Annual Worth Analysis

Aris Ubando

Annual Worth Analysis

Annual worth is also known by other titles:
Equivalent Annual Worth (EAW) Equivalent Annual Cost (EAC) Annual Equivalent (AE) Equivalent Uniform Annual Cost (EUAC)

The alternative selected by the AW method will always be the same as that selected by the PW method, and all other alternative evaluation methods.
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Annual Worth Analysis

The AW value is the economic equivalent of the PW and FW value at the MARR for n years.
AW = PW , , = FW , ,
where n = the number of years for equal-service comparison; this is the LCM or the study period of the PW or FW analysis

Advantages of Annual Worth Analysis

When all cash flows are converted to an AW value, this value applies for every year of the life cycle and for each additional life cycle.
The AW value needs to be calculated for only one life cycle. The AW value determined over one life cycle is the AW for all future life cycles. Therefore, it is not necessary to use the LCM of lives to satisfy the equal-service requirement.
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Assumptions of Annual Worth Analysis

When alternatives are being compared with different lives, the assumptions for AW method are:
1. The service provided are needed for at least the LCM of the lives of the alternatives. 2. The selected alternative will be repeated for succeeding life cycles in exactly the same manner as for the first life-cycle. 3. All cash flows will have the same estimated values in every life cycle.
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Example 1: Simple Annual Worth

National Homebuilders, Inc. evaluated cut-andfinish equipment from vendor A (6-year life) and vendor B (9-year life). The PW analysis used the LCM of 18 years. Consider only the vendor A option now. The cash flow for the all three life cycles (first cost $-15,000; annual M&O costs $3,500; salvage value $1,000). Demonstrate the equivalence at i = 15% of PW over three life cycles and AW over one cycle. Using LCM of 18 years, the present worth for vendor A was calculated as PW = $-45,036.
AW = $-7349
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Capital Recovery and AW Values

An alternative should have the following cashflow:
Initial investment P. This is the total first cost of all assets and services required to initiate the alternative. Salvage Value S. This is the terminal estimated value of assets at the end of their useful life. Annual amount A. This is the equivalent annual amount (costs only for cost alternatives; costs and receipts for revenue alternatives). Often this is the annual operating cost (AOC) or M&O cost.

The AW value for an alternative is comprised of two components: capital recovery for the initial investment P at a stated interest rate (usually the MARR) and the equivalent annual amount A.

AW = CR +
where: CR = the capital recovery component A = the total annual amount from uniform uniform recurring cost and nonrecurring amounts *CR & A represent costs

Capital Recovery and AW Values

Capital recover (CR) is the equivalent annual amount that the asset, process , or system must earn (new revenue) each year to just recover the initial investment plus a stated rate of return over its expected life. CR = , , + , ,

Example 2: Capital Recovery

Lockheed Martin is increasing its booster thrust power in order to win more satellite launch contracts from European companies interested in opening up new global communications markets. A piece of earthbased tracking equipment is expected to require an investment of $13 million, with $8 million committed now and the remaining $5 million expanded at the end of year 1 of the project. Annual operating costs for the system are expected to start the first year and continue at $0.9 million per year. The useful life of the tracker is 8 years with a salvage value of $0.5 million. Calculate the CR and AW values for the system, if the corporate MARR is 12% per year.
CR = $-2.47 million per year AW = $-3.37 million per year
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Evaluating Alternatives by Annual Worth Analysis

For mutually exclusive alternatives, whether costor revenue-based, the guidelines are as follows:
One alternative: If AW 0, the requested MARR is met or exceeded and the alternative is economically justified. Two or more alternatives: Select the alternative with the AW that is numerically largest, that is, less negative or more positive. This indicates a lower AW of cost alternatives or a larger AW of net cash flows for revenue alternatives.
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Seatwork
Lubys Cafeterias is in the process of forming a separate business unit that provides meals to facilities for the elderly, such as assisted care and long-term care centers. Since the meals are prepared in one central location and distributed by trucks throughout the city, the equipment that keeps food and drink cold and hot is very important. Michele is the general manager of this unit, and she wishes to choose between two manufacturers of temperature retention units that are mobile and easy to sterilize after each use. Use the cost estimates below to select the more economic unit at a MARR of 8% per year. Description Initial cost P, $ Hamilton (H) -15,000 Infinity Care (IC) -20,000

Annual M&O, $/year

Refurbishment cost, $ Trade-in value S, % of P Life, years

-6,000
0 20 4

-9,000
-2,000 every 4 years 40 12 AWH = $-9,863 per year AWIC = $-11,571 per year

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