Chapter 5

Present Worth
Analysis

Principles of Engineering Economic Analysis, 6th edition

Systematic Economic Analysis Technique

1. Identify the investment alternatives
2. Define the planning horizon
3. Specify the discount rate
4. Estimate the cash flows
5. Compare the alternatives
6. Perform supplementary analyses
7. Select the preferred investment

Principles of Engineering Economic Analysis, 6th edition

Measures of Economic Worth

Present Worth (> $0)

Future Worth (> $0)
Annual Worth (> $0)
Capitalized Worth (> $0)
Discounted Payback Period (< Value, e.g. 2 yrs)
Payback Period (< Value)
Internal Rate of Return (> MARR)
External Rate of Return (> MARR)
Modified Internal Rate of Return (> MARR)
Benefit/Cost Ratio (> 1.0)

Principles of Engineering Economic Analysis, 6th edition

Measures of Economic Worth

The following are consistent measures of
economic worth, i.e., yield the same
recommendation (if performed correctly)

Present Worth
Future Worth
Annual Worth
Internal Rate of Return
External Rate of Return
Benefit/Cost Ratio

Capitalized worth yields the same

recommendation if the planning horizon is
infinitely long or equal to a least common
multiple of lives of the investment alternatives
Principles of Engineering Economic Analysis, 6th edition

Present Worth Analysis

Ranking versus incremental analysis

Before-tax versus after-tax analysis
Equal versus unequal lives
Single versus multiple alternatives
Finite versus infinite planning horizon
Discounted payback period and payback
period analyses

Principles of Engineering Economic Analysis, 6th edition

Present Worth Method

Single Alternative
converts all cash flows to a single sum
equivalent at time zero using i = MARR
over the planning horizon
the most popular DCF method
n

PW (i %) At (1 i )

i 0

(bring all cash flows back to time zero and add them up!)
Principles of Engineering Economic Analysis, 6th edition

Present Worth Analysis

Multiple Alternatives
n

Maximize PW j (i %) A jt (1 i )
j

i 0

Choose the alternative with the

greatest present worth
Principles of Engineering Economic Analysis, 6th edition

Present Worth Examples

Principles of Engineering Economic Analysis, 6th edition

Discounted Payback Period Method

determines how long it takes to fully
recover an investment while considering the
time value of money
increasing in popularity
determine the smallest value of m such that
m
t
t
t 0

A
(
1

i
)

(determine the point in time when cumulative discounted cash flow > $0)

Principles of Engineering Economic Analysis, 6th edition

Payback Period Method

determines the length of time required to recover the
initial investment without considering the time value of
money
not equivalent to those already considered
a popular method of valuing investments
determine the smallest value of m such that

A 0
t 0

(ignores cash flows that occur after the payback period)

Principles of Engineering Economic Analysis, 6th edition

Discounted Payback Period

Examples

Principles of Engineering Economic Analysis, 6th edition

Capitalized Worth Method

a perpetuity is an investment that has an

infinite life
the capitalized worth is the present worth of
a perpetuity
the capitalized worth indicates the amount
of money needed up front such that the
interest earned will cover the cash flow
requirements forever for the investment
used mostly by government

CW (i ) AW (i ) / i
Principles of Engineering Economic Analysis, 6th edition

Capitalized Worth Method

Examples

Principles of Engineering Economic Analysis, 6th edition

Chapter 6
Future Worth
Analysis

Principles of Engineering Economic Analysis, 6th edition

Systematic Economic Analysis Technique

1. Identify the investment alternatives
2. Define the planning horizon
3. Specify the discount rate
4. Estimate the cash flows
5. Compare the alternatives
6. Perform supplementary analyses
7. Select the preferred investment

Principles of Engineering Economic Analysis, 6th edition

Future Worth Method

converts all cash flows to a single sum
equivalent at the end of the planning
horizon using i = MARR
used mostly for financial planning
not a popular corporate DCF method
n

FW (i %) At (1 i )

n t

t 0

(take all cash flows to time n and add

them up!)
Principles of Engineering Economic Analysis, 6th edition

Future Worth Examples

Principles of Engineering Economic Analysis, 6th edition

Chapter 7
Annual Worth
Analysis

Principles of Engineering Economic Analysis, 6th edition

Systematic Economic Analysis Technique

1. Identify the investment alternatives
2. Define the planning horizon
3. Specify the discount rate
4. Estimate the cash flows
5. Compare the alternatives
6. Perform supplementary analyses
7. Select the preferred investment

Principles of Engineering Economic Analysis, 6th edition

Annual Worth Method

converts all cash flows to a uniform
annual series over the planning
horizon using i=MARR
a popular DCF method

i (1 i )
AW (i %) At (1 i )

n
t 0
(1 i ) 1
AW (i %) PW (i %) ( A | P i %, n)

Principles of Engineering Economic Analysis, 6th edition

Annual Worth Examples

Principles of Engineering Economic Analysis, 6th edition

Capital Recovery Cost

Principles of Engineering Economic Analysis, 6th edition

Capital recovery cost is the uniform annual cost equivalent of the initial
investment and terminal or salvage value for an asset. Specifically, if an
investment of P is made in an asset and the asset is disposed of for a salvage
value of F after years, then, based on the firm's cost of capital of i%, the capital
recovery cost (CR) is defined as
CR = P(A|P, i%,n)-F(A|F,i%,n)
where costs are shown as positive-valued and revenues are shown as
negative-valued.

CFD for Capital Recovery Cost (CR).

Principles of Engineering Economic Analysis, 6th edition

Capital Recovery Cost

Example

Principles of Engineering Economic Analysis, 6th edition