ENGINEERING

ECONOMY
ENGR. ALJON ED E. CASTILLO, RCE

MODULE 9 : COMPARING ALTERNATIVES

COMPARING ALTERNATIVES
DEALS WITH SITUATIONS IN WHICH ONE HAS MORE THAN
ONE CHOICE AND USING ENGINEERING ECONOMIC
PRINCIPLES, ONE NEEDS TO DECIDE BETWEEN THE
ALTERNATIVES SO AS TO GO WITH THE ONE THAT IS MOST
ECONOMICALLY JUSTIFIED
METHODS USED IN THE
SELECTION OF ALTERNATIVES
ØPRESENT WORTH METHOD
Ø ANNUAL COST/WORTH METHOD
Ø EQUIVALENT UNIFORM ANNUAL COST (EUAC) METHOD
Ø RATE OF RETURN (ROR) METHOD
Ø PAYBACK (PAYOUT) PERIOD METHOD
Ø CAPITALIZED COST
Ø BENEFIT/COST RATIO ANALYSIS
PRESENT WORTH METHOD
THIS METHOD INVOLVES FINDING THE EQUIVALENT VALUE OF EACH
ALTERNATIVE AT THE PRESENT TIME, IDENTIFIED AS TIME 0. IF ONLY COSTS
ARE INVOLVED, WE CAN SELECT THE ALTERNATIVE WITH THE SMALLEST
PRESENT WORTH OF COSTS . IF COST AND REVENUES ARE INVOLVED, WE
SELECT THE ALTERNATIVE WITH THE GREATEST PRESENT WORTH ON NET
REVENUES .
TO PERFORM PRESENT WORTH OR ANNUAL WORTH ANALYSIS, AN
INTEREST RATE AND A STUDY PERIOD MUST BE SPECIFIED . THE INTEREST
RATE IS USUALLY THE MINIMUMACCEPTABLERATE OF RETURN (MARR) OF
THE ORGANIZATION .
PRESENT WORTH METHOD
PRESENT WORTH ANALYSIS CAN ONLY BE
USED WHEN THE ALTERNATIVES HAVE THE
SAME LIVES . IF THE ALTERNATIVES HAVE
DIFFERENT LIVES, SOME MECHANISM MUST
BE USED TO COMPARE THEM OVER THE
COMMON STUDY PERIOD .
 SITUATION 1
[Link] FROM TWO DIFFERENT MANUFACTURERS ARE BEING
CONSIDERED FOR APPLICATION . BOTH MOTORS ARE 50 HP, 460
VOLTS, 3- PHASE, 60 HZ, BUT MOTOR A OPERATES AT 80%
EFFICIENCY WHEREAS MOTOR B OPERATES AT 88% EFFICIENCY . THE
EXPECTED USED FOR MOTORS ARE 20 YEARS . MOTOR A COSTS
PHP600 ,000 AND MOTOR B COSTS PHP750,000 . ELECTRICAL
ENERGY COST PHP3.00 PER KW- HR AND THE MOTORS WILL BE
OPERATED AT 8 HOURS PER DAY, 250 DAYS PER YEAR . ASSUME
TAXES ARE 5% AND RATE OF INTEREST IS 10%. WHICH MOTOR IS
PURCHASED? ALSO, LIFE OF BOTH MOTORS IS 15 YEARS .
ANNUAL COST (WORTH) METHOD
THE ANNUAL WORTH METHOD INVOLVES FINDING THE EQUIVALENT END-
OF - PERIOD VALUE OF EACH ALTERNATIVE. THE PERIODS ARE USUALLY IN
YEARS . IF ONLY COSTS ARE INVOLVED, WE CAN SELECT THE ALTERNATIVE
WITH THE SMALLEST EQUIVALENT UNIFORM ANNUAL COST (EUAC) OR NET
ANNUAL COST (NAC) . IF COSTS AND REVENUES ARE INVOLVED, WE CAN
SELECT THE ALTERNATIVE WITH THE GREATEST EQUIVALENT UNIFORM
ANNUAL BENEFIT, OR NET ANNUAL WORTH (NAW).
IF TWO ALTERNATIVES HAVE THE SAME ANNUAL WORTH, THEN THE ONE
WITH THE GREATEST INVESTMENT IS PREFERRED . THE EXTRA INVESTMENT
MAKES EXACTLY THE REQUIRED MARR.
ANNUAL COST (WORTH) METHOD
PROBLEMS THAT CAN BE SOLVED BY THE PRESENT WORTH METHOD CAN
ALSO BE SOLVED BY THE ANNUAL WORTH METHOD. AN ANNUAL WORTH
ANALYSIS IS SOMETIMES PREFERRED OVER A PRESENT WORTH ANALYSIS
BECAUSE PEOPLE THINK BETTER IN TERMS OF ANNUAL AMOUNTS THAN AN
EQUIVALENT AMOUNT TO TIME ZERO . BOTH METHODS YIELD THE SAME
RESULTS.
ANNUAL WORTH ANALYSIS IS THE EASIEST METHOD WHEN THE ALTERNATIVES
HAVE DIFFERENT LIVES . NO SPECIFIC STUDY PERIOD NEED BE SPECIFIED, BUT
THE IMPLICIT ASSUMPTION THAT THE ALTERNATIVE ARE COMPARED OVER THE
LEAST COMMON MULTIPLEOF THE LIVES .
 SITUATION 2
2 . PERFORM A PRESENT WORTH ANALYSIS OF EQUAL SERVICE
MACHINES WITH THE COSTS SHOWN BELOW, IF THE MARR IS 10% PER
YEAR . REVENUES FOR ALL THREE ALTERNATIVES ARE EXPECTED TO BE
THE SAME .
 EQUIVALENT UNIFORM
ANNUAL COST (EUAC) METHOD
IN THIS METHOD, ALL CASH FLOW (IRREGULAR OR UNIFORM) MUST BE
CONVERTED TO AN EQUIVALENT UNIFORM ANNUAL COST, THAT IS, A
YEAR - END AMOUNT WHICH IS THE SAME EACH YEAR . THE ALTERNATIVE
WITH THE LEAST EUAC IS PREFERRED . WHEN THE EUAC METHOD IS USED,
THE EUAC OF THE ALTERNATIVES MUST BE CALCULATED FOR ONE LIFE
CYCLE ONLY. THIS METHOD IS FLEXIBLE AND CAN BE USED FOR ANY TYPE
OF ALTERNATIVE SELECTION PROBLEMS . THE METHOD IS A MODIFICATION
OF THE ANNUAL COST METHOD.
 SITUATION 3
3. A PROJECT ENGINEER WITH ENVIRONCARE IS ASSIGNED TO START UP A NEW
OFFICE IN A CITY WHERE A 6 YEAR CONTRACT HAS BEEN FINALIZED TO TAKE
AND ANALYZE OZONE - LEVEL READINGS . TWO LEASE OPTIONS ARE AVAILABLE,
EACH WITH A FIRST COST ANNUAL LEASE COST, AND DEPOSIT - RETURN
ESTIMATES SHOWN BELOW. RATE OF INTEREST IS 15%.
RATE OF RETURN (ROR) METHOD
RATE OF RETURN (ROR) – IS THE RATE PAID ON THE UNPAID BALANCE OF
BORROWED MONEY OR THE RATE EARNED ON THE UNCOVERED
BALANCED OF AN INVESTMENT. IT IS ALSO CALLED AS INTERNAL RATE OF
RETURN (IRR), RETURN ON INVESTMENT (ROI) AND PROFITABILITY INDEX
(PI).

IF
ROR > MARR, SELECT THE ALTERNATIVE WITH THE BIGGER INVESTMENT
ROR < MARR, SELECT THE ALTERNATIVE WITH THE SMALLER INVESTMENT
RATE OF RETURN (ROR) METHOD
RATE OF RETURN (ROR) – IS THE RATE PAID ON THE UNPAID BALANCE OF
BORROWED MONEY OR THE RATE EARNED ON THE UNCOVERED
BALANCED OF AN INVESTMENT. IT IS ALSO CALLED AS INTERNAL RATE OF
RETURN (IRR), RETURN ON INVESTMENT (ROI) AND PROFITABILITY INDEX
(PI).

IF ROR > MARR, THEN INVESTMENT IS PROFITABLE

IF ROR < MARR, THEN INVESTMENT IS UNPROFITABLE
 SITUATION 1
1. It is estimated that insulation of steam pipes in factory will reduce the fuel bill
by as much as 20 % The cost of the insulation is P90,000 installed and the annual
cost of taxes and insurance is 5% of the initial cost Without insulation, the
annual fuel bill is P180,000 . If the insulation is worthless after 6 years' use, what
would be the rate of return and recovery period? i=12%
 SITUATION 2
2 . A FIRM IS CONSIDERING PURCHASING EQUIPMENT THAT WILL
REDUCE COSTS BY PHP40 ,000 . THE EQUIPMENT COSTS PHP300 ,000
AND HAS A SALVAGE VALUE OF PHP50,000 AND A LIFE OF 7 YEARS .
THE ANNUAL MAINTENANCE COST IS PHP6,000 . WHILE NOT USED BY
THE FIRM, THE EQUIPMENT CAN BE RENTED TO OTHERS TO GENERATE
AN INCOME OF PHP10,000 PER YEAR . IF MONEY CAN BE INVESTED
FOR AN 8% RETURN, IS THE FIRM JUSTIFIED IN BUYING THE
EQUIPMENT?
PAYBACK (PAYOUT) PERIOD METHOD
IN THIS METHOD, THE PAYBACK PERIOD OF EACH ALTERNATIVE IS
COMPUTED . THE ALTERNATIVE WITH SHORTEST PAYBACK PERIOD IS
ADOPTED . THIS METHOD IS SELDOM USED .

PAYBACK PERIOD – IS THE LENGTH OF TIME REQUIRED TO RECOVER THE

FIRST COST OF AN INVESTMENT FROM THE NET CASH FLOW PRODUCED
BY THAT INVESTMENT FOR AN INTEREST RATE OF ZERO .
 SITUATION 1
• IN A MARBLE BLOCK QUARRYING OPERATION, HAND ROCK DRILLS, COSTING PHP50 ,000 EACH,
ARE USED . IT HAS A DRILLING RATE OF 10 CM PER MINUTE, PRODUCES 10 CUBIC METERS OF
BLOCK PER MONTH AND CONSUMES 60 LITERS OF DIESEL FUEL FOR COMPRESSOR DRIVE, PER
ROCK DRILL PER CUBIC METER PRODUCED UTILIZING 1 WORKER PER DRILL.
• A MODERN EQUIPMENT QUARRY BAR MOUNTED ROCK DRILL IS BEING OFFERED FOR PHP180,000
PER UNIT AND HAS A DRILLING RATE OF 60 PER MINUTE THAT WILL PRODUCE 60 CUBIC METERS
OF BLOCK PER MONTH, BUT CONSUMES 120 LITERS OF DIESEL FUEL FOR THE COMPRESSOR
DRIVE, PER 6 CUBIC METERS OF BLOCK UTILIZED, UTILIZING 2 WORKERS PER QUARRY BAR DRILL.
• CONSIDER DIESEL FUEL AT PHP6.00 PER LITER AT THE QUARRIES, WORKER EARNING PHP80.00 PER
DAY, 25 DAYS PER MONTH, 5 YEARS LIFE OF BOTH DRILLS WITH 20 % SALVAGE VALUE,
NEGLECTING COST OF MONEY, OTHER COST AT PHP500 PER CUBIC METER AND MARBLE
BLOCKS SOLD AT PHP2 ,000 PER CUBIC METER. WOULD YOU RECOMMEND THE PURCHASE OF
THE NEW EQUIPMENT?
 CAPITALIZED COST
CAPITALIZED COST – IS THE PRESENT WORTH OF
AN ALTERNATIVE THAT WILL LAST “FOREVER .”
PUBLIC SECTOR PROJECTS SUCH AS BRIDGES,
DAMS, IRRIGATION SYSTEMS AND RAILROAD
FALL INTO THIS CATEGORY .
 SITUATION 1
• TWO METHODS OF CONVEYING EATER ARE BEING STUDIED .
METHOD A REQUIRES A TUNNEL, FIRST COST PHP180,000 , LIFE
PERPETUAL, ANNUAL OPERATION AND UPKEEP IS PHP3,000 .
METHOD B REQUIRES A DITCH PLUS FLUME; FIRST COST OF
DITCH IS PHP40 ,000 , LIFE PERPETUAL, ANNUAL DEPRECIATION AND
UPKEEP IS PHP1,500 , FIRST COST OF FLUME IS PHP30,000 , LIFE 10
YEARS, SALVAGE VALUE IS PHP5,000 , ANNUAL OPERATION AND
UPKEEP IS PHP4,000 . IF MONEY IS WORTH 6%, DETERMINE WHICH
METHOD IS TO BE RECOMMENDED?
 BENEFIT/COST RATIO
ANALYSIS
BENEFIT/COST RATIO ANALYSIS – IT IS THE MOST COMMONLY USED
METHOD BY GOVERNMENT AGENCIES FOR ANALYZING THE DESIRABILITY
OF PUBLIC PROJECTS .

IF B/C ≥ 1.0, ACCEPT THE PROJECT AS ECONOMICALLY ACCEPTABLE

FOR THE ESTIMATES AND DISCOUNT RATE APPLICABLE .
 BENEFIT/COST RATIO
ANALYSIS
ØCOST – ESTIMATED EXPENDITURES TO THE GOVERNMENT ENTITY FOR
CONSTRUCTION, OPERATION, AND MAINTENANCE OF THE PROJECT LESS
ANY EXPECTED SALVAGE VALUE.
ØBENEFITS – ADVANTAGES TO BE EXPERIENCED BY THE OWNERS, THE
PUBLIC .
ØDISBENEFITS – EXPECTED UNDESIRABLE OR NEGATIVE CONSEQUENCES
TO THE OWNERS IF THE ALTERNATIVE IS IMPLEMENTED. DISBENEFITS MAY BE
INDIRECT ECONOMIC DISADVANTAGES OF THE ALTERNATIVE.
 BENEFIT/COST RATIO
ANALYSIS
THE BENEFIT COST RATIO ON THE CAPITAL INVESTED IS

IF B/C < 1, SELECT THE ALTERNATIVE WITH THE LOWER

INVESTMENT/INITIAL COST
IF B/C > 1, SELECT THE ALTERNATIVE WITH THE HIGHER
INVESTMENT/INITIAL COST
 SIGNIFICANT DIFFERENCES IN THE
CHARACTERISTICS OF PUBLIC AND PRIVATE
SECTOR ALTERNATIVES
Characteristic Public Sector Private Sector
Some large; more medium to
Size of Investment Larger
small
Life Estimates Longer (30 – 50+ years) Shorter (2 – 25 years)
Annual Cash Flow
Estimates No profit; costs, benefits and Revenues contribute to profits;
disbenefits are estimated costs are estimated

Taxes, fee, bonds, private Stocks, bonds, loans, individual

Funding
funds owners
Higher, based on market cost of
Interest Rate Lower
capital
Alternative Selection
Multiple criteria Primarily based on rate of return
Criteria
Environment of the
Politically inclined Primarily economic
Evaluation
 SITUATION 1
THE NATIONAL GOVERNMENT INTENDS TO BUILD A DAM AND
HYDROELECTRIC PROJECT IN THE CAGAYAN VALLEY AT A TOTAL COST OF
PHP455 ,500 ,000 . THE PROJECT WILL BE FINANCED BY SOFT FOREIGN LOAN
WITH AN INTEREST OF 5% PER YEAR . THE ANNUAL COST FOR OPERATION,
MAINTENANCE, DISTRIBUTION, FACILITIES AND OTHERS WOULD TOTAL
PHP15,100,000 . ANNUAL REVENUES AND BENEFITS ARE ESTIMATED TO BE
PHP56,500 ,000 .
IF THE STRUCTURES ARE EXPECTED TO LAST FOR 50 YEARS WITH NO
SALVAGE VALUE, IS THE PROJECT ECONOMICALLY ACCEPTABLE?
 SITUATION 2
TWO ROUTES ARE UNDER CONSTRUCTION FOR A NEW HIGHWAY. ROUTE A
WOULD BE LOCATED ABOUT 5 MILES FROM THE CENTRAL BUSINESS
DISTRICT AND WOULD REQUIRE LONGER TRAVEL DISTANCES BY LOCAL
COMMUTER TRAFFIC . ROUTE B WOULD PASS DIRECTLY THROUGH THE
DOWNTOWN AREA AND ALTHOUGH ITS CONSTRUCTION COST WOULD BE
HIGHER, IT WOULD REDUCE THE TRAVEL TIME AND DISTANCE FOR LOCAL
COMMUTERS . THE COSTS FOR THE TWO ROADS ARE AS FOLLOWS :
 SITUATION 2

IF THE ROADS ARE ASSUMED TO LAST FOR 30 YEARS WITH NO SALVAGE

VALUE, WHICH ROUTE SHOULD BE ACCEPTED ON THE BASIS OF A
BENEFIT/COST RATIO ANALYSIS USING AN INTEREST RATE OF 15%.
 SITUATION 3
A small entrepreneur invested a capital of P80,000 for a buy and sell
business. He estimated to have a gross income of P25 ,000 annually and an
operating cost of P6000 annually. It is assumed the business to have a life of
10 years. If the rate of interest is 12%. Compute the benefit cost ratio.
THANK
YOU
ENGR. CASTILLO