MER 439 Design of Thermal Fluid Systems

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• MER 439 - Design of Thermal Fluid Systems
• Engineering Economics Comparing Alternatives
• Professor Bruno
• Fall Term 2006

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Todays Plan

• (1) Comparing Alternatives
• (2) Group Meetings

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Choosing Between Alternatives

• 5 Methods (that we will cover)
• (1) Present Worth Method
• (2) Annual Cost Method
• (3) Capitalized Cost Method
• (4) Benefit Cost Ratio Method
• (5) Rate of Return

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Present Worth Method(Equal Lives)

• Two uses
• comparison of alternatives
• placing valuation on prospective receipts
• (What would you be willing to pay now for the
  earnings you expect to make later?)
• Calculate the PW of each alternative
• the greatest PW (investments)
• smallest PW (costs)

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Present Worth Example
Three ideas to reduce labor costs are proposed A
- Continue with current method B - Build
Equipment to reduce labor costs C - Purchase New
Equipment
Use i 10 and n 10 yrs
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Unequal Lives

• PW method requires that the lives of all of the
  options are equal.
• If the alternatives have different lives assume
  costs are repeated. Repeat until Lowest Common
  Multiplier of the unequal lives.
• Two excavating machines are available
• Which one should be selected based on an interest
  rate of 18 per year?

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Annual Cost Method

• Alternatives that have unequal lives are more
  easily compared using the annual cost method
• Assumes each alternative will be replaced by an
  identical twin at the end of its life. (infinite
  renewal)
• EXAMPLE Which of the following alternatives is
  superior over a 30 year period if the IR is 7?

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Annual Cost Method

• AA 1800(A/P, 7, 30) 5 150
• AB 450(A/P, 7, 10) 20 84
• Alternative B is better because its annual cost
  is lower than that of Alternative A.

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Capitalized Cost Method

• The present worth of a project with an infinite
  life is called the capitalized or life cycle
  cost.
• It is the amount of money required at time zero
  to perpetually support the project on the earned
  interest only.
• CC Initial Cost Annual Costs/i

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Capitalized Cost Example

• Compare the following machines using i 18 per
  year
• Machine X Machine Y
• First Cost 50,000 200,000
• Annual Operating Costs 62,000 24,000
• Salvage Value 10,000 0
• Overhaul after 6 years ---- 4,000
• Life, years 7 ?

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Benefit Cost Method

• Generally used for Public Projects
• B Benefits Cash Inflows
• C Costs Cash Outflows
• Want B-C gt 0 or B/C gt 1

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Rate of Return Method

• It is often useful to calculate the rate of
  return on an investment.
• Solve for the interest rate that equates the
  worth of cash inflows to that of cash outflows
• gt Result is IRR - Internal Rate of Return
• Set up PW or AW 0 and solve for i.

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Rate of Return Example

• If you pay me 15,000 now and I promise to pay
  you back in 10 end of year payments of 1,250
  what is your rate of return?

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Rate of Return Example

• Okay heres a better deal
• If you pay me 15,000 now and I promise to pay
  you back in 10 end of year payments of 2,800
  what is your rate of return?