Objective:
Presenting methods for evaluating and comparing projects
Lecture 9
Comparison Methods Part
1, cont’d.
Engineering Economy 85-313-(01 & 02)
Comparison of Alternatives with Unequal
Lives
- PW comparisons can not be used with projects of different lives
- Methods of transforming projects to equal lives:
- Repeated lives:
- Repeat the service life of each alternative to arrive at a common
time period to all alternatives (least common multiple).
- Assume that each alternative can be repeated with the same costs
and benefits in the future.
- Study period:
- Adopt a specific time period that is given for the analysis.
-Assume a specific salvage value whenever the life of one of the
alternatives exceeds that of a the given study period.
Engineering Economy 85-313-(01 & 02)
Topics Covered:
- Relations Among Projects
- Minimum Acceptable Rate of Return (MARR)
- Present Worth (PW) and Annual Worth (AW) Comparisons
- Present Worth for Independent Projects
- Present Worth for Mutually Exclusive Projects
- Annual Worth Comparisons
Topics to be Covered:
- Present Worth (PW) and Annual Worth (AW) Comparisons
- Comparison of Alternatives with Unequal Lives
- Payback Period
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Engineering Economy 85-313-(01 & 02)
Example 4.6 (p. 98):
A mechanical engineer has decided to introduce automated
material-handling equipment for a production line. She
must choose between two alternatives, building the
equipment or buying the equipment off the shelf. Each
alternative has a different service life and a different set of costs.
Alternative 1: Build custom automated material-handling equipment
with an expected service life of 10 years.
First cost Labour Power Maintenance Taxes & Insurance
$15,000 $3,300/yr $400/yr $2,400/yr $300/yr
Alternative 2: Buy off-the-shelf standard automated material-handling
equipment with an expected service life of 15 years.
First cost Labour Power Maintenance Taxes & Insurance
$25,000 $1,450/yr $600/yr $3,075/yr $500/yr
3
If the MARR is 9%, which alternative is better? 4
Engineering Economy 85-313-(01 & 02)
1
 Repeated indefinitely
assumption (AW method)
z There is a more convenient approach for an annual
worth comparison of projects of unequal lives if it
can be assumed that the alternatives are repeated
indefinitely.
z Since the project would repeat indefinitely, its
annual costs would remain the same no matter
how many times it is repeated, it is not necessary to
determine the LCM of the service lives.
z The AW can be assessed for whatever time period
is most convenient for each alternative.
Engineering Economy 85-313-(01 & 02)
Payback Period, cont’d.
- If the annual savings are not constant every year,
savings are deducted from the first cost until the first cost is
recovered.
Example 4.9 (p. 103):
A project of initial cost $8,000 and annual savings of $3,000, $2,000
and $1,500 for the next 3 years and $1,000 for the following 2 years.
What is its payback period?
- Paid amount after 3 years = $3,000+$2,000+$1,500=$6,500
- Paid amount after 5 years = $6,500+$1,000+$1,000=$8,500
- Payback period = 4.5 years assuming savings occur continuously
throughout the year
- Payback period = 5 years assuming savings occur at the end of
each year
Engineering Economy 85-313-(01 & 02)
Payback Period
- It is a rough estimate of the time it takes for an investment
to pay for itself when the interest rate is assumed to be zero
- It should be used as a preliminary filter rather than a sole criterion
for evaluating projects.
Payback period = (first cost)/(annual savings)
Example 4.8 (p. 103):
A project with initial cost $5,000 and annual savings of $2,000.
- Assuming that the savings occur over the whole year:
Payback period = $5,000/$2,000 = 2.5 years
- Assuming that the savings occur at the end of the year:
Payback period = 3 years
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Engineering Economy 85-313-(01 & 02)
Payback Period, cont’d.
- The project with shorter payback period is the preferred
investment.
- The maximum payback period is defined by the company
depending on the type of project and the company’s financial
situation.
- Payback periods are usually between 2 and 4 years.
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Engineering Economy 85-313-(01 & 02)
2
 Discounted Payback Period Recommended Problems
The present worth of each year’s savings is subtracted from
the first cost until the first cost is diminished to zero.
Problems: 4.1, 4.9, 4.13, 4.17, 4.25 & 4.42
Example (p. 104):
A project with initial cost $5000 and annual savings of $2000. If the
interest rate is 10%, the present worth of savings would be:
Year PW Cumulative
1 $2,000(P/F,10%,1)=$1,818 $1,818
2 $2,000(P/F,10%,2)=$1,653 $3,471
3 $2,000(P/F,10%,3)=$1,503 $4,974
4 $2,000(P/F,10%,4)=$1,366 $6,340

The discounted payback period is over 3 years, compared with 2.5

years calculated for the standard payback period
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Engineering Economy 85-313-(01 & 02) Engineering Economy 85-313-(01 & 02)