Bunker Hill Community College Intro to Engg

Prof. Jacobs Spring 2019 ENR-101

Introduction to Engineering

Engineering Economics

This homework will walk through the procedure of cost-benefit analysis of a relatively simple cash flow.

You will evaluate two design alternatives based on both a comparison of the net present value and the

internal rate of returns. Remember that the steps that you are going to walk through here are

conducted at the end of an arduous process of coming up with a reasonable estimate of costs and

benefits. For public expenditures this would likely include discussions with and possibly polling of the

public and public interest groups. These are typically referred to as “stakeholders”. Years ago,

stakeholder interests were largely ignored, however in today’s political environment they may be

decisive.

As discussed in class, there are two fundamental means of comparing design alternatives. The

equivalence method simply calculates the Net Present Value for each design alternative at a specified

discount rate. If no alternative has a Net Present Value greater than 0, then the do-nothing alternative

is preferable. If one or more Net Present Value is greater than 0, then the design alternative with the

higher Net Present Value is selected.

For the rate of return method, the alternatives are compared based on the internal rate of return of the

incremental costs and benefits between alternatives and the institution’s project planning discount rate.

The internal rate of return is the discount rate for which a project’s Net Present value are equal to zero.

We’ll work out an example with two alternatives to explain further how this works.

Design Alternative 1

Cash Flow Item | Amount |

Initial cost | $1,000,000 |

Annual maintenance | $40,000 per year in year 1 with increase of $60,000 per year in subsequent years |

Annual Benefit | $375,000 per year |

Project Life | 10 years |

Bunker Hill Community College Intro to Engg

Prof. Jacobs Spring 2019 ENR-101

Design Alternative 2

Cash Flow Item | Amount |

Initial cost | $1,500,000 |

Annual maintenance | $40,000 per year in year 1 with increase of $60,000 per year in subsequent years |

Annual Benefit | $450,000 per year |

Project Life | 10 years |

Procedure:

Create Cash Flow Diagrams

1. Tabulate the cash flows for design alternatives 1 and 2. Make sure to note costs as negative

values and benefits as positive.

2. Plot the cash flow for alternative 1 as a bar chart. (Hint: In my experience, if you are doing this

in Excel and select the project year and cash flow as two columns of data and then insert a

column chart, you’ll find that it will create a bar chart with the year and the cash flow as two

categories. In order to get Excel to plot the project year on the x-axis, I found that I needed to

select Insert -> Recommended Charts and then selected the 2nd item, which was a bar chart in

which the year 0 coincides with the first bar from the left.) Here’s what I get for alternative 1.

3. Plot the cash flow for alternative 2 as a bar chart.

($1,200,000.00)

($1,000,000.00)

($800,000.00)

($600,000.00)

($400,000.00)

($200,000.00)

$0.00

$200,000.00

$400,000.00

0 1 2 3 4 5 6 7 8 9 10

Cash Flow Diagram for Alternative 1

Bunker Hill Community College Intro to Engg

Prof. Jacobs Spring 2019 ENR-101

Rank Alternatives using Equivalence Method

4. Using the table below, calculate P/G for a discount rate of 7 percent and a duration of ten years.

Present Value of |
Converts | Symbol | Formula |

Single Payment | To P from F | ( |