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Future Worth Analysis + Capitalized Cost

This document contains information about future worth analysis, life cycle costing, and capitalized cost. It discusses how future worth analysis can be used to evaluate large capital investments over a study period or the lowest common multiple of project lives. Life cycle costing is useful for evaluating the total costs over the entire life of a system, product, or service. Capitalized cost treats alternatives that last forever similarly to perpetual investments by calculating the present worth with an infinite time horizon. The document provides an example problem demonstrating the capitalized cost approach. It also discusses how to evaluate independent projects under budget constraints.

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136 views19 pages

Future Worth Analysis + Capitalized Cost

This document contains information about future worth analysis, life cycle costing, and capitalized cost. It discusses how future worth analysis can be used to evaluate large capital investments over a study period or the lowest common multiple of project lives. Life cycle costing is useful for evaluating the total costs over the entire life of a system, product, or service. Capitalized cost treats alternatives that last forever similarly to perpetual investments by calculating the present worth with an infinite time horizon. The document provides an example problem demonstrating the capitalized cost approach. It also discusses how to evaluate independent projects under budget constraints.

Uploaded by

jefftboi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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&

TODAY:
Presentation by Jhed and Glenna
Future Worth Analysis
Life Cycle Costing
Capitalized Cost

Thought for the Day:

Future Worth Analysis


FW evaluation of alternatives is especially
applicable for LARGE capital investment
situations when maximizing the future worth
of a corporation is important (e.g., buildings,
power generation, acquisitions)
Evaluation approach: Determine FW value
from cash flows or PW with an n value in F/P
factor
equal to study period, or
equal to LCM of alternatives lives

LIFE CYCLE COSTING (LCC)


Another application of PW analysis
Useful when entire life cycle of a system is under evaluation
e.g., new car model or aircraft model; introducing new
technology
PW evaluation must include cost estimates for all stages of the
product or service:
Design (initial and detail)
Development
Production cost
Marketing cost
Operating costs
Warranty commitments
Phase-out costs
etc.

CAPITALIZED COST (CC)


PW of alternative that will last forever
Especially applicable to public project
evaluation (dams, bridges, irrigation,
hospitals, police, etc.)
CC relation is derived using the limit as
n for the P/A factor

PW = A(P/A,i%,n) =
PW = A[1/i ]

CAPITALIZED COST (CC)


Refer to PW as CC when n is large (can be
considered infinite). Then

and AW = CC i
Example: If Php 10,000 earns 10% per year, Php
1,000 is interest earned annually for eternity.
Principal remains in tact
Cash flows for CC computations are of two
types -- recurring and nonrecurring

EXAMPLE
Find CC and A values at i = 5% of long-term public
project with cash flows below. Cycle time is 13 years.
Nonrecurring costs: first $150,000; one-time of $50,000
in year 10
Recurring costs: annual maintenance of $5000 (years 14) and $8000 thereafter; upgrade costs $15,000 each
13 years
Step 1

(cont )

2.

CC of nonrecurring costs:
CC1 = -150,000 50,000(P/F,5%,10) = $-180,695
3. AW of recurring $15,000 upgrade:
AW = -15,000(A/F,5%,13) = $-847 per year
AW of recurring maintenance costs years 1 to :
AW = $-5000 per year forever
4. CC of extra $3000 maintenance for years 5 to :
CC2 = -3000(P/F,5%,4)/0.05 = $-49,362
CC for recurring upgrade and maintenance costs:
CC3 = (-847-5000)/0.05 = $-116,940
5. Total CC obtained by adding all three CC components
CCT = -180,695 49,362 116,940 = $-346,997
The AW value is the annual cost forever:
AW = CC i = -346,997(0.05) = $-17,350

CAPITALIZED COST (CC)


For two long-life or infinite-life alternatives:
SELECT ALTERNATIVE WITH LOWER CC OF
COSTS

For one infinite life and one finite life:


Determine CC for finite life alternative using
AW of 1 life cycle and relation CC = AW/I
SELECT ALTERNATIVE WITH LOWER CC OF
COSTS

CAPITALIZED COST (CC)


1 long-term (assumed infinite); 1 finite life
Long-term alternative (LT): $8 million now; $25,000
renewal annual contract
Short-term alternative (ST): $2.75 million now;
$120,000 AOC; life is n = 5 years
Select better at MARR = 15% per year

CCLT = -8,000,000 25,000/0.15 = $-8.17 million


CCST = AW/0.15
= [-2,750,000(A/P,15%,5) 120,000]/0.15
= $-6.27 million
Conclusion: Select ST with lower CC of costs

INDEPENDENT PROJECTS
Situation: Select from several (m) projects. Revenue
and costs are estimated for each
Solution approach: Basically different from that for ME
alternatives
One-time projects; no equal-service evaluation
necessary; LCM not necessary
Two types of budget situations are possible -- no
limit or stated limit
No limit: select from none (DN alternative) to all m
projects using criterion
SELECT ALL PROJECTS WITH PW 0 AT MARR

INDEPENDENT PROJECTS
Procedure for stated budget limited
evaluation
No more than specified amount (b) can be
invested and each project must
demonstrate PW 0 at MARR
Form ME bundles of projects which do not
exceed limit. Include DN alternative. There
are 2m ME bundles

(cont )

Select from 4 independent


projects at MARR of 15% per
year; b = $15,000

2. PW = investment + NCF(P/A,15%,n)
Project

Life, n

PROCEDURE:

$6646

1. Total of 24 = 16 bundles. Only 6


require $15,000 or less:

-1019 (out)

973

1553

F, G, H, J, FH, DN

PW at 15%

3. PW of viable bundles (after G is


removed)
PWF = $6,646
PWH = $973
PWJ = $1,553
PWFH = 6,646 + 973 = $7,619
PWDN = $0
4. Bundle with largest PW is FH. Select
these two projects

TRY THIS!
1. A mechanical engineer is considering two
robots for purchase by a laptop-assembly
company. Robot X will have a first cost of
P8,000,000, an annual maintenance and
operation (M&O) cost of P3,000,000, and a
P400,000 salvage value. Robot Y will have a
first cost of P9,700,000, an annual M&O cost of
P2,700,000, and a P500,000 salvage value.
Which should be selected on the basis of a futue
worth comparison at an interest rate of 10% per
year? Use a 7-year study period.

TRY THIS!
2. A production plant manager has been presented with two
proposals for automating an assembly process. Proposal A
involves an initial cost of P15,000,000 and annual operating
cost of P2,000,000 per year for the next 4 years. Thereafter,
the operating cost is expected to be P2,700,000. This
equipment is expected to have a 20-year life with no salvage
value. Proposal B requires an initial investment of
P28,000,000 and an annual operating cost of P1,200,000 per
year for the first 3 years. Thereafter, the operating cost is
expected to increase by 120,000 per year. This equipment is
expected to last 20 years and have a P2,000,000 salvage
value. If the companys minimum attractive rate of return is
10%, what proposal is more attractive based on present
worth?

TRY THIS!
3. A new software for the purpose of monitoring
property tax is installed. The installation cost is Php
1,500,000 and there is an additional cost of Php
500,000 after 10 years. The annual software contract
cost is Php 50,000 for the first 4 years and Php
80,000 thereafter. In addition, there is expected to
be a recurring major upgrade cost of Php 150,000
every 13 years. Assume that interest rate is 5%/ year.
If the new software will be used for the indefinite
future, compute the capitalized cost.

REFERENCES:
Blank, Leland & Anthony Tarquin. Engineering
Economy (7th Edition). New York: The
McGraw-Hill Companies, Inc., 2012.
METU Open Courseware (Engineering
Economy and Cost Analysis)
http://ocw.metu.edu.tr/course/view.php?id=80

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