CE 314 Engineering Economy
Chapter 6
Annual Worth (AW) Analysis
Annual Worth (AW) Analysis
Annual Worth (AW) Analysis is defined as the
equivalent uniform annual worth of all estimated
receipts (income) and disbursements (costs) during
the life cycle of a project.
Salvage Value
Income
n years
Annual Cost
Initial Overhaul Cost
Cost
= n years
Equivalent Uniform Annual Worth ($/year)
1
Annual Worth (AW) Analysis
Two Cases:
1) Alternatives have the same economic life.
2) Alternatives have different economic lives.
Case 1: No problemo. Compute AW for both
alternatives and select alternative that has the
highest AW or lowest Annual Cost (AC).
Case 2: The AW or AC has to be calculated for only
one life cycle.
Example:
A project engineer with EnvironCare is assigned to start up a new office
in a city where a 6-year contract has been finalized to take and to
analyze ozone-level readings. Two lease options are available, each with
a first cost, annual lease cost, and deposit-return estimates as shown
below:
Location A Location B
First Cost, $ -$15,000 -$18,000
Annual lease cost,
-$3,500 -$3,100
$ per year
Deposit Return, $ $1,000 $2,000
Lease Term, years 6 9
2
PW = $45,036
As you will see when we study
Chapter 5, when performing a
Present Worth (PW) Analysis the 3 life cycles
two alternatives must be analyzed
over the same number of years.
In this example, Location A has
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
$1000
an economic life of 6 years. Its 0 1 2 3 4 5 6
competitor Location B has an
Life Cycle 1
i = 15% per year
economic life of 9 years. The $3,500
0 1 2 3 4 5 6
$1000
Least Common Multiple (LCM) of $15,000
Life Cycle 2
years for this example is 18
years. Therefore for Location A
$3,500
$1000
the costs must be duplicated for
$15,000
0 1 2 3 4 5 6
three cycles as shown in the Life Cycle 3
diagram to the right. Two cycles
of Location B would have to be $3,500
used if a PW analysis were $15,000
required.
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
An AW approach makes the
analysis of these two alternatives
continues
easier if we can make the AW = $7349 per year
following assumptions:
Assumptions:
1) The services provided are needed for the indefinite future.
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.
Validity of Assumptions:
1) If the services provided are not expected to be needed in
the future a common economic life must be determined for
the alternatives.
2) If the costs are not expected to change exactly with the
inflation or deflation rate then cash flow estimated must
be made for each life cycle.
More on this later in Chapter 5!
3
Capital Recovery
Capital Recovery is defined as the equivalent annual
cost of owning the asset plus the return on the
initial investment.
CR = - [P(A/P, i%,n) – S(A/F.i%,n)]
Capital Recovery only includes the initial cost and
salvage value!
Relationship between Capital Recovery and AW:
AW = - CR – A
Where A = equivalent annual cost or worth of all
costs with the exception of the initial cost and all
annual receipts with the exception of the salvage
value.
Evaluating Alternatives by Annual Worth (AW) Method
For mutually exclusive alternatives, calculate AW using the
MARR value.
One alternative: AW > or = to 0, MARR is met or exceeded.
Two or more alternatives: Choose the lowest cost or highest
income AW value using the MARR value.
4
AW of a Permanent Investment
There are some situations where financial decisions made by
engineers assume that the life of a project is long enough to be
considered “infinite”. Public Works projects are typically
assumed to have infinite lives. Dams, Stadiums, Airports, etc.
are examples where the economic life of a project is
considered infinite. Endowments for universities are also
considered to have infinite lives since the money taken from
the fund is interest generated by the principal. The principal is
left in the fund indefinitely.
A=P i(1 + i)n
(1 + i)n – 1
For an infinite life n infinity and using L'Hospital's Rule:
lim n infinity = i(n)(1 + i)n-1 = i
n(1 + i)n-1 – 0
AW of a Permanent Investment
A = P(i) for a perpetual investment
This equation determines the equivalent annual worth or cost
of an investment assuming that the project has an infinite
life.
In Chapter 5, we will learn that the Present Worth (PW) of a
perpetual investment is given a special name: Capitalized Cost
(CC).
CC = A/i or CC = AW/i
