Engineering Economy
LEARNING OUTCOMES
1. Advantages of AW
2. AW analysis
3. Perpetual life
4. Capital Recovery
© 2012 by McGraw-Hill All Rights Reserved
1
Selection Guidelines for AW Analysis
© 2012 by McGraw-Hill All Rights Reserved
Calculation of Annual Worth
AW for one life cycle is the same for all life cycles!!
An asset has a first cost of $20,000, an annual operating
cost of $8000 and a salvage value of $5000 after 3 years.
Calculate the AW for one and two life cycles at i = 10%
AWone = - 20,000(A/P,10%,3) – 8000 + 5000(A/F,10%,3)
= $-14,532
AWtwo = - 20,000(A/P,10%,6) – 8000 – 15,000(P/F,10%,3)(A/P,10%,6)
+ 5000(A/F,10%,6)
= $-14,532
© 2012 by McGraw-Hill All Rights Reserved
2
Advantages of AW Analysis
AW calculated for only one life cycle
Assumptions:
Services needed for at least the LCM of lives of alternatives
Selected alternative will be repeated in succeeding life cycles
in same manner as for the first life cycle
All cash flows will be same in every life cycle
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ME Alternative Evaluation by AW
Not necessary to use LCM for different life alternatives
A company is considering two machines. Machine X has a first cost of
$30,000, AOC of $18,000, and SV of $7000 after 4 years.
Machine Y will cost $50,000 with an AOC of $16,000 and SV of $9000
after 6 years.
Which machine should the company select at an interest rate of 12% per
year, using AW analysis?
Solution: AWX = -30,000(A/P,12%,4) –18,000 +7,000(A/F,12%,4)
= $-26,412
AWY = -50,000(A/P,12%,6) –16,000 + 9,000(A/F,12%,6)
= $-27,052
Select Machine X; it has the numerically larger AW value
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3
AW of Permanent Investment
Use A = Pi for AW of infinite life alternatives
Find AW over one life cycle for finite life alternatives
Compare the alternatives below using AW and i = 10% per year
C D
First Cost, $ 50,000 250,000
Annual operating cost, $/year 20,000 9,000
Salvage value, $ 5,000 75,000
Life, years 5 ∞
Solution: Find AW of C over 5 years and AW of D using relation A = Pi
AWC = -50,000(A/P,10%,5) – 20,000 + 5,000(A/F,10%,5)
= $-32,371
AWD = Pi + AOC = -250,000(0.10) – 9,000
= $-34,000 Select alternative C
© 2012 by McGraw-Hill All Rights Reserved
Capital Recovery and AW
Capital recovery (CR) is the equivalent annual amount that
an asset, process, or system must earn each year to just
recover the first cost and a stated rate of return over its
expected life. Salvage value is considered when calculating
CR.
CR = -P(A/P,i%,n) + S(A/F,i%,n)
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4
Calculation of Capital Recovery
An asset has a first cost of $20,000, an annual operating
cost of $8000 and a salvage value of $5000 after 3 years.
Determine the capital recovery value at i = 10%
Use previous example: (note: AOC not included in CR )
CR = -20,000(A/P,10%,3) + 5000(A/F,10%,3) = $ – 6532 per year
Now AW = CR + A
AW = – 6532 – 8000 = $ – 14,532
© 2012 by McGraw-Hill All Rights Reserved
Summary of Important Points
AW method converts all cash flows to annual value at MARR
Alternatives can be mutually exclusive, independent,
revenue, or cost
AW comparison is only one life cycle of each alternative
For infinite life alternatives, annualize initial cost as A = P(i)
