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Perpetuity

must be capitalized for perpetuity:

1.) finding the NPW of all the onetime, non-recurring cash flows (=

CCPart 1 )

2.) finding the Annual Equivalent of

one cycle of all the recurring

cash flows, and then computing P

(= CCPart 2) from the perpetuity

relationship A = P(i)

3.) summing (1.) and (2.) to find the

total capitalized cost:

1

CCTotal = CCPart 1 + CCPart 2

Perpetuity Example

A new football stadium will replace the

current municipal stadium at an initial

cost of $250 million.

One year later, the old stadium will be

demolished at a net cost of $1.5 million.

Annual maintenance is expected to be

$900 000, and every 15 years the

skyboxes will be remodeled at a cost of

$500 000.

Find the capitalized cost if the discount

rate is 10%, compounded annually.

2

Perpetuity Example

DIAGRAM:

0

15

30

n= yrs

$900 K

$1.5 M

$500 K

$500 K

$250 M

CC1 = $250 000 000 + $1 500 000 (P|F,10%,1) = $ 251 363 650

CC2 = $900 000 + $500 000 (A|F,10%,15) =

$ 9 157 500

0.10

CCT = CC1 + CC2 = $251 363 650 + $9 157 500 = $ 260 521 150

ReviewingNPW

Two approaches to handle

differing project lives:

Common Multiple Period:

Projects are assumed to be

repeated until a common

multiple point in time is

established.

Study Period: Select a study

period for both projects

and estimate cash flows to

conform to the study

4

Equivalent

Annual Worth Analysis

Equivalent Annual Worth

(EAW) can be used to

compare projects.

Equivalent Annual Cost

(EAC) can be used instead

of EAW if revenues are not

included.

EAC = EAW

Equivalent Annual

Worth Analysis

Revenue projects are

expected to make money

at a rate at least as high

as the MARR, so select

largest EAW that is 0.

Service projects are have

to do situations, so

select largest EAW (lowest

EAC).

6

For a capital purchase (P)

with a salvage value (S),

the EAC can be calculated

two ways:

1.P(A/P, i, n) S (A/F, i, n)

2.(P S) (A/P, i, n) + S( i )

Annual equivalent

for loss of value

Opportunity

cost

Land is considered to have

infinite life; it can be sold

for its purchase price

(neglecting inflation).

P = S and EAC = S*i

Example 1

The Ragweed Pollination Company needs a

new building to expand seed production.

The building will cost $600,000, last for 30

years, and is expected to sell for

$100,000. It will be built on property that

costs $200,000, which will be sold with the

building. Energy costs are projected to be

$45,000 the first year increasing by $3,000

each year after that. Needed equipment

will cost $70,000 and last 10 years with

no salvage value. It will be replaced with

identical equipment 10 and 20 years from

now. Annual maintenance is projected to

be $20,000. Determine the Equivalent

Annual Cost (EAC) for the proposed

9

expansion using a MARR of 18%

1st Costs:

Annuals:

Increases:

Replacements:

Salvage:

Lifetime:

MARR:

FIND:

200 000

Land

600 000

Building

70 000

Equipment

20 000

Maintenance

45 000

Energy

3 000/yr Energy

70 000

70 000

100 000

200 000

Land

30 yrs

18%,

cpd annually

EAC (= EAW)

10

$200 K

EAC = ?

DIAGRAM:

10

20

$100 K

n=30 yrs

$20 K

$200 K

$600 K

$45 K

G=$3 K

$70 K

EAC = A0 + AN + AI + AR + AS

$70 K

$70 K

+ 3 000 (A|G,18%,30)

+ [70 000 (P|F,18%,10) + 70 000 (P|F,18%,20)] (A|P,18%,30)

(100 000 + 200 000) (A|F,18%,30)

= 157 731 + 65 000 + 16 034 + 2 888 390 = $241 263 / yr

11

Example 2

A 1000-foot tunnel must be constructed as part of

a new aqueduct system for a major city. Two

alternatives are being considered. One is to build

a full-capacity tunnel now for $400,000. The

other alternative is to build a half-capacity tunnel

now for $200,000, and then to build a second

parallel half-capacity tunnel 20 years hence for

$300,000. The cost of repair of the tunnel lining

at the end of every 10 years is estimated to be

$20,000 for the full capacity tunnel and $18,000

for each half-capacity tunnel.

half-capacity tunnel should be constructed now.

Solve the problem by annual worth analysis,

using an interest rate of 6% per year compounded

annually, and a 50-year analysis period. (Note:

There will be no tunnel lining repair at the end of

the 50 years.)

12

10

0

$20 K

20

30

40

$20 K

$20 K

$20 K

n=50 yrs

$400 K

EAWF = (A|P,6%,50)[ 400 000 20 000(P|F,6%,10) 20 000(P|F,6%,20)

20 000(P|F,6%,30) 20 000(P|F,6%,40)]

= $26 807 / yr

DIAGRAM: Half Tunnel

10

0

$200 K

$18 K

20

$18 K

30

$18 K

$18 K

40

n=50 yrs

$18 K

$18 K

$300 K

EAWH = (A|P,6%,50)[ 200 000 18 000(P|F,6%,10) (300 000 +18 000)(P|F,6%,20)

(18 000 +18 000)(P|F,6%,30) (18 000 +18 000)(P|F,6%,40)]

= $20 223 / yr

13

Example 3

Your in-laws paid cash for a home they

purchased 18 years ago for $100,000. They

just sold it for $100,000. They were bragging

that, neglecting such expenses as taxes,

insurance, and utilities, it did not cost them

anything to live in the house for the 18 years.

Having just completed an engineering

economics course as a part of your

engineering degree, you knew immediately

that your in-laws reasoning was incorrect.

Identify and describe the engineering

economic principle involved.

Include in your explanation what it

actually cost your in-laws each year to

own the house provided that they value

money at 6% per year compounded

annually. (Do not include changes in the

14

purchasing power of money, and continue

principle of Example 3?

The economic principle is OPPORTUNITY COST:

= ($100 000 $100 000)(A|P,6%,18) + $100 000(6%)

= $0 + $6 000

= $6 000 / year to live in the house for each of the past 18 years.

Effectively, you could tell your in-laws that if they had truly lived in the house

for free, they could have spent $6 000 per year on better raising your spouse

but then, again, maybe you shouldnt.

15

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