy the machinery and have it instaUed. Operation
21 and maintenance costs, which are $11,000 per year for the first 3 years, increase by $1000 per year for the machine 's 10-year life.
28 of 48 1/25/2020, 11:08 AM
The machi nery has a salvage value of 12% of its initial cost. Interest is 25%. What is the fu ture worth of cost of the machinery?
9- A bank account pays 3% interest with monthly compounding. A series of deposits started with a deposit of $5000 on January J. ,
2.2 2007. Deposits in the series were to occur ,each 6 months. Each dep osit in the series is for $150 less than the one before it. The Jast
fD deposit in the series will be due on July 1, 2021. What is the future worth of the acco unt on July 1, 2024, if the balance was zero
before the first deposit and no withdrawals are made?
9- Jamal Brown is a 55-year-old engineer. Accordi ng to mortality tab]es, a male at age 55 has an average life expectancy of 21 more
2.3 years. Jamael has accumulated $200,000 toward his reti11ement. He is now adding $10,000 per year to his reti.rement fund. The
fund ea.ms 5% interest. Jamal will retire when he can obtain an annual income from his reti.rement fund of $100,000, assuming he
Hves to age 76. He will make no provision for a retirement income after age 76. \,Vhat is the youngest age at whkh Jamal can
red.re?
9- An engineering graduate starts a new job at $68,000 per y,ear. Her investments are deposited at the end of the yea.r into a mutual
2.4 fund that earns a nominal interest m~e of 5% per year with quarterly compounding. How much money will be in the account
fD immediately after she makes the Jast deposit?
(a) She makes $4000 annual deposits for the next 40 years .
(b) She makes the $4000 deposits for 10 years, then stops all investments for the next 10 years, and then resumes deposits of
$6000 per year for the next 20 years.
Contribilted by Gillian Nicholls, Southeast Missouri State University
9- A company is considering buying a new bottle-capping machine. The initia.l cost of the machine is $1.2M and it has a 10-year life.
2.5 ontl'lly maintenance costs are expe,cted to be $2000 per month for the first 7 years and $2500 per mo nth for th,e remaining years.
(D The machine requires a major overhaul costing $100,000 at the end of the fifth year of service. Assume that al] these costs occur at
the end of the appropriate period.
(a) What is the fu ture value of all the costs of own ing and operating this machine if the nominaJ interest rate is 9% compounded
monthly?
(b) Bottle caps a.re in the top 10 items found in beach cleanups. What are other items on such Hsts, and what are beach ci ties
do ing to reduce thfa debris?
9- The Association of Genera] Contractors (AGC) is endowing a fund of $1.5 rnimon for the Construction Enginee.ring Technology
2.6 Program at Gramb]jng State University. The AGC established an escrow account in which 15 equal end-of-year deposits that earn
I 8% compound interest were to be made. After seven deposits, th e Loujsiana legislature revised laws relating to the licensing fees
AGC can charge its members, and there was no deposit at the end of Year 9. What must the amount of the remaining equa:I end-of-
year deposits be, to ensure that the $1.5 mill.ion is available on schedule fo r the Construction Engine,ering J:echnology Program?
9- A recent college grnduate got a good job and began a savings account. He authorized the bank to autornaticaUy transfer $500 each
2.7 month from his checking account to the savings account. The bank made the first withdrawal on July 1, 2015, and is instructed to
make the last withdrawal on January 1, 2040. The bank pays a nominal interest rate of 6% and compounds t,.,rice a month. What is
the future worth of th e account on January 1, 2040?
9- A business executive is offered a management job at Generous Electric Company, which offers him a 5-year contract that calJs for
2.8 a sa.lary of $62,000 per year, plus 600 shares of GE stock at the end of the 5 years. Thjs executive is currently employed by
fD Pearless Bus Company, which a.lso has offered him a 5-year contract. It caJJs for a salary of $65,000, plus 100 shares of fearless
stock each year. The Fearless stock is rnnsently worth $60 per share and pays an annual dividend of $2 per share. Assume end-of-
year payments of salary and stock. Stock dividends begin one year after the stock is received.. The executive believes that the value
of the stock and the dividend wiU 1semain co nstant. If the executive considers 9% a suitable rate of return in this situation, what
must the Generous Et,ecuic stock be worth per sha1se to make the two offers equal.ly attractive? ' se the futmse worth analysis
method in your rnmpa1ison.
9- Jean invests $1000 in Year 1 in a socially responsible fund, and doubles the amount each year after that (so the investment is
2'9 $1000, 2000, . . . ).
G (a) If she do1:!s thjs for 10 years, and the investment pays 4% annual interest, what is the future worth of her investment?
(b) What arse sodaHy/ethkaJJy responsible investment funds? How do they differ from other types of investments? Why do
people invest in them?
Benefit-Cost Ratio
9- Each of the th1se,e mutually exclus ive alternatives shown has a 5-year useful lif,e. If the MARR is 10%, which alternative should be
•
30 selected? Solve· the problem by benefit-cost ratio analysis .
A B C
Cost $600.0 $500.0 $200.0
Uniform annual benefit 158.3 138.7 58.3
29 of 48 1/25/2020, 11:08 AM
9-- Consider three mutually exclusive altematives, each with a 15-year useful life. If the MARR is 12%, which aJternative should be
31 selected? Solve the problem by benefit-cost ratio analysis.
Icost
A B C
Uniform annual benefit 130 60 35
9-- An investor is considering buying some land for $100,000 and constructing an office building on it. Three different buildings are
•
32 being analyzed.
Building Height
2 Stories 5 Stories 10 Stories
Cost of budding (excluding cost of land} $500,000 $900,000 $2,200,000
ResaJe value'+' of land + buj]ding after 20-yea.r horizon 200,000 300,000 350,000
Annual net rental income 70,000 110,000 215,000
* Resale value considered a reduction in cost- not a benefit.
Using benefit-cost ratio ana]ysis and a 7% MARR, determine which aJternative, if any, should be selected.
9-- Using benefit-cos t ratio analysis, determine which one of the three mutually exclusive alternatives shoo.Id be selected. Each
33 altemative has a 10-year usefuJ life. Assume a 20% MARR.
A B C
First cost $560 $340 $120
Uniform annu.al benefit 140 100 40
Salvage value 40 0 0
9-- A government agency is planning a new office building close to its cmTent headqua.rters. Four proposed sites are to be evaluated.
34 Any of these sites will save the agency $650,000 per year, since two of its current sateUite offices wrn no longer need to be f\ented.
G The agency uses a 6% intef\est rate and assumes that the building and its benefits will fast for 25 years. Based on a benefit-cost
analysis what should the agency do?
Site
A B C
Initial cost $7.1 $6.5M $7.5
Annual O&M 0.09M 0.125M 0.12
Contributed by Hamed Kashani, Saei d Sadri, and Baabak Ashuri, Georgia Institute of Technolo9Y
9-- Using benefit-cost ratio analysis, a 10-year useful Jife, and a 25% ARR, determine which of the folJowing mutually exclusive
35 altematives should be selected.
A B C D E
Cost $100 $200 $300 $400 $500
Annual benefit 37 60 83 137 150
9- Pive mutuaJJy exclusive investment alternatives have been proposed. Based on benefit-cost ratio analysis, and a MARR of 15%,
•
36 which alternative should be selected?
Year A B C D E
0 -$200 -$100 -$125 -$150 -$225
1-5 68 25 42 52 68
9-- Three mutuaUy exclusive projects are being considered by Sesame Street Productions (SSP). SSP uses a ARR of 8%. SSP has
J.7 hi>;irrl ;ihrmt vnm· 1>YN>ll 1:int ;m ::i lv,;k dd l k ::m rl w;i n~<: vm1 tn h1>ln th1>m m;i k1> ;i rl1>ridnn Tkine, ::i R IC ::in;ilvd<: whirh nrni1>t"t rln vn11
30 of 48 1/25/2020, 11:08 AM
37 heard about your excellent analysis skills and wants you to hel p them make a decision. Using a B/C analysis, which project do you
recommend to SSP? Assume all benefits and costs repeat for Project A.
Project A ProjectB Project C

Initial cost $300 $450 $765
Annual benefits $200 $190 $300
Project A Project B Project C
Project life (years) 2 4 4
B/C ratio 1.19 1.40 1.30
Contributed by Gana Natarajan, Oregon State University

9- Bums City m ay build a garbage indnerator on the outskirts of town. EnvironmentaJ impact statements and safety
38 planning/inspection wiJJ cost $21,000 (payable at start of consu-uction). The annual upkeep and operating costs a11e expected to be
I $34,000. The new incinerator will save $14 each annually for 24,000 billed customers. Consultants have estima~ed an annual
(D disbene.fit to the sunounding area of $36,500. At the ,end of a 10-year usefuJ life the incinerator will be dismantled at a cost of
$50,000. sing benefit-cost ratio analysis and assuming a cost of money of 5% what is the maximum that Burns City can pay to
build the incinerator? Contributed by Ed Wheeler; University of Tennessee, Marrin
9- Looking at Figure 9-1 another way to pick the best mutually exclusive alternative is to maximize the perpendicular distance from
39 the alternative's point to the B/C = 1. Explain why th.is is true. Contributed by Hector Medina, Liberty University
9- ComeJJ has two options for upgrading their athletic faciU ties. The off-campus option costs only $2.5 million, but it wm require
40 frequent bus service to those facilities at an annua.1 rnst that starts at $200,000 and increases by 5% per yea.r (buses, drivers' and
I mechanics' salaries, m ajntenance, road wear, etc.). Improving the on-campus facilities will cost $5.0 million, but no extra
n·ansportation costs are required. Both options involve an estimated annual maintenance cost of $1 mJrnon for about 30 years
before new facilities will again be needed. Using benefit-cost ratio analysis, determine which option is more economically
•efficient Use an interest rate of 10% per year. Contributed by D. P. Loucks, Cornell Universily
9- A do-nothing and twu mutually exclusive a.ltematives a11e being considered for reducing traffic congestion. User benefits come
41 from reduced congestion once the proj ect is complete, while user djsbenefits are due to increased congestion during construction.
The interest rate is 8%, and the life of each aJtemative is 15 yea.rs. Which aJtemative should be chosen?
Alternative A B
User benefits ($Wyr) 2. 1 2.6
User djsben eflts ($M) 1.2 2.1
First cost ($M) 6.9 9.9
Operations and maintenance ($M/yr) 0.75 0.825
{a) Use the benefit--cost ratio.
(b) Use the modified benefit-cost ratio .
(c) Use the public/government version of the B/C ratio.
(d) Assume these numbers app]y to a private firm and use a present worth index .
(e) Are your recommendations for (a) through (d) consistent? Which measure gives the largest value? Why?
9- A school is overcrowded and there are th.ree options. The do-nothing aJ terrn1tive cor11esponds to continuing to u:se modular
4.2 classrooms. The school can be expanded, or a new school can be buiJt to "split the load" between the schools . User benefits come
(9 fro m improvements in school performance for th.e expan ded or new schools. If a new school is built, there a.re more benefits
because more students will be able to walk to school, th.e average distance for those who ride the school buses will be shorter, and
the schools will be smaller and more "student fiie ndly." The disbenefits for th,e expanded school are due to the impact of the
construction process dmi ng the school year. The interest rate is 8%,. and the Life of each alternative is 20 years. Which alternative
should be chosen? What is the incremental ratio or the prefened alternative?
(a) Use the bene.fit--cost ratio.
(b) Use the modified benefit-cost ratio ,
(c) Use the public/government version of the B/C ratio.
(d) Assume these numbers apply to a private firm and use a present worth index.
(e) Are your-recommendations for(a) through (d) consistent? Which measure gives the largest value? Why?
({) Describe the ethica.1 issues involved in the overcrowded schoo]s di]emrna in terms of stakeho]ders and impacts.
Payback Period and Exact Methods

9- A project has the following costs and benefits. What is the payback period?
31 of 48 1/25/2020, 11:08 AM
::,- J-\ JJ!Ujt!LL lld:S lilt!' lUllUWJ.llg l.:U~~S d llU Ut!lll!UL!>. V\' ll dl lS Ult! piiJUdl.:K [J1!!1UU f
43
Year Costs Benefits
0 $65,000
1-2 15,000
3 5,000 $50,000
Year Costs Benefits
4-10 $10,000 in each year
9- Able Plastics, an injection-molding film, has negotiated a contract with a national chain of department stores. Plastic pencil boxes
44 are to be produced for a 2-year period. If the firm invests $62,000 for special remova] equipment to unload the completed pencil
O boxes from the molding machine, one machjne operator can be eliminated saving $32,000 per year. The 11emoval equ1pment has no
salvage va]ue and is not expected to be used after the 2-year production contract is completed. The eq uipment would be
se1vicea ble for about 15 years. What is the payback period? Should Abl.e Plastics buy the removal equipment?
9- A car dealer leases a small computer with software for $5000 per year. As an alternative he could buy the computer for $7500 and
45 lease the softwa11e for $3500 per year. Any time he would dedde to switch to some other computer system he could cancel the
software lease and seU the computer for $500.
(a) If he buys the computer and leases the software, what is the payback period?
(b) If he kept the computer and software for 8 years, what would be the benefit-cost ratio, based on a 5% interest rate?
9- Tom Sewel has gathered data, on the relative costs of a so]ar water heater system and a conventional electri,c water heater. The data
•
46 a11e based on statistics for a mid-American city and assume that during cloudy days an electrk heating element in the solar heating
system wrn provide the necessary heat.
The .instal.led cost of a conventional e]ectJic water tank and heater is $850. A fam ily of four uses an average of 300 liters of hot
CD water a day,, which takes $280 of eJectricity per year. The glass-lined tank has a 20-year guarantee. This is probably a reasonable
estimate of its actual useful Life.
The in stalled cost of two solar panels, a small electric pump, and a storage tank with auxUiary electric heating element is $2200. ]t
will cost $85 a year for electricity to run the pump and heat water on cJoudy days. The solar system will requke $225 of
maintenance work every 5 years. Neither the conventiona.l elecuic water heater nor the solar water heater will .have any salvage
value at the end of its useful life.
Using Tom 's data, what is the payback period if the solar water heater system is installed, rather than the conventional electric
water heater?
9- A cannery .is considering installing an automatic case-sealing machine to replace current hand methods. If they pul'Chase the
47 machine for $5000 in June, at the beginning of the canning season, they wilJ save $500 per month for the 4 months each year that
the plant is in operation. Ma,intenance costs of the case-sealing machine are expected to be negligible. The case~sealing machine is
expected to be useful for five annual canning seasons and then wilJ have no salvage value. What is the payback period? What is
the nominal annual rate of retu.m?
9- A large project requires an investment of $210 miUion . The construction wiU take 3 years: $55 mimon will be spent during the
48 first yea1~ $85 million dming the second year, and $70 mi llion during the thiro year of construction. Two project operation periods
O are being considered: 10 years with the expected net profit of $50 million per year and 20 years with the expected net profit of $35
mil.lion per year. For simplicity of cal.culations it is assumed that all cash flows occur at end of year. The company minimum
required return on investment is 15% .Calculate for each alternative:
(a) The payback period
(b) The total equivalent investment cost at the end of the construction period
(c) The equiva,lent uniform annual worth of the project (use the operation period of each alternative)
Which operation period should be chosen?
9- Two alternatives with ,identical benefits are being considered:
49
A B
Initial cost $500 $800
Uniform annual cost 200 150
Useful life, in years 8 8
(a) Compute the payback period if Alt.Bis purchased ra.ther than Alt A.
(b) Use a MARR of 10% and benefit-cost ratio analysis to identify the alternative that should be selected.
9- Consider four mutually exclusive altema.tives:
50
ffi I Al n l c l n
32 of 48 1/25/2020, 11:08 AM
,... UO' ~ i,
Cost $65 $55 $25 $80

Uniform annual benefit 16.3 15.1 5.2 21.3
Each alternative has a 6-year useful life and no salvage va.lue. The MARR is 9%. \,',fhich alternative shouJd be selected, based on
(a) The payback period
(b) Future worth anaJysis

(c) Benefit-cost ratio analysis
9- Consider three alternatives:
51
A B C
First cost $50 $150 $110
Uniform annual benefit 30 45 45
Useful life, in years* 3 9 6
* At the end of its useful life, illl identica.l alternative (with the same cost, ben.efits, and useful life) may be installed.
All the alternatives have no saJvage value. If the MARR is 10%, which alternative should be selected?
(a) Solve the problem by payback period .
(b) Solve the problem by future worth analysis.
(c) Solve the problem by benefit-cost ratio analysis.
(d) If the answers in parts (a), (b), and (c) differ, explain why th.is is the case.
9- Consider three mutually exclusive al ternatives. The MARR is 10%.
52
y z
0 Year X
- $125 -$60 -$65
0
1 40 15 20
2 40 15 20
3 40 15 20
4 40 15 20
(a) For Alt X, compute the benefit-cost ratio.

(b) Based on the payback period, which alternative should be selected?
(c) Determine the prefe1Ted alternative based on an exact economic ana.lysis method.
9- You are an investor who wants to make your investment back as quickly as possibJe. There are four potential projects that you can
53 invest in. Which project should you choose?
Project 1 Project 2 Project 3 Project4

Initial Cost $50,000 $60,000 $65,000 $125,000
Annual Revenues 8500 12,500 8,500 18,000
Length of Owne.rship 6 4 9 10
Contributed .by Gana Natarajan, Oregon State University

9- Three mutually exclusive alternatives are being cons.idered:
54
0 A B C
Initial cost $750 $485 $350
Benefi t at end of the first year 250 200 185
Uniform benefit at end of subsequent years 160 112 83
Useful life, in years 6 5 4
At the end of its useful life, an aJtemative is not replaced. If the MARR is 10%, which alternative should be sel.ected
(a) Based on the payback period?
(b) Based on benefit-cost ratio analysis?
33 of 48 1/25/2020, 11:08 AM
\U) Ud~t:!U U lJ lJ~Ht:!ll l-t..U~ l I dUU d lJd!LJ~L:l:
9--
55 Year E F G H
0 -$90 -$110 -$100 -$120
1 20 35 0 0
2 20 35 10 0
Year E F G H
3 20 35 20 0
4 20 35 30 0
5 20 0 40 0
6 20 0 50 180
(a) Based on the payback period, which alternative is prefened?

(b) Based on future worth analysis, which of the four alternatives is prefen"ed at 5% interest?
(c) Based on future worth analysis, which alternative is prefen"ed at 20% interest?
(d) At 10% inte11est, what is the benefit-cost ratio for Alt. G?
9-- A new piece of laboratory equipment costing $10,000 promises to save $4000 per year in materials and overtime pay. H the cost of
56 money is 12% and projects must have a 3-year discounted paybac k period, should the eq uipment be purchased?
9-- A new high~effidency motor is being conside11ed for a large compressor. The new motor will cost $20,000 but will save $8000 per
57 year in electricity. If the £inn 's MARR is 15%, what is the discounted payback period?
CD
9-- Two alternative pumps are being compa1"ed. Pump A costs $5200, will save $1275 per year in operating and maintenance
58 expenses, and is expected to last for 6 years. Pump B costs $6000, will save $1550 per year, and is also expected to last for 6
years. If the cost of capital is 12%,. which has the better discounted payback period?
9-- Two equipment investments a.re estimated as follows:
59
Year A B
0 -$15,000 -$18,000
1 5,000 6,500
2 5,000 6,500
3 5,000 6,500
4 5,000 6,500
5 5,000 6,500
Whkh investment has the better discounted payback period if i = 14%?
Sensitivity
9-- If the MARR is 12%, compute the va.lue of X that makes the tv.ro alternatives equally desirable.
•
GO
A B
Cost $800 $1000
Uniform anm1al benefit 230 230
Useful life, in years 5 X
9-- Analyze Problem 9-60 again with the followi ng changes:

GI (a) What if B's firs t cost is $1200?
CD (b) What if B's annual benefit is $280?
(c) What if the ARR is 10% annually?
(d) What if (a), (b), and (c) happen simultaneously?
9-- Consider two alternatives:
62
•
34 of 48
A R
1/25/2020, 11:08 AM
A B
Cost $650 $425
Uniform annual benefit 95 95
Useful life, in years Infinjty X
Assume that Alt B is not replaced at the end of its useful life. H the ARR is 10%, what must be the us,eful life of B to make
Alternatives A and B equal.ly desirable?
9-- If the MARR is 5%, compu~e the va]ue of X that makes the two alternatives equa.lJy desjra ble.
63
A B
Cost $150 $X
Uniform annual benefit 40 65
Salvage value 100 200
Useful life, in years 6 6
9- Ithaca is considering a new $45,000 snowp low that wiH save the d ty $400 per day of use compared to the existing one. It should
G4 last 12 years and have a resale value of $2500.
0 (a) To obtain a 14% rate of return what is the minjmum number of days per year on average It wiU have to be used.
C9 (b) Research the environ mental impact of road salt What are other options?
Contributed by D. P. Loucks, Cornell University
9-- Victoria is choosing between a standard Honda Civic for $20,000 or a hybrid Civic for $25,000, She calculates her annual cost of
G5 ownership including payments but not including gasoline to be $5000 for the standard and $5800 for th.e hybrid. The standard
Civic will cost Victoria 18/mile for gasoline, while the hybrid wiJI cost her only 12/miJe. How many miles must Victoria drive in a
year before the hybrid vehide becomes more cost efficient to her?
Contributed by Paul R. McCright, University of South Florida
9- jdwest Airlines flies a short nonstop with 148-passenger planes. Considering al.I the costs of owrung each plane p]us the salari.e s
66 fo r their crews and th,e fuel costs and landing fees, the fixed cost for a single flight is $16,500. lf the costs associated with each
O passenger (reservations cost, check-in cost, baggage handling cost, snack cost, etc.) totaJ $75 pe.r passenger and the average ticket
price is $214 (before the va1ious taxes are added), what percentage of seats must be filled for the flig)1t to break even?
9- Pence posts for a particular job cost $18.03 each to install, including the labor cost. They will last 10 years , If the posts are uwted
67 with a woo d preservative, they can be expected to have a 15-year life, Assuming an 8% interest .rate, how much could one afford
to pay for the wood preservativ,e treatment?
9-- A piece of property is purchased for $25,000 and yields a $1500 year1y net profi t The property is sold after 10 years. What is its
•
68 minimum price to break even with in terest at 8%?
C9
9-- AnaJyze Problem 9-68 again with the following changes:
69 (a) What if th.e propeny is purchased for $12,000?
Q {b) What if the yearly net profit is $925?
(c) What if it is sold after 7 years?
(d) What if (a), (b), and (c) happen simultaneously?
9-- idwest Airlines (MWA) is planning to exp and its fleet of jets to replace some old planes and to ,expand its routes. It has recejved
70 a proposal to purchase 112 small jets over the next 4 years . What annual net revenue must each jet produce to break even on its
O operating cost? The analysis shou.ld be done by finding the EUAC fo r the 10-year planned ownership period. MWA has a ARR
of 12%, purchas,es the jet for $22 million, has opera ting and maintenance costs of $3.2 million the first yea1~ increasing 8 % per
yea1~ and performs a major maintenance upgrade costing $4.5M at .end of ~ear 5. Assume the plane has a salvage value at end of
Year 10 of $13 million.
9-- Plan A requires a $30,000 investment now. Plan B requires an $28,700 investment now and an additional $10,000 investment at a
71 later ti.me. At 12% interest, compute the breakeven point for the ti.ming of the $10,000 investment.
9-- A low-carbon-steel machine pa.rt, operating in a corrosive atmosphere, lasts 8 yea.rs and costs $250 instaJled. If th.e part is treated
-
72 fo r conosion resistance, it wil.l cost $325 installed. How long must th,e treated part last to be the preferred altemative, assuming
35 of 48 1/25/2020, 11:08 AM
O 9% interest?
9- Analyze Problem 9-72 again with the followi ng changes:
73 (a) What if the installed cost of the corrosion-treated part is $400?
Q {b) What if the untreated part will last onJy 4 years?
(c) What if the ARR is 12% annually?
{d) What if (a), (b), and (c) happen simultaneously?
9- Tyrella Jackson is buying a used car. Alternative A is an American-built compact. It has an initial cost of 8900 and operating
74 costs of 9c/km, excluding depreciation. Prom resal.e statistics, Tyrella estimates the American car can be resold at the end of 3
O years for $1700. Alternative B is a foreig n-built Fiasco. Its initial cost is $8000, the operating cost, also excluding depreciation, is
8¢/km. How low couJd the resa.le value of the Fiasco be to provide eq ually economical transportation? Assume Tyrella will drive
12,000 km/year and considers 8% as an appropriate interest rate.
9- AnaJyze Problem 9~74 again with the followi ng changes:
75 (a) What if the Fiasco is more reUable than expected, so that its operating cost is $0.075/km?
Q (b) What if TyreUa drives only 9000 km/year?
(c) What if TyreUa's inte~est rate is 6% annually?
{d) What if (a), (b), and (c) happen simultaneously?
9- A car company has decided to spend $140 on a museum for exhibiting its classk cars. Land can be purchased for $650,000. The
76 museum bui.lding wiD require 50,000 squa.re feet of general space, while each car displayed wiJJ req uire an additional 1000 square
O feet. The design and planning process will oost $80,000, which shou]d be paid immediately. The construction of the building will
cost $550 per square foot, and the building win be completed within the next 2 years, whi]e the cost of constructi.on wiU be
disui.buted evenJy between the 2 years of construction. AU cars will be purchased during the second year of construction at an
average cost of $95,000 per car. The annual operation of the museum will cost $1,750,000 plus $25,000 per car. If the funds are
invested at 8% per year and the museum is to exist forever, how many cars can the trustees pu~hase? Contributed by Hamed
Kashani,. Saeid Sadri, and Baabak Ashuri, Georgia Institute of Technology
9- A road can be paved with ejfuer asphalt or concrete. Concrete costs $20,000/krn and lasts 20 years. Assume the annual
77 maintenance costs a:re $700 for concrete and $1000 for asphaJt per kiJorneter per year. Use an interest rate of 5% per year.
C9 Contributed by D. P. Loucks, Camell University
(a) What is the maximum that should be spent for asphalt if it lasts only 10 years?
(.b) Assume the asphalt road costs $8500 per kilometer. How long must it fast to be the preferred alternative?
{c) Resea~h and summa.rize conclusfons of two scholarly artides on the environmental comparison of asphalt versus concrete.
9- Christina Cook studied the situation described in Problem 9-46 and decided that the solar system will not requi.re the $180 of
78 maintenance every 4 years. She believes fu ture replacements of either the conventionaJ electric water heater, or the solar water
O heater system can be made at the same costs and useful lives as the· initial installation. Based 0 11 a 10% interest rate, what must be
the useful life of the solar system to make it no more expe11sjve than the el,ecni.c water heater system?
9- A newspaper is considering buying locked vending machjnes to replace open newspaper racks in the downtown area . The vending
79 machines cost $75 each. It is expected that the annual revenue from semng the same quantity of newspapers will increase $12 per
vending machine. The useful life of the vending machine is unknown .
(a) To determine the sensitivity of rate of return to useful life, prepare a graph for rate of return versus useful life for lives up to
10 years.
(b) If the newspaper requfres a 15% rate of return, what minimum usefuJ life must it obtain from the vending machines?
(c) What would be the rate of return if the vending machines were to Jast indefinitely?
9- Rental equipment is for sale for $110,000. A prospective buyer estimates he would keep the eq uipment for 12 years and spend
80 $6000 a year on maintaining it. Estimated annuaJ net receipts from equipment rentals wouJd be $14,400. It is estimated the rentaJ
O equipment couJd be soJd for $80,000 at the end of 12 years. If the buyer wants a 7% rate of return on his .investment, what is the
maxjmum prke he should pay for the equipment?
9- either of the following machines has any net salvage value.
81
ca Original cost
A B
$55,000 $75,000
Annual expenses
Operation 9,500 7,200
Ma.intenance 5,000 3,000
Taxes and insurance 1,700 2,250
At what useful life are the machines equivalent jf
36 of 48 1/25/2020, 11:08 AM
(a) 10% interest is used in the computations?

(b) 0% interest is used in the computations?
'- Jane Chang is making plans for a summer vacation. She wilJ take $1000 with her in the form of traveler's checks. Prom the
8.2 newspaper, she fin ds that if she purchases the checks by May 31, she will not have to pay a service charge. Th.at is, she will obtain
O $1000 worth of traveler's checks for $1000. But if she waits to buy the checks untiJ just before starting her summer trip, she mus t
pay a 1% service charge. (It will cost her $1010 for $1000 of U"aveler s checks.)
Jane can obtain a 13% interest rate, compounded weekly, on hel' money. How many weeks after May 31 can she begin her trip and
still justify buyin g the traveler's checks on May 31?
'- A motor with a 200-horsepower output is needed in the factory for intermittellt use . A Graybar motor costs $7000 and has an
B3 electrical efficiency of 90%. A Bluebal] motor costs $6000 and has an 85% ,efficiency. Neither motor would have any sa)vage
value, since the cost to remove it would equal its scrnp value. The annual m aintenance cost for either motor is estimated at $500
per yea.r. Electric powe.r costs $0.12/kWh (1 hp = 0.746 kW). lf an 13% interest rate is used in the calcuJations, what is the
minimum number of hours the higher initial cost Graybar motor must be used each year to justify its purchase?
'- A machine costs $5240 and produces benefits of $1000 at the end of each year for 8 years. Assume an annual interest rate of 10%.
84 (a) What is the payback period (in years)?
0 (b) What is the breakeven point (in years)?
(c) Since the answers in (a) and (b) are different, which one is "correct"?
'- The Financial Advisor is a weekly column in the locaJ newspaper. Assume you mus t answer the following question. "I recenUy
8.5 retired at age 65, and I have a tax-free retirement annuity coming due soon. I have th11ee options. I can 11eceive (A) $30,976 now,
(B) $359.60 per month for the rest of my life, or (C) $5 13.80 per month for the next 10 years. What should I do?" 1gnore the
timing of the monthly cash flows and assume that the payments are received at the end of year. Assume the 10-year annuity will
continue to be paid to loved hei.rs if the person dies befOl'e the 10-year period is ove.r.
Contributed .by D. P. Loucks, Cornell University
(a) If .i = 6%, deveJop a choice table for Uves from 5 to 30 years. (You do 11ot know how long this person or other readers may
Uve.)
(b) If .i = 10%, develop a choice table for lives from 5 to 30 years. (You do 11ot know how long this person or other readers may
Hve.)
(c) How does increasing the interest rate change your recommendations?
Minicases
'- A proposed steel m1U may include a rn-generation el ectrical plant. This plant will add $2.3M in first cost with net annual savings
86 of $0.27 considering operating costs and electrical bills. The plant will have a $0.4 salvage value after 25 years. T he firm uses
(D an interest rate of 12% and present worth index (PWI) in its decision making.
The publk utility offers a subsidy for co-generation facilities because it wilJ not have to invest as much in new capadty. This
subsidy is calculated as 20% of the co-generation facility s flrst cost, but it is paid annually. The utility calculates the subsidy using
a benefit---<:ost rntio at 8% and a life of 20 years.
(a) Is the plant econornkally justifiable to the flrm without the subsidy? \\lllat is the PW]?
(b) What is th.e annual subsidy?
(c) Is the plant economically justifiable to the flrm with the subsidy? Now what is the PW]?
(d) How important is the difference in interest rates, and how does it affect these results?
(e) How impmiant is the difference in horizons, and how does it affect these results?
(f) What is th.e ' co" aspect of a co-generation power plant? \.\lhat are the primary benefits of this system, and who accrues those
benefits? Why aren' t all power plants designed in th.is fas hion?
'- Assume a cost improvement project has only a firs t cost of $100,000 and a monthly net savings, M. There is no salvage value.
87 Graph the project's 1RR for payback periods from 6 months to the project' s life of N years. The firm ac,cepts projects wi th a 2-year
payback period or a 20% IRR. When are these standards consistent and when are they not?
(a) Assume th.at N = 3 years.
(b) Assume that N =5 years.
(c) Assume that N = 10 years.
( d) What recommendation do you have for the firm about its proj eel acceptance criteria?
9- The Louisiana Department of Transpmiation and Development {LaD OID) in 2009 approved the feasi bility analysis for upgrading
88 6 miles of US-167 South sta11ing at the intersection with US-80 (California Avenue). An existing two-lane highway between is to
be converted to a four-lane divided freeway. The proposed new freeway is projected to avernge 25,000 vehicles per day over the
next 20 years. Truck vol umes represent 6.25% of the total n·affic. Annual maintenance 0 11 the existing highway is $1875 per lane
mUe. The existin g: acd dent rate is 5.725 per mimon vehicle m iles (MVM). Capital improvement in vestment monev can be secured
37 of 48 1/25/2020, 11:08 AM
L Printed by: [email protected]. Printing is for personal, private use only. No part of this book
may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. __]
mue. 1 ne extsang accmem race 1s :::, ,1 L:J per mmmn vemc1e mues l!Vl v MJ. L.apn.ai 1rnprovemem mvesrmem money can oe securea
at 6.25%. Which alternative is preferred (use benefit/cost ratio analysis)?
Plan 1: Add two adjacent lanes for $562,500 per mi.le. This wil.l reduCce auto travel time by 2.5 minutes and truck travel time
by 1.25 minutes. It will reduce the acddent rate to 3..125 per MVM. Annual majntenance is estimated to be $1560 per lane
mile.
Plan 2: Make grade improvements while adding two adjacent lanes at a cost of $812,500 per mile. This would reduce auto
and truck travel time by 3.75 minutes each. The accident rate is estimated to be 3.10 per MVM. Annual maintenance is
estimated to be $1250 per lane mUe.
Plan 3: Construct a new freeway on new aUgnment at a rost of $1,000,000 per mile. This wou.ld reduce auto travel time by
6.25 minutes and truck travel time by 5 minutes. Plan 3 is 0.5 miles longer than the others. The esti.m ated accident rate is 3.00
per MVM. Annual maintenance is estimated to be $1250 per lane mile. Plan 3 abandons the existing highway with no salvage
value.
Additional data:
Operating cost-autos: 15¢ per mile

Operating cost-trucks: 22.5 ¢ per mile
Time saving-autos: 3.75 per vehide minute
Time saving-trucks: 18.75¢ per vehicle minute
Average accident cost: $1500
Contributed by Benedict Nwokolo, Grambling State University
CASES
The foUowin.g cases from Cases in Eflgineeri.n g E conomy (www.oup.com/us/newnan) are suggested as matched with
this chapter.
Great White Han

CASE 1G
Proposal comparison using B/C analysis for RF'P with unclear speciflcations.
A Free Lunch?
CASE 17
ls proposal too good to be true from two perspectives? Realistic (unordered) statement of facts.
APPENDIX9A
INVESTING FOR RETIREMENT AND OTHER FUTURE NEEDS
Key Words
defined benefilt
defined contribution
risk
volatility
DEFINED CONTRIBUTION AND DEFINED BENEFIT PLANS

Firms and individuals often borrow to buy capital items like buildings/homes, land, and vehicles. The money is needed
now, and often the Hem is some kind of security for the loan. However, pension funds, retirement accounts, college
savings, and down payments are accumulated by saving and investing. Because pensions and retirement have the longest
horiwns, compound interest plays a larger mle than in shorter horizon problems.
Planning for retirement has become even more important to individuals because of a shift in how it is handled. As
recently as 2000, 60% of Fmtune 500 firms offered defined benefit retirement plans~also called pensions. Today it is
estimated thar about 90% offer new employees only defined contribution plans. Many governmental units have also
shifted from traditional pensions to defined contribution plans.
A defined benefit plan is overseen by a firm or a government body for its employees. The employer is responsible for
. , ... . . . ... . . ... . - , .
38 of 48 1/25/2020, 11:08 AM
.I. ,J u ,J .I. .J :I. J I.
managing the fund and ensuring that there is enough money to cover all obligations. In many cases, both the employee
and the employer contribute to the fund. Most payouts involve a fmmula, whereby the employee can calculate his or her
monthly or annual benefit, which continues until death. As an example, E,quation 9A-1 is applied to a 30-year employee
who earned $80,000 yearly in the 3 years before retirement.
Annual benefit = av-erage salary 138n ye.ars x 2 % x yearsernploymeat (9A-1) (9A-1)

= 80,00(} X 2% X 30 = 48,000/yr
The benefit is predictable, and thus makes retirement planning much easier.
With a defined contlibution plan, the employee designates the amount to be directed toward redrement and is
responsible for its management. The employer may match pmt of an employee's contribution, and may offer a limited seI
of fund plans. Based on the choices available, employees seiect how much they deposit annually, for how many years, and
what funds they invest in. Empioyees choose how safely or aggressively the funds are invested. The total in the account is
the defined contribution; that total determines how much can be withdrawn and for how long. Thus, employees must
also choose the withdrawal rate for the funds after they retire. Employees must estimate how long they will live.
Retirement planning has become more d1fficult and more necessary. Social secmi ty provides a safety net. but it is
income replacement only for those who work half-time at the minimum wage. For those retiring in 2016 who contributed
at the maximum taxed level for 35 years, the annual social security benefit is $31,668-rnuch less than engineers typically
eam.
WHAT RETURNS ARE REASONABLE TO EXPECT AND WHAT RISKS

GO WITII THEM
Table 9A- 1 summarizes the pedormance of three types of investments over the last 60 years: the U.S . stock market, U.S.
government bonds with typical maturities of 10 to 30 years, and U.S. treasury bills (T-bills) with typical maturities of 1 to
6 months. Since these are market or nominal values., Table 9A- 1 also indudes the inflation rate (see Chapter 14 for more
information). Over the past 60 years, stocks have returned about 7.3% over inflation, long-term treasury bonds about
2.5% above inflation, and T-bills about 0.8% above inflation. These are real rates of return.
The standard deviation and high and low values show that stocks have higher risks than bonds and much higher risks
than T-bills. The annual returns vary much more for stocks, so stocks have a higher volatility than bonds or T-bills.
Note that the geometric mean is the correct average rather than the arithmetic average. The geometric rate of retum is
the interest rate that would be calculated using the present worth, the future value, and the number of years. It can also be
calculated using Equation 9A- 2.
Geometric 111ean = [ JL=

n
l(1 + r1
] J/11
- 1
(9A-2)
where r; = return in year i
The atithrnetk average of annual returns overstates expected returns (especially over long intetvals with positive and
negative annual values) . A quick example is gaining 50% one year and losing 50% the other year in either order. The
arithmetic average is 0% change. The geometric average using Equation 9A-2 is - 13.4% ( = ✓(0 .5 x 1.5) - 1 . You are
not back where you started, as an arithmetic average of 0% would indicate. Instead, you have lost 25%, as the geomen·ic
average indicates. You have 75% (= 1.5 x 0.5) or(= 0.866 x 0.866) of what you started with. Example 9A-1 is another
illustration of average geomenic and arithmetic retums.
EXAMPLE 9A-1
What is the average monthly return for a firm that had these stock prices?
Date Stock Price

03/01/2018 $14.02
04/02/2018 13.12
05/01/2018 14.05
What is the arithmetic average monthly return? What is the geometric average monthly return? Which correctly
measures average monthly returns? What are the equivalent nominal annual returns?
39 of 48 1/25/2020, 11:08 AM
SOLUTION
(I) The monthly return for March is (13.12 - 14.02)/14.02 = -0.0642
(H) The monthly return for April is (14.05 - 13.12)/13.12 = 0.0709
Ant. h met1c
.
average = _-_0._064
_ 2_ _ __ 0_0033.5 __ _0._33_5o/.
0_._07_09 _o
2 month
(iii)Nominal annual return = 0.335% x 12 = 4.02%
Geometric return = J 1 - 0.0642)(1 + 0.0709) - 1 = 0.00107

= 0.107 · per month
(iv)Nominal annual return = 0.107% x 12 = 1.28%
The geometric average is the correct solution, as detailed by using the initial and final prices in the next solution.
5 BUTTON SOLU TIO
A B C D E F G H I
1 Problem i n PMT PV FV Solve for Answer
2 Exp. 9A-1 2 0 14.02 14.05 RATE 0.107% monthly
3 1.28% nominal
The solution using RATE is the average monthly return, and it is the geometric average.
The presence of a standard deviation demonstrates that returns vary from year to year. On average, the investments in
Table 9A- 1 will increase, but returns may be positive or negative in any given year. All Investments carry 1i sk, and this
risk Is often characterized by the standard deviation. Investments that have a higher 1isk are expected to deliver a higher
return in order to compensate for that risk.
Figure 9A- 1 plots the geomeuic means and standard deviations of the three investment types. The arrows emphasize
that both higher returns and lower risks are prefe1Ted. Thus the best mix of investments depends on how the investor
evaluates the trade-off between tisk and return. Chapter 10 includes more on probahiUties in economic models. Appendix
lOA explains why a combination of stocks and bonds is expected to perform better than either alone; this is also why a
diversified pmtfolio of stocks is expected to perfonn better than one with only a few stocks.
Tull>I~ 9A-l Returns and Standard Deviations for Investments and Inflation
Common Stocks Treasury Bonds Treasury Bills Inflation Rate
Geometric mean 11.0% 6.2% 4.5% 3.7%
Standard deviation 17.5% 10.8% 2.8% 2.9%
aximum 1950-2012 52.6% 40.4% 11.6% 13.3%
jnjmum 1950-2012 -35.5% -12.2% 0.0% -0.5%
12%
I
I ■
I ________ __ _____ 1I
___________ _1_ ________________ :L S tOCk_S
______________ _
10% I I I
I I I
l\•l o:re rehlm : : :
is better : : :
C: 8% ------------t----------------~----------------~---------------
1 I I
3 I I I
~ :I :I Bond:s :I
___________ _,_ _______________ l _ _. _____________ L ______________ _
1l 6% I I I
il Toills :I
~ ■ : I I
~ 4% ----------------t----------------~----------------~---------------
1 I I
I I I
I I I
: Less risk
_______________ _1_ _______________ Isbetter :
1 ________________ L ______________ _
2% I I I
40 of 48 1/25/2020, 11:08 AM
0% + - - - - - - - - - - - - - - - - - t - - - - - - - - - - - - - - - - <
0% 5% !0% 15% 20%
Risk = Standard Devialion of Return
FIG RE 9A-1 Retums and risks for investments.
EXAMPLE 9A-2
An engineer has just finished paying off a student loan and is ready to start saving for retirement. Her current annual
salary is $63,000. She expects salary increases to exceed inflation, but to be safe she wants to assume that salary
increases wm be matched with inflation . She expects to work for another 35 years. If she invests 15% of her salary,
how much can be expected to be in her acmunt if she invests in T-bills, bonds, or stocks?
SOLUTION
The first step is to detetmine the interest rates. Since this problem is in constant-value dollars, like nearly all of the text
(except for bonds) up to Chapter 14, the interest rates are the market rates minus inflation. From the first paragraph of
this section, stocks have returned about 7.3% over inflation, long-term treasury bonds about 2.5% above inflation, and
T-bil]s about 0.8% above inflation.
To make the solution more flexible, the spreadsheet sta11s with a data block.
A B C D E F G H
1 $63,000 Salary
2 15% %saved
3
4 Exp. 9A-1 i n PMT PV FV Solve fo r Answer
5 T-bill 0.8% 35 -9,450 0 fV $379,957
6 Bonds 2.5% 35 -9,450 0 fV $519,072
7 Stocks 7.3% 35 -9,450 0 fV $1,394,949
EXAMPLE 9A-3 Example 9A- 2 Revisited

The engineer in Example 9A-2 has decided that a retirement goal of $1 million is adequate. What fraction of her salary
must be saved if she invests in T-bills, bonds, or stocks?
SOLUTION
The first step is to detennine the annual deposits at the different interest rates. As in Example 9A-2, the interest rates
are the market rates minus inflation: stocks have returned about 7.3% over inflation, long-term treasury bonds about
2.5% above inflation, and T-bills about 0.8% above inflation.
To make the solution more flexible, the spreadsheet stans with a data block.
A B C D E F G H I
1 $63,000 Salary
2
3 Exp. 9A-3 i n PMT PV FV Solve for Answer % salary
4 T-bill 0.8% 35 0 1,000,000 PMT -$24,871 39.5%
5 Bonds 2.5% 35 0 1,000,000 PMT -$18,206 28.9%
6 Stocks 7.3% 35 0 1,000,000 p T -$6,774 10.8%
An investor who chooses to invest safely before retirement should also invest safely after retirement. If the $1M is
invested al a lower rate, then less can be withdrawn each year to live on. It is common to suggest that al/ investors
should invest more safely once they are approaching retirement or are already retired.
41 of 48 1/25/2020, 11:08 AM
EXAMPLE 9A-4 Examples 9A-2 and 9A-3 Revisited

The engineer i.n Examples 9A- 2 and 9A- 3 wants to know how many years she can live on her savings before they are
exhausted. Assume the common guideline of retirement spending equals 80% of pre-retirement net income. Also
assume the same investments and returns before and after retirement. How long after retirement before her $1 million
is exhausted?
SOLUTION
The average returns were determined for the earlier examples: stocks have returned abom 7.3% over inflation, long-
term treasury bonds about 2.5% above inflation, and T-bills about 0.8% above inflation. The required savings at each
rate were detetmined in Example 9A-2 . ote that the annual amount spent before retirement is $63, 000 x (1 -
%saved)- The expected spending level after retirement is 80% of that. So the spending level with T-biUs is $30,503 (=
(63, 000 - 24, 871) X 80%).
A B C D E F G H I
I 563,000 Salary
2 80% % ret ireme nt spending
3 Exp. 9A-3 ( II PME PV FV Solve for An,~wer % w:uy
4 T-bills 0.8% 35 0 1,000,000 PMT ~s24.1m 39.5'%
5 Bond.~ 2.5% 35 0 1,000,000 PMT -Sl8,206 28. 9"/G
6 Stock~ 7.3% 35 0 1,000,000 PMT -S6,r74 10.11%
7
8 Exp. 9A-4 ( n PMJ' PV FV Solve for A:n.,;wer
9 T b ills 0.8% 30,503 1,000,000 0 NPER 3&.2
10 Bond.,; 2.5% 35,836 1,000,000 0 N PER 48.4
II Stocke~ 7.3% 44 ,9110 1,000,000 0 NPER #Nl.JM !
No answer is returned for stocks. The reason is that an annual return of 7.3% on $1 million is $73,000. This is more
than the expected retirement spending. It is also more than the pre-retirement saJary!
EXAMPLE 9A-5 Example 9A- 2 Revisited

An engineer has just finished paying off a student loan and is ready to start saving for retirement. Her current annual
salary is $63,000. Assume that her salaiy increases 2% faster than inflation. She expects to work for another 35 years.
If she invests 15% of her salary, how much can be expected to be in her account if she invests in T-bills, bonds, or
stocks?
SOLUTION
The interest rates were identified in Example 9A- 2, but the annuity functions used in Examples 9A- 2 through 9-4
cannot be used here. The annual deposit increases with the salary, so tables of cash flows must be created. Each year a
deposit equal to a percentage of the income is made. The balance in year t is that deposit plus (1 + retum) x the
previous year's balance. There is no interest in year 1 because the deposit is assumed to be made at the end of the year.
A B C D E F
I S63 000 Salary
2 15% % 1,aved
3 2% atumal salary increa.~e
4 T-bill~ Bends Stocks
5 Year Salaiy Deposit 0.8% 2.5% 7.3%
6 I 63,000 9,450 9,450 9,450 9,450
7 2 64,260 9,639 !9, 165 19,325 19,779
II 3 65 ,545 9,&32 29,1 50 29,640 31,054
9 4 66, 1156 I0,02S 39,411 40,410 43,3 50
IO 5 68, 193 10,229 49,956 51 ,649 5-6,743
---
40 35 123, 523 18,52 $ ~534,IOS 705, 567 • 1,743,063
41 /
42 lr $C40-t-O39"(1 + 0SS) /
43 ,..SC40+F39°( I+FS5)
42 of 48 1/25/2020, 11:08 AM
STUDE NT STUDY GUIDE

These questions are intended for self-study. Click the [solution] box to reveaJ a. detailed solution.
9A- An initial investment of $1000 in irade Plas tics has annual returns. that have varjed a lot. For those returns find the arithmetic
1 average and the geometric mean. Wh ich one is. the proper measw-e?
Year Annual Return
1 30%
2 -25%
3 -15%
4 35%
4i•'41dtWi
9A- A 45-year-old engineer earning $120,000 per year wants. to retire at age 65 with $2 mill.ion. The ,engineer has nothJng saved and
2. expects. to earn 7% annually on the investment?
(a) How much money must be invested each year?
(b) I th.e employer does a 100% match of retirement savings up to 4% of the employee's salary, how much money must each
invest annual.ly?
4i•1••dMd
9A- A 45-yea.r-old engineer earning .$110,000 per year wants to retire at age 70 with $1.75 million. The ,engineer has nothing saved
3 and expects to earn 6% annually on the investment? What fraction of the salary must be invested each year to reach the goal?
4i•l••dt-f§i
9A- A 25-year old engineer wants to spend $40,000 per year traveling as long as possible before switching to saving for retirement.
4 The engineer plans to retire at 60 ,vith $1.5 m.illfon and then resume traveling. The engineer expects. to eam 8% annuaJJy on the
investment.
(a) For how many years must the engineer save for retirement?
(b) How long can the engineer traveJ before beginning to save for retirement?
4i•l•Giuf§i
9A- An engineering manager retired with investments of $1,200 000 safely invested at 4%. She is 62 an d needs $60,000 pe.r year for
5 living expenses., in additio n to he.r social security benefit.
(a) How long wiJJ her investment last if Jt remains invested at 4%?
(b) How much can she spend if it must last untiJ she is 86?
4i•ll'dM§i
9A- A new employee puts 10% of his salary of .$72,000 into a retirement acc-ount. He expects. his salary to increase 3% per year. The
G money is invested in a mutual fund that he expects. to average a 6.5% return . How much is in the fund after 10 years?
&ffi•Gi 0ii
PROBLEMS
Key to icons: D = click to reveal answer; e = Green, which may include environmental ethics; CJ =Ethics other than
green; = autograded prob]ems that are available online in Dashboard; = The icon indicates that a spreadsheet is
recommended.
For these problems assume that stocks, bonds. and T-biHs return, respectively, 7.3%, 2.5%, and 0.8% over inflation.
9A- A 25-year-old engineer earning $65,000 per year wants to 1-etire at age 55 w:ith $2 mUJion, and plans. to invest in a stock fund.
1 (a) How much money must be invested each year?
{b) If the ,employer does a 100% match of retirement savings up to 3% of the employee's salary, how much money must each
invest annually?
9A- An engineer eamjng .$70,000 per year wants. to retire in 30 years with $1. million and plans. to invest in a treasury bond fund .
43 of 48 1/25/2020, 11:08 AM
-- • •-• ._._. b ...... ......... ... .... .... ......... ~t::, ....- ~ .._.,...,.....,.., ..,. .... .. J .... .................... ..,. ......., ................. ... .. ...,...,.J .._ ...., ......
~ ~, ......... . ..., ... , ........................... ........... . ...... .t" ._...., . _• ..,. .. ...,. ...... , ................. ... ......... .............. J ..,. ......... ...... ............ ...... .
2 (a) How much money must be invested each year?

I (b) If this person works 5 additional yeaFS, how much money must be in vested each year?
{c) I the employer does a 100% match of retirement savings up to 4.25% of the employee's salary, and the engineer wants to
retire in 30 years, how much money must each invest annually?
9A- A risk-averse 25-year-old engineer earning $70,000 per year wants to reti.!'e at age 65 with $2 million and plans to safely invest in
3 nwsury bil.ls.
(a) How much money must be invested each year?
(b) If the employer does a 100% match of retirement savings up to 5% of the employee's salary, how much money must each
invest annual.ly?
A-4 A new employee earning $48,000 annually has set a retirement goa.l of $1 mHhon. She plans to work fo r 40 years, and wiJJ invest
I in stocks.
(a) What fractio n of her salary must be saved?
(b) If the employer does a one-to-one match of retirement savings up to 4% of the employee's salary, what fraction of her salary
must be saved ?
9A- An employee earning $63,000 per year has set a goal of retiring in 40 years with $1 million. She will invest in treasury bonds.
5 {a) What fraction of her salary must be saved?
(b) If th e employer does a one-to-one match of retirement savings up to 5% of the ,employee's salary, what fraction of her salary
must be saved ?
9A- A new engineer started her firs t job earning $60,000 annually, and wants to retire in 40 years with $1 million. She will invest in
G n-easury bil.ls.
I (a) What fractio n of her salary must be saved?
(b) If the employer does a one-to-one match of retirement savings up to 4% of the employee's salary, what fraction of her salary
must be saved ?
9A- A manager just retir-ed at age 62, with his reti.rement savings of $800,000 invested in stocks. If he needs $60,000 per year fo r
7 living expens.es, how long will his savings last?
9A- A manager retired at age 65, and has her retirement savings of $1,500,000 invested in treasury bonds. She needs $65,.000 per year
•
8 fo r living expenses, in addi.tion lo her soda! security benefit. How long will her investment fas t?
9A- A person worked for many years with the same company and has accurnu.lated a retirement account of $900,000. U $30,000 per
9 year needs to be withdrawn from this account, how long will the savings last if invested in treasury bills?
9A- A new employee puts 4% of his salary of $65,000 into a retirement account, and his employer matches this, als.o putting 3% into
10 the account. The money is invested in a diversified stock fund . His salary increases 2. % per year.
I (a) What is the value of the account after 10 years?
(b) What is the value of the employer's matching funds?
(c) How much will be in th e account after 40 years?
9A- An engineer changed jobs and is signing up fo r benefits. The company 401(k) incl udes a low cost treasury bond fund. The
11 engineer will put 3% of her saJary o.f . 70,000 into the accou.nt, and her employer win match half this amount. Her salary is
expected to increase 2.8% per year.
(a) What is the value of the account after 10 years?
(b) If she expects to work for 30 years, how much will be in the account?
9A- A long-term employee is nearing retirement and will adj ust his retirement account. The account has $500,000 in it. T he employee
12 will put that money and all new money in a treasury bill {T-bill) account. He puts 6% of his $135,000 salary into the account, and
I his emp loyer matches half of this amount. m s saJary increases 2% per year. What is the vaJue of the account after 10 yea.rs?
9A- i ke just changed jobs, leaving a company after 6 years. He is fully vested, and can keep the money his employer deposited in
13 his retirement account. His employer has been contributing $200 per month into a djversified stock fund.
(a) Using average market rates, how much money has accumulated in the account?
{b) If th.is money is "rolled over" into another retiremen t account with an 8% annual return, how much will this be worth after
30 years?
9A- Aonka became concerned about the stock market due to recent loss.es, and wants safe investments in treasury bonds. She moved
14 $350,000 in her retirement account into an ET F specializing in government bonds, which average 2.5% above inflation. Her
f!I sa.lary is cunently $92,000 per year, and she expects raises of 2.0% each year. Her employer wm match retirement savings up lo
44 of 48 1/25/2020, 11:08 AM
CHAPTER 10
UNCERTAINTY IN FUT'U RE EVENTS
Moving the Load
Most organizations hire third-patty caniers to move freight. Some choose to outsource aU of their transportation
requirements to caITiers, thereby avoiding the expense of acquiring, operating, and maintaining their own private fleet.
Even organizations that have their own fleets, such as Walmart and Sysco, also rely on third-patty carriers for flexible
transportation capacity, which is cti.tical in the face of uncertain demand. Such blended operations are quite common, with
catTiers handling roughly one-third of the outbound freight for U.S. films with private fleets.
Carriers typicaUy offer full-truckload (FTL) and less-than-tmckload (L1L) shipping. FTL shipping Is ideal for Iarge Joads
-an FTL shipment via an 18-wheel semi-truck with a 53-foot trailer can typically accommodate up to 30 pallets and
50,000 pounds of freight. Scheduling an FTL shipment with a earlier tends to be a straightfotward process and is
convenient for the shipper. Fmthennore, transit times are relatively sh011--an entire truck is dedicated to the shipment
directly from the shipper to a single destination. However, the shipper must pay for the entire truck, which is not cost-
effective when shipping small volumes.
By contrast, LTL shipping is typically for loads weighing more than 5,000 pounds on more than 10 pallets. With LTL
shipping, multiple shippers share space on the same truck, and each pays only for the capacity that it uses. However, LTL
shipments can cost up to 10 times more per pallet than a fuUy loaded FTL shipment. Organizing LTL shipments can be
complex and time-consuming, as caniers attempt to fill truck capacity, reduce empty backhauls, and minimize the total
distance traveled between multiple shippers and destinations.
Shippers have traditionally hired freight brokers to serve as i.ntennediaries to connect them with ca1Tiers. Recently,
however, some shippers have started to replace their brokers with digital freight apps. Thls method, known as
"crowdshipping" or ''crowd logistics," operates similarly to ride-share and food-delivery apps but is focused on
commercial carriers and LTL freight. Digital freight apps, such as Uber Freight, allow catTiers to view available
shipments, including real-time pricing, destinations, and shipper requirements (e .g., hazmat, time windows), via a
smartphone.
From the carTier's perspective, crowdshipping offers advantages over traditional brokerage services: it gives drivers the
flexibility to choose and organiz,e their own loads and routes, the pricing is dear, and crowdshipping providers tend to pay
drivers more quickly than brokers. For LTL shippers, crowdshipping provides a cost-effective avenue for increasing
logistics capacity as needed and eliminating brokerage fees.
45 of 48 1/25/2020, 11:08 AM
Despite these advantages, adoption of digital freight apps has been slow. Crowdshipping providers have struggled to
consistently source sufficient catTiers to meet shippers• demand. Many carriers are accustomed to working with brokers,
with whom they have developed trust-based relationships over time, and they prefer to outsource the burden of Joad
sourcing to these brokers. Some shippers also have concems about the safety and reliability of using a digital app to select
ca11"iers. ■
Contributed by Caroline C. Krejci, University of Texas at Arlington
QUESTIONS TO C ONSIDER
1. Is crowdshipping likely to be more beneficial for large shippers (e.g., Walmart) or smaU-scale organizations?
2. For what sources of uncertainty in a supply chain is crowdshipping likely to be most effective?
3. What are the ethical implications of replacing human brokers with digital freight apps?
After Completing T his Chapter ...

The student should be a.hie to:
• Use a range of estimated variables w evaluate a project.
• Desc1i be possible outcomes with probability distributions.
• Combine probability distributions for individual variables into joint probability distributions.
• Use expected values for economic decision making.
• Use economic decision trees to describe and solve more complex problems.
• Measure and consider risk when making economic decisions.
• Understand how simulation can be used to evaluate economic decisfons.
• Understand why and how diversification reduces risk for investments and project portfolios. (Appendix lOA)
Key Words
beta distribution
chance node
decision node
decision tree
discrete probability distribution
dominated projects
efficient frontier
expected value
joint probability distribution
most likely
optimistic
outcome node
pessimistic
pruned branch
rea] options
risk
scenario
simulation
standard deviation
statisticaUy independent
SUMPRODUCT
46 of 48 1/25/2020, 11:08 AM
An assembly line is built after the engineeting economic analysis has shown that the anticipated product demand will
generate profits. A new motor, heat exchanger, or filtration unit is installed after analysis has shown that future cost
savings will economically justify current costs. A new road, school, or other public facility is built after analysis has
shown that the future demand and benefits justify the present cost to build. However, future perfotmance of the assernhly
line, motor, and so on is uncertain, and demand for the product or public facilhy is more unce11ain.
Engineering economic analysis is used to evaluate projects with fong-term consequences when the time value of
money matters. Thus, it must concern itself with future consequences; but desc1ibing the future accurately is not easy. In
this chapter we consider the problem of evafoating the future. The easiest way to begin is to make a careful estimate and a
breakeven analysis. Then we examine the possibility of predicting a range of possible outcomes. Finally, we consider
what happens when the probabilities of the various outcomes are known or may be estimated. We will show that the tools
of probability are quite useful for economic decision making.
ESTIMATES AND THEIR USE IN ECONOMIC ANALYSIS

Economic analysis requires evaluating the future consequences of an alternative. In practically every chapter of this book,
there are cash flow tables and diagrams that describe precisely the costs and benefits for future years. We don't really
believe that we can exactly foretell a future cost or benefit. Instead, our goal is to select a single value representing the
best estimate that can be made.
Breakeven analysis, as shown in Examples 9-11 and 12., is one means of examining the impact of the variability of
some estimate on the outcome. It helps by answering the question, How much variability can a parameter have before the
decision will be affected? While the prefe1Ted dedsion depends on whether the salvage value is above or below the
breakeven value, the economic difference between the altematives is small when the salvage value is "close" to
break even.
What-if analysis, which was detailed in Example 9-13, is another way of creating and evaluating scenarios that
describe future uncettainties. Breakeven and what-if analyses do not solve the basic problem of how to take the inherent
variabiHty of parameters into account in an economic analysis. This is the task of this chapter.
A RANGE OF ESTIMATES
It is usually more realistic to describe parameters with a range of possible values, rather than a single value. A range could
include an optimistic estimate, the most likely estimate, and a p,essimistic estimate. Then, the economic analysis can
determine whether the decision is sensitive to rhe range of projected values. Sets of such optimistic, most likely, and
pessimistic estimates are often used to fotm optimistic, most likely, and pessimistic scenarios.
EXAMPLE 10-1
A firm is consideting an investment. The most likely data values were found during the feasibility study. Analyzing
past data of similar projects shows thar optimistic values for the first cost and the annual benefit are 5% better than
most likely values. Pessimistic va]ues are 15% worse.
The film's most experienced project analyst has estimated the values for the useful life and salvage value. ote that
5% better and 15% worse is not 5% and - 15% for cost. A lower cost is better and a higher cost is worse.
O(Jtimistic Most Likely Pessimistic
Cost $950 $1000 $1150

et annual benefit 210 200 170
Salvage value 100 0 0
Useful life, in yea.rs 12 10 8
Compute the rate of return for each estimate. If a 10% before-tax minimum attractive rate of return is required, is the
investment justified under all three estimates? If it is justified only under some estimates, how can these results be
used?
47 of 48 1/25/2020, 11:08 AM
SOLUTION
A B C D E F G H
1 Scenario i n PMT PV FV Solve for Answer
2 Optimistic 12 210 -950 100 i 19.80%
3 ost Likcely 10 200 -1000 0 i 15.10%
4 Pessimistic 8 170 -1150 0 i 3.90%
To solve with tabu]ated factors, the equations for the respective cases are:
Optimistic
PW= 0 = -$950+ 210(P/ A, IRRopc 12) + JOO(P/ F, IRRopc 12)
Most Likely
PW= 0 = - 1000+ 200 P/ A,IRRrnostlit.ely, IO)

(P/ A, IR.Rmostlil.ely 10) = 1000/ 200 = 5
Pessimistic
PW= 0 = - 1150 + 170 P/ A,IRR~ , 8

(P/ A, IRRpm,8 = 1150/ 170 = 6.76
48 of 48 1/25/2020, 11:08 AM

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Engineering Economic Analysis - Pages 300 - 349 https://print.vitalsource.com/print/9780190931940?brand=Yuzu&from=...

A $100,000 $30,000 30%

B 300,000 66,000 22%

C 500,000 80,000 16%

Initial investment $8,500 $18,500 26,500 $30,000

Annual saving in mate1ia]s costs 3,500 6,000 7,400 9,000

Annual operating cos t 2, 100 3,000 3,200 4, 100

Cash vs. Loan vs. Lease

deposit of $1500. Wha t shouJd I do?'

Clean, Lower Cost Space Travel

1. What has happened more recently with reusable launches?

After Completing This Chapter ...

Chapter 9 examines four topics:

FUTURE WORTH ANALYSIS

Semiannual aving = 35/week)(26 wee ks) = $910

Daily Habit to Weekly Treat 1

FW = 520(F /A, 2 1/ 2 %, 90) = 520(329.2 , = $171 , 184

85.k L___ _____ _! }200.(00

FW of cost = 85 ,000(F/ P 8%,3) 200000(F/ A 8%,3

Remodel Available Factory

0- -1- -2- -3 = 0------3

FW of cost = 850,000(F / P, 8%, 3) + 250 OOO(F/ A 8% 3)

BENEFIT-COST RATIO ANALYSIS

ThltJle 9-1 Benefit-Cost Ratio Analysis

These could also be stated as a ratio of benefits to costs, or

EXAMPLE 9-3 Examples 5-1, 6-5, and 7-13 Revisited

The increment is justified at the MARR of 7%. Device B should be purchased.

EXAMPLE 9-4 Examples g:.....6 and B- 7 Revisited

Cost $4000 $2000 $6000 $1000 $9000 $10,000

Cost ( = PW of cost) 1000 2000 4000 $6000 9000

ti.Cost 1000 $2000 2000

$4000 $6000 8000 .$ I0,000

Variations on the Theme of the Benefit- Cost Ratio

PW-benefitSright tllflls = - 900,000 + 1,600,000(P /A, 10%, 15)

PW-cos.tsrlght tums = 8,900000+ 150,000 P/A, 10%, 15)

The benefit-cost ratio for public divided by government consequences is

B/ C ratio = $11.27M/ $10.04M = 1.122

PW-costs1eft mums - right turns = 3,000,000 + 75,000(P/ A 10%, 15

B/ C ratio = $3 .364M/ $3.570M = 0.942

PW-benefit Ye.ars 1 to 11 = (1 600 000 - 150,(X}O)( P / A, lOo/t , 15)

P\V-cost = 8,900,000 + 900,000 = $9.8M

PW-index = $11.03M/ $9.8M = 1.125

Thus, the minimal reconfiguration is better than doing nothing.

PW-benefi tsYear. 1 ton = 600,000 - 75 000 P/ A, 109.: , 15)

PW-costs = 3 000,000 + 1,200,000 = $4.2M

PW-index = $3.993M/ $4.2M = 0.951

PAY BACK PERIOD SOLUTION

$2783/$1200 per year = 2.3 years

To minirni1.ie the payback period, choose Alt. B.

TIME VALUE OF MONEY SOLUTION

PAYBACK PERIOD SOLUTIO

So choosing to minimize the payback period would result in choosing Machine A

TIME VALUE OF M ONEY SOLUTION

SENSITIVITY AND BREAKEVEN ANALYSIS

Construction A1ter native Costs

2 Pull-staged 8% 0 -40,000 120,000 PER 4.27 = PER(B2,D2,E2,F2)

n=S PW= 100, 000 + 120, 000(0.6806} = $181, 700

iC: 100,000 &

From the tables

n = 14 + H5 - 14)(0.3405 - 0.3333)1(0.3405 - 0.31.52

EXAMPLE 9-11 Examples 9,_5, and 9--6 Revisited

GRAPHING WITH SPREADSHEETS FOR SENSITIVITY AND

85.k L_ ___ _! }200.(00