Chapter 5 Present Worth Analysis

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Chapter 5Present Worth Analysis
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Chapter Outline

• Assumptions in Solving Economic Analysis Problems
• Economic Criteria
• Applying Present Worth Techniques
• Useful Lives Equal the Analysis Period
• Useful Lives Different from the Analysis Period
• Infinite Analysis Period

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Learning Objectives

• Understand common assumptions in solving economic
  analysis problems
• Apply present worth techniques in various
  situations in selecting the best alternative

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Vignette Boeing versus Airbus

• Boeing has been working on development of the
  Sonic Cruiser. It is lighter and 15 faster than
  conventional jet.
• Airbus has also been working on its version of
  lighter plane. But Airbus is betting on size
  rather than speed. Its new model A380 will be
  the largest passenger plane in the world. By
  using several new composite materials, Airbus
  could reduce the weight and the manufacturing
  cost by 20. The lighter planes will allow
  airlines to cut their operating cost by about 8

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Vignette Boeing versus Airbus

• How would airlines compare the two new planes?
• What economic criteria should the airline company
  use?
• What economic factors should be included in the
  comparison?

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Assumptions in Solving Economic Analysis Problems

• End-of-Year Convention

F
P

• Viewpoint of Economic Analysis Studies
• Generally, the point of view from the total firm
  is taken

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Economic Criteria

• Methods
• Present worth
• Annual cash flow
• Rate of return

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Applying Present Worth Techniques
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Example 5-1 Applying Present Worth when Useful
Lives are Equal
Device B
Device A
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Example 5-2 Applying Present Worth when Useful
Lives are Equal

• Build a full-sized facility for 400 million now,
  or build a reduced-size facility now for 300
  million and expand it 25 years hence for an
  additional 350 million, at 6 interest?

For the single-stage construction
For the two-stage construction
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Example 5-3 Applying Present Worth when Useful
Lives are Equal
Speedy
Allied
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Example 5-4 Applying Present Worth when Useful
Lives are Equal
Atlas
Tom Thumb
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Present Worth when Useful Lives are Different
from Analysis Period

• Least Common Multiple of Useful Lives from
  Various Alternatives
• Assuming service will be needed indefinitely
• Repeating same cash flows in each cycle for each
  alternative
• Analysis Period
• Need to estimate the terminal values for all
  alternatives at the end of the analysis period

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Example 5-5 Applying Present Worth using Analysis
Period
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Present Worth with Infinite Analysis Period
(Capitalized Cost)
(5-2)
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Example 5-6 Capitalized Cost

• How much should one set aside to pay 50 per year
  for maintenance on a gravesite if interest is
  assumed to be 4?

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Example 5-7 Capitalized Cost
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Example 5-7 Capitalized Cost(Alternate Solution
1)
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Example 5-7 Capitalized Cost(Alternate Solution
2)
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Example 5-8 Multiple Alternatives
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Example 5-9 Multiple Alternatives
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Example 5-10
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Example 5-11
2000
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Example 5-11
1500