Engineering Economy

Lecture 8
Evaluating a Single Project
PW, FW, and AW

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 Capital Projects Evaluation
1. Present worth (PW)
2. Future worth (FW)
3. Annual worth (AW)
4. Internal rate of return (IRR)
5. Payback period (generally not appropriate as a
primary decision rule)

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 Minimum Attractive Rate of
Return (MARR)
A capital project must provide a return that exceeds a
minimum level established by the organization to be
attractive.

This minimum level is reflected in a firm’s Minimum

Attractive Rate of Return (MARR).

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 Market/
Salvage
Annual value
Revenues

0 10

Annual
Expenses

Investment

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  A positive PW or FW or AW for an
investment project means that the project is
acceptable
 PW > 0 ✔
 FW > 0 ✔
 AW > 0 ✔

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 Present Worth Method
 The most frequently used method.
 The present worth (PW) is found by discounting all
cash inflows and outflows to the present time at an
interest rate equal to MARR.
PW(MARR%)

 A positive PW for an investment project means that

the project is acceptable (it satisfies the MARR).
PW(MARR%) > 0 ✔

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 Example 1
Consider a project that has an initial investment of
$50,000 and that returns $18,000 per year for the
next four years. If the MARR is 12%, is this a good
investment?

PW(12%) = -50,000 + 18,000 (P/A, 12%, 4)

PW(12%) = -50,000 + 18,000 (3.0373)

PW(12%) = $4,671.40 → This is a good investment!

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 Example 2
A piece of new equipment has been
proposed by engineers to increase
the productivity of a certain manual
welding operation. The investment
cost is $25,000, and the equipment
will have a market value of $5,000 at
the end of a study period of five
years.
Increased productivity attributable to
the equipment will amount to $8,000
per year after extra operating costs
have been subtracted from the
revenue generated by the additional
production.
If the firm's MARR is 20% per year,
is this proposal a sound one? Use the
PW method.
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 Example 2 Solution
PW(20%)=

$8,000(P/A,20%,5) + $5,000(P/F,20%,5) – $25,000

=$934.29

This equipment is economically justified

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 Future Worth Method

 FW is based on the equivalent worth of all cash

inflows and outflows at the end of the study
period at an interest rate equal to MARR.
 Decisions made using FW and PW will be the
same.

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 Example 2 again using FW
A piece of new equipment has been
proposed by engineers to increase
the productivity of a certain manual
welding operation. The investment
cost is $25,000, and the equipment
will have a market value of $5,000 at
the end of a study period of five
years.
Increased productivity attributable to
the equipment will amount to $8,000
per year after extra operating costs
have been subtracted from the
revenue generated by the additional
production.
If the firm's MARR is 20% per year,
is this proposal a sound one? Use the
FW method.
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 Example 2 Solution
PW(20%)=
– $25,000 +$8,000(P/A,20%,5) +
$5,000(P/F,20%,5)
=$934.29
FW(20%)=
$5,000 +$8,000(F/A,20%,5) – $25,000(F/P,20%,5)
=$2,324.80
This equipment is economically justified

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 Annual Worth Method
 Annual worth is an equal periodic series of
dollar amounts that is equivalent to the cash
inflows and outflows, at an interest rate equal
to MARR.
 The AW of a project is annual equivalent
revenue or savings minus annual equivalent
expenses, less its annual capital recovery (CR)
amount.

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 Capital Recovery
 CR is the annual equivalent cost of the capital
invested.

 The CR covers the following items.

 Loss in value of the asset.
 Interest on invested capital (at the MARR).
 The CR distributes the initial cost (I) and the
salvage value (S) across the life of the asset.

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 A project requires an initial investment of $45,000,
has a salvage value of $12,000 after six years, incurs
annual expenses of $6,000, and provides an annual
revenue of $18,000. Using a MARR of 10%,
determine the AW of this project.

Since the AW is positive, it’s a good investment.

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 Example 2 again using AW
A piece of new equipment has been
proposed by engineers to increase
the productivity of a certain manual
welding operation. The investment
cost is $25,000, and the equipment
will have a market value of $5,000 at
the end of a study period of five
years.
Increased productivity attributable to
the equipment will amount to $8,000
per year after extra operating costs
have been subtracted from the
revenue generated by the additional
production.
If the firm's MARR is 20% per year,
is this proposal a sound one? Use the
AW method.
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 Example 2 Solution
PW(20%)=

$8,000(P/A,20%,5) + $5,000(P/F,20%,5) – $25,000

=$934.29

FW(20%)=

$8,000(F/A,20%,5) + $5,000 – $25,000(F/P,20%,5)

=$2,324.80

AW(20%)= R–E Capital Recovery CR

$8,000 + $5,000(A/F,20%,5) – $25,000(A/P,20%,5)

=$312.40

This equipment is economically justified

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 Thank you!

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