1. Slide Sets to accompany Blank & Tarquin, Engineering Economy, 6 th Edition, 2005 © 2005 by McGraw-Hill, New York, N.Y All Rights Reserved 6-1 Developed By: Dr. Don Smith, P.E. Department of Industrial Engineering Texas A&M University College Station, Texas Executive Summary Version Chapter 6 Part -1 Annual Worth Analysis

2. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 2 Chapter 5 – Annual Worth Analysis PURPOSE Compare alternatives using an annual worth basis TOPICS  AW calculations  Alternative evaluation using AW  AW of permanent investments

3. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 3 AW Advantage  AW is also called  AE – annual equivalent  EAC (or EAW) – equivalent annual cost (or worth)  EUAC (or EUAW) – equivalent uniform annual cost (or worth)

4. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 4 AW Advantage  An AW analysis is commonly preferred over a PW analysis because the AW value is easy to calculate and it is understood by most individuals.  The major advantage over all other methods is that the equal service requirement is met without using the least common multiple (LCM) of alternative lives.  The AW value is calculated over ONE life cycle and is assumed to be exactly the same for any succeeding cycle.  If this assumption not correct; use a study period and specific estimates for cash flows

5. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 5 AW Value Calculation

6. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 6 AW Value Calculation

7. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 7 Calculating Project AW AW is the sum of 2 separate components:  Capital recovery (CR)  Equivalent annual A of operating costs (A of AOC) AW = CR + A of AOC

8. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 8 Capital Recovery (CR) CR is the annual equivalent cost A incurred by initially spending an amount P on an asset (project) and using it for n years plus the return on the investment P at i% per year The A/P factor is used to convert P to an equivalent annual cost. If there is some anticipated positive salvage value S at the end of the asset’s useful life, its equivalent annual value is removed using the A/F factor.

9. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 9 Capital Recovery (CR) Example: Project costs P = $-13 million Estimated salvage S = $0.5 million Estimated life = 8 years Expected return i = 12% per year

10. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 10 Sec 5.1 – Capital Recovery 0 1 2 6 7 8 P = $13M S = $0.5M Return expected: i = 12% Capital recovery: Find A per year Capital recovery is the equivalent annual amount A to recover $13M at 12% per year if the salvage is $0.5M after 8 years CR = -13M(A/P,12%,8) + 0.5M(A/F,12%,8) = $-2.576M per year Conclusion: Project must develop revenue of at least $2.576M per year to recover P and make 12% on the investment

11. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 11 Sec 5.1 – Calculating AW AW: sum of CR plus A value of annual costs AW = CR + A of AOC  If AOC estimate is same each year, add A to CR  If AOC varies, find A value first, then add to CR Example: For previous project, estimate AOC at $0.9M each year. AW = -2.576M – 0.9M = $-3.476M per year Conclusion: Project must develop revenue of at least $3.476M per year to recover P, A and return 12% per year

12. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 12 Sec 5.1 – AW Value Calculation

13. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 13 Sec 5.1 – AW Value Calculation

14. Slide to accompany Blank and Tarquin Basics of Engineering Economy, 2008 © 2008, McGraw-Hill All rights reserved 5 - 14 AW Value Calculation In class

15. Slide Sets to accompany Blank & Tarquin, Engineering Economy, 6 th Edition, 2005 © 2005 by McGraw-Hill, New York, N.Y All Rights Reserved 6-15 Chapter 6 Part -1 End of Slide Set