Present Worth Method.pptx

1. Economic Evaluation of Alternatives
Objectives:
 To select the best alternative economically.
 Understand the various bases for comparison of
alternatives.
Bases for Evaluation of Alternatives:
 Present worth method
 Future worth method
 Annual equivalent method
 Capitalized cost method
 Rate of return method
Engineering Economics

2.  Cash flows are known.
 Cash flows are in constant-value dollars.
 The interest rate is known.
 Comparisons are made with before tax cash flows.
Engineering Economics
Assumptions in Economic Evaluation of Alternatives

3. Present Worth Method
 It is the equivalent value at present of the asset based on time value of
money.
 It is the discounted value of future sums i.e. all future cash flows are
discounted to the present and compared.
 PW is very much suggested because any cash flows we have at present are
known and are certain then those uncertain values at some future date.
 PW comparisons are made only between co terminated proposals to assure
equivalent outcomes.
Two methods in calculating present worth:
• Cost dominated cash flow diagram
• Revenue dominated cash flow diagram
Engineering Economics

4. Cost Dominated Cash Flow Diagram
 In a cost dominated cash flow diagram, the cost will be
assigned a positive sign and revenues will be assigned a
negative sign.
 In the cost dominated cash flow diagram, the alternative
with minimum present worth should be selected as best
alternative.
If,
P – Represents initial investment
Cj – Net cost of the operation and maintenance at the end of jth year.
S – Represent the salvage value at the end of nth year
Engineering Economics

5. A generalized cash flow diagram to demonstrate the present
worth method of comparison is shown below.
Engineering Economics
To compute the present worth amount of the above cash flow diagram for a given
interest rate i,

6. Problem
1. A construction company receives two bids for an elevator
to be installed in their newly constructed apartment, the
details of which are given in the table. Determine the best
bid based on present worth method @ 12% interest rate.
Engineering Economics
Alternative Initial Cost (Rs) Service Life Annual operating cost (Rs)
1 580000 15 29500
2 640000 15 30800

7. Engineering Economics

8. Revenue Dominated Cash Flow Diagram
 In a revenue dominated cash flow diagram, all receipts will
be assigned a positive sign and costs a negative sign.
 In the revenue dominated cash flow diagram, the
alternative with maximum present worth amount should be
selected as the best alternative.
Engineering Economics
If,
P – Represents initial investment
Rj – Net revenue at the end of jth year.
S – Represent the salvage value at the end of nth year

9. Revenue dominated cash flow diagram:
Engineering Economics
To compute the present worth amount of the above cash flow diagram for a given
interest rate i,

10. Problem
1. The following table gives an initial outlay and the annual
revenues of a production firm using three different
technologies. Find the best alternative if the interest rate is
20% compounded annually.
Engineering Economics
Technology Initail Outlay (Rs)
Net Annual Revenue
(Rs) Life (Yrs)
1 1300000 400000 10
2 2100000 650000 10
3 2300000 860000 10

11. Engineering Economics
3. The details of feasibility report of a project are shown
below. Check the feasibility of the project based on present
worth if i=20%.
o Initial outlay:Rs.5000000
o Life of Project : 20 years
o Annual revenue: Rs.1500000
o Modernizing cost at the end of 10th year: Rs.2000000
o Salvage Value: Rs.500000

12. Engineering Economics