MECHANICAL ENGINEERING

DEPARTMENT
3rd year Power
Engineering Economics
&
Vocational Legislations
GEN331

Lecture #07

Dr. Sayed Ali Zayan 2nd Term 2022/2023

Example: B/C ratio
Determine the B/C ratio for a project with the following data.
 First cost $20,000
 Project life 5 years
 Salvage value $ 4,000
 Annual benefits $10,000
 Annual O&M costs $ 4,400
 Interest rate 8%

Solution
 The conventional B/C ratio and modified B/C ratio, based on AW, are computed as follows:

CR =($20,000 — $4,000)(A/P, 8%, 5) + $4,000 (0.08) = $4,327

Example: B/C ratio
Conventional B/C ratio =

Modified B/C ratio =

Since B/C>1.0 (by either ratio), this investment opportunity is

worthwhile.
Example:
Analysis of accidents in one state indicates that
increasing the width of highways from 6 meters to 7.5
meters may decrease the annual accident rate from 125
per 100,000,000 to 72 per 100,000,000 vehicle-
kilometers. Calculate the average daily number of
vehicles that should use a highway to justify widening on
the basis of the following estimates: average loss per
accident, $ gninediw fo tsoc retemolik-rep ;1,500
1.5 tnemevapmeters, $ fo efil lufesu ;150,000
25 ,tnemevorpmiyears; annual maintenance, 3% of first
cost; interest rate, .5%
Solution:
 Annual saving in number of accidents:
125 - 72 = 53 accident / 100,000,000 vehicle-kilometers
 The benefit from the annual saving in number of accidents:
B = (53 accident/100,000,000 Vehicle-Km) (1,500 $/accident)
Or B = 79500 (N) / 100,000,000 $/Km
Where: N = Number of vehicles in the road.
First cost for widening = 150,000 /Km
Annual maintenance = 0.03 ×150,000 $/Km = 4500 $/Km
 Then, total cost
C = 150,000 (A/P, 5%, 25) + 4500
= 150,000 (0.07095) + 4500 = $ 15,142.5 /Km/yr
Solution:
 The No. of vehicles:

B/C = 1 or

B = C
or
N * (79500 /100,000,000) = 15,142.5
then
N = 19,047,160 / yr
 No. of vehicle per day:
N = 19,047,160 / 365 = 52,184 vehicles per day
Comparing Mutually Exclusive Alternatives:
Incremental Analysis
To apply incremental analysis, we compute the incremental differences for
each term (B, I, and C’ ) and take the B/C ratio on the basis of these
differences. To use BC(i) on incremental investment, we may proceed as
follows:
 1. If one or more alternatives have B/C ratios greater than unity, eliminate
any alternatives with a B/C ratio less than that.
 2. Arrange the remaining alternatives in increasing order of the
denominator (I + C').
Thus, the alternative with the smallest denominator should be the first
(j), the alternative with the second smallest denominator should be
second (k), and so forth.
Comparing Mutually Exclusive Alternatives:
Incremental Analysis
3. Compute the incremental differences for each term (B, I, and C’ ) for the
paired alternatives (j, k) in the list:

4. Compute the BC(i) on incremental investment by evaluating

If BC(i)k-j >1, select alternative k. Otherwise select alternative j.

5. Compare the alternative selected with the next one on the list by
computing the incremental benefit–cost ratio. Continue the process until you
reach the bottom of the list. The alternative selected during the last pairing
is the best one.
Example:
Three mutually exclusive alternative public works projects are currently under
consideration. Their respective costs and benefits are included in the table below.
Each of the projects has a useful life of 50 years, and the interest rate is 10
percent per year. Which, if any, of these projects should be selected?

Solution:
Costs:
PWA =$8,500,000 + $750,000(P/A, 10%, 50) - $1,250,000(P/F,10%,50) = $15,925,463
PWB = 10,000,000 + 725,000(P/A, 10%, 50) – 1,750,000(P/F,10%,50) = $ 17,173,333
PWC = 12,000,000 + 700,000 (P/A, 10%,50) – 2,000,000(P/F,10%,50) = $18,923,333
Solution:
Benefits:
PWA = 2,150,000(P/A,10%,50) = $21,316,851
PWB = 2,265,000 (P/A, 10%, 50) = $22,457,055
PWC = $2,500,000 (P/A, 10%, 50) = $ 24,787,036

Project A is acceptable

Reject B and accept A

Decision: Recommend project C

7 Payback Analysis
 Payback analysis is another use of the present worth technique. It is
used to determine the amount of time, usually expressed in years,
required to recover the first cost of an asset or project. Payback is
allied with breakeven analysis; this is illustrated later in the section. The
payback period, also called payback ‫فترة االسترداد‬or payout
period‫فترة الدفع‬, has the following definition and types.
 The payback period np is an estimated time for the revenues, savings,
and any other monetary benefits to completely recover the initial
investment plus a stated rate of return i.

There are two types of payback analysis as determined by the required

return.
 No return; i = 0%: Also called simple payback, this is the recovery of
only the initial investment with no interest.
 Discounted payback; i > 0%: The time value of money is considered in
that some return, for example, 10% per year, must be realized in
addition to recovering the initial investment.
7 Payback Analysis
 The terminology is P for the initial investment in the asset, project, contract,
etc., and NCF for the estimated annual net cash flow. annual NCF is
NCF = cash inflows − cash outflows
 To calculate the payback period for i = 0% or i > 0%, determine the pattern
of the NCF series.

 Note that np is usually not an integer. The equations that determine a

payback period differ for no-return and discounted analyses. For t = 1, 2, . . .
, n p,
No return. i=0%; NCF, varies annually:
Where

P = initial investment,
NCF = the estimated annual Net Cash Flow = cash inflows − cash outflows
7 Payback Analysis
No return, i=0%; annual uniform NCF:

Discounted, i>0%; NCF, varies annually:

Discounted, i>0%; annual uniform NCF:

After np years, the cash flows will recover the investment in year 0 plus the
required return of i%. If the alternative is used more than np years, with the
same or similar cash flows, a larger return results. If the estimated life is less
than np years, there is not enough time to recover the investment and i%
return. It is important to understand that payback analysis neglects all cash
flows after the payback period of np years.
Example:
Two independent investment opportunities are shown
below. What is the payback period for each? If you require
a 3 year payback period, should none, either or both be
purchased?
Solution
Machine A: Assume cash flows occur during each year

 First cost = $15 000

 Annual net benefits = 9 000 − 6 000 = $3 000

 Payback period is (15 000)/(3 000) = 5 years

Machine B:

 First cost = $20 000

 Annual net benefits = $11 000 − 8 000 = $3 000

 Payback period is (20 000)/(3 000) = 6.7 years

(7 years if you assume flows occur at the end of a year)

Therefore you should not invest in either (paybacks too long).

Answer sheet:
Review:
For the following cash flows the correct relationship is:
a. 300 = 80 (P/A,i,4) + 25 (P/F,i,5)
b. 300 = 80 (P/A,i,5) – 215 (P/F,i,5)
c. 300 = 80 (P/A,i,5) + 105 (P/F,i,5)
d. none of the above

John buys a video game for $300. After using it for 2

years, he expects to sell it for $20. If i = 10% per year,
the future worth in dollars is
a. 300(F/P,10%,2) – 20
b. 280 + 10% of 280
c. 20 – 300(F/P,10%,2)
d. 300 – 20(P/F,10%,2)
Review:
 Consider the following cash flow diagram.

What is the value of X if the present worth of the diagram is $400 and the
interest rate is 15% compounded annually?

a. $246 b. $200 c. $165 d. $146

 There are two choices for replacing a punch press. The basic model has a useful
life of 8 years while the deluxe model of 12 years. The analysis period for this
problem under the AW-criterion is
a) 24 years for both b) 4 years for basic and 6 years for deluxe
c) 20 years d) 8 years for basic and 12 years for deluxe
Review:
 A new drill press costs $12,000. It would potentially produce an additional $4,000 of
revenue per year and have an operating expense of $1,200. What is the PW of the
drill press if the new equipment is expected to last 8 years and i = 10%?
a. $14,938 b. $15,534 c. $21,735 d. $19,345
 What type of cash flow series would have a constant increase in regular cash flows?
a. geometric series b. uniform series c. arithmetic series
d. none of the above
 If the present worth of costs exceeds that of the benefits, PW for the project is
a. Positive b. negative c. equal to zero d. always an integer
 While comparing the PW of alternatives of unequal useful lives, the following
assumptions are made EXCEPT
a. The suppliers of the resources will continue in business.
b. The alternatives will cost the same. c. The benefits will remain unchanged.
d. The alternatives are perpetual.
Review:
 In order to establish a contingency fund to replace equipment after
unexpected breakdowns, a manufacturer of thin-wall plastic bottles
plans to deposit $100,000 now and $150,000 two years from now into
an investment account. Assuming the account grows at 15% per year,
the equation that does not represent the future value of the account in
year 5 is:
(a) F = 100,000(F∕P,15%,5) + 150,000(F∕P,15%,3)
(b) F = [100,000(F∕P,15%,2) + 150,000] (F∕P,15%,3)
(c) F = [100,000 + 150,000(P∕F,15%,2)] (F∕P,15%,5)
(d) F = 100,000(F∕P,15%,5) + 150,000(F∕P,15%,2)
Review:
Based on the following cash flows for alternatives X and Y at an interest rate of 10%
per year.

 In comparing the alternatives on a present worth basis, the PW of machine X is

closest to:
(a) $23,160 (b) $40,560 (c) $58,950 (d) $72,432
 In comparing the alternatives on a future worth basis, the FW of machine X is
closest to:
(a) $23,160 (b) $40,560 (c) $58,950 (d) $71,860
 The capitalized cost of machine Y is closest to:
(a) $17,726 (b) $86,590 (c) $177,260 (d) $207,720