Annual Cash Flow Analysis

University of Sharjah
Dept. of Civil and Env. Engg.
Engineering Economics
Week 8: Annual Cash Flow Analysis
Dr. Mohsin Siddique

Assistant Professor
[email protected]
Ext: 2943
Date: 14/04/2014
Part I
Outcome of Todays Lecture

After completing this lecture
The students should be able to:
Define equivalent uniform annual cost (EUAC) and Equivalent
uniform annual benefits (EUAB)
Resolve an engineering economic analysis problem into its annual
cash flow equivalent
Conduct an equivalent uniform annual worth (EUAW) analysis
for a single investment
Use EUAW, EUAC, and EUAB to compare alternatives with equal,
common multiple, or continuous lives, or over some fixed study
period.
Techniques for Cash Flow Analysis

Present Worth Analysis
Annual Cash Flow Analysis
Rate of Return Analysis
Incremental Analysis
Other Techniques:
Future Worth Analysis
Benefit-Cost Ratio Analysis
Payback Period Analysis

Concepts of Annual Cash Flow Analysis
Comparing Alternatives using Annual Cash Flow Analysis:

Same-Length Analysis Period
Different-Length Analysis Periods
Infinite-Length Analysis Period
Other Analysis Periods
Techniques for Cash Flow Analysis
Problem 6-1
Compute the value of C for the following diagram, based on 10%
interest rate.
G=$15
$15
=
= $15 + $15 (A/G, 10%, 4)

= $15 + $15 (1.381) = $35.72
0
0
Problem 6-8
As shown in the cash flow diagram, there is an annual disbursement of
money that varies from year to year from $100 to $300 in a fixed pattern
that repeats forever. If interest is 10%, compute the value of A, also
continuing forever, that is equivalent to the fluctuating disbursements.
Problem 6-8
Pattern
repeats
infinitely
There is a repeating series:; 100 200 300 200. Solving this series for A
gives us the A for the infinite series.
Problem 6-8
$100
200
100
100
0
A= $100 + [$100 (P/F, 10%, 2) + $200 (P/F, 10%, 3) + $100 (P/F, 10%, 4)] (A/P, 10%, 4)
= $100 + [$100 (0.8254) + $200 (0.7513) + $100 (0.6830)] (0.3155)
= $100 + [$301.20] (0.3155)
= $195.03
10

The basic idea is to convert all cash flows to a series of EUAW (equivalent
uniform annual worth):
Net EUAW = EUAB -EUAC
EUAC: Equivalent Uniform Annual Cost
EUAB: Equivalent Uniform Annual Benefit
An expenditure increases EUAC and a receipt of money decreases EUAC.

To convert a PW of a cost to EUAC, use:
EUAC = (PW of cost) (A/P, i%, n)
Where there is salvage value?
A = F(A/F, i%, n)
A salvage value will reduce EUAC and increase EUAB
When there is an arithmetic gradient, use the (A/G, i%, n) factor.

If there are irregular cash flows, try to first find PW of these flows; then,
EUAC may be calculated from this PW.
Criteria for selection of an alternative:
Maximize Net EUAW (EUAB EUAC)
Minimize EUACOR Maximize EUAB
11
Analysis Period
Five different analysis-period situations occur:
1. Analysis Period Equal to Alternative Lives
2. Analysis Period a Common Multiple
3. Analysis Period for a Continuing Requirement
4. Infinite Analysis Period
5. Some Other Analysis Period:
Analysis period may be equal to life of the shorter-life

alternative, the longer-life alternative, or something
different. In this case, terminal values at the end of a
specific year become very important.
12
Analysis Period Equal to Alternative Lives

We have an ideal situation (rarely the case in real-life ):
Study period = life-cycle of any of the alternatives
Example 6-6: In addition to the do-nothing alternative, three alternatives
are being considered for improving the operation of an assembly line. Each
of the alternatives has a 10-year life and a scrap value equal to 10% of its
original cost. If interest is 8%, which alternative should be adopted.
13

Plan A
Plan B
$14,000
$1500
$9,000
0
10
10
$6000
$8000
$25,000
$15,000
Plan C
$14,000
14
$33,000
$3300
10
$6000
$2500
15
Problem 6-32
16
Problem 6-32
First Cost
Maintenance
Annual Power Loss
Property Taxes
Salvage Value
17
Useful Life
Around the Lake

$75,000
$3,000/yr
$7,500/yr
$1,500/yr
$45,000
15 years
Under the Lake

$125,000
$2,000/yr
$2,500/yr
$2,500/yr
$25,000
15 years
Problem 6-32
Around the Lake
0
$75,000
$45000
15
$25000
0
Under the Lake
15
$3000
$2000
$7500
$2500
$1500
$2500
$125,000
Around the Lake

EUAC = $75,000 (A/P, 7%, 15) + $12,000 - $45,000 (A/F, 7%, 15)
= $75,000 (0.1098) + $12,000 - $45,000 (0.0398)
= $18,444
Under the Lake
EUAC = $125,000 (A/P, 7%, 15) + $7,000 - $25,000 (A/F, 7%, 15)
= $125,000 (0.1098) + $7,000 - $25,000 (0.0398)
= $19,730
18
Go around the lake.
Analysis Period a Common Multiple of

Alternative Lives
Assume a replacement with an identical item with same cost and
performance. When the lives of two alternatives vary, one can use a
common multiple of the two lives to determine the better project.
Nevertheless, compare alternatives based on their own service lives.
Example 6-7: Two pumps are being considered for purchase. If interest is
7%, which pump should be bought. Assume that Pump B will be replaced
after its useful life by the same one.
19
Analysis Period a Common Multiple of

Alternative Lives
$1000
$1500
0
12
$7,000
(EUAC-EUAB)A
(EUAC-EUAB)B
20
$5,000
Analysis Period with a Repeatability

Assumption
Under the circumstances of identical replacement (repeatability):
If two or more alternatives have
unequal lives, only evaluate the
annual worth (AW) for one life
cycle of each alternative
The annual worth of one cycle
is the same as the annual worth
of all future cycles
21
Problem 6-37
22
Problem 6-37
Machine X
5
$2000
Machine Y
12
0
$150
$5,000
$8,000
Machine X
EUAC= $5,000 (A/P, 8%, 5)= $5,000 (0.2505) = $1,252
Machine Y
EUAC= $8,000(A/P, 8%, 12) + $150 - $2,000 (A/F, 8%, 12)
=8000(0.1327) +150 -2000( 0.0527) = $1,106
Select Machine Y.
23
Part II
24
Analysis Period for a Continuing Requirement

Many civil infrastructure provide a continuing requirement/service.
There is no distinct analysis period; therefore, assume it is long but
undefined.
Compare different-life alternatives assuming identical replacement.
In this case, compare the annual cash flows computed for
alternatives based on their own different service lives.
(EUAC-EUAB)A
(EUAC-EUAB)B
25
Infinite Analysis Period

At times we may have an alternative with a finite useful life in an infinite
analysis period situation.
With identical replacement:
EUAC for infinite analysis period = EUAC for limited life
26
Infinite Analysis Period
EUAC for infinite analysis period = P (A/P ,i, )+ any other annual (costs-benefits)
(A/P, i,) = i
(EUAC-EUAB)A= $100(A/P,8%, ) -$10.00 = $100* 0.08 -$10.00 = $-2.00
(EUAC-EUAB)B= $150(A/P,8%,20) -$17.62 = $150 * 0.1019-$17.62 =$-2.34
(EUAC-EUAB)C= $200(A/P,8%,5) -$55.48 = $200 * 2.505 -$55.48 =$-5.38
27
Select alternative C
Problem 6-41
28
Problem 6-41
Because we may assume identical replacement, we may compare 20 years

of B with an infinite life for A by EUAB EUAC.
Alternative A
EUAB EUAC (for an inf. period)
= $16 - $100 (A/P, 10%, )
= $16 - $100 (0.10)= +$6.00
Alternative B
EUAB EUAC (for 20 yr. period)
= $24 - $150 (A/P, 10%, 20)
= $24 - $150 (0.1175)= +$6.38
Choose Alternative B.
29
Summary
Popular analysis technique:
Easily understood -results are reported in $ per time period,
usually $ per year
AW method is often preferred to the PW method
Only have to evaluate one life cycle of an alternative
Assumption for AW method: Cash flows in one cycle are assumed
to replicate themselves in future cycles
No need to convert lifetimes of all projects to their least common
multiple!
AW offers an advantage for comparing different-life alternatives
For infinite life alternatives, simply multiply P by i to get AW value
30
Assignment # 4
6.7, 6.16, 6.21, 6.29, 6.42
Date of Submission: _____________
Assignment should be hand written
31
Thank You
Feel Free to Contact
[email protected]
Tel. +971 6 5050943 (Ext. 2943)
32

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University of Sharjah

Dept. of Civil and Env. Engg.

Dr. Mohsin Siddique

Outcome of Todays Lecture

Techniques for Cash Flow Analysis