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SEEM 2440A/B - ENGINEERING ECONOMICS

First term (2011 2012)

Assignment 6

Due: 5:00 p.m., 2-Dec-2011 (Friday)

Important notes:

1. You must submit your assignment on time. No late assignment will be accepted. 2. You must drop your assignment into the assignment collection box A18. Dont

hand in your assignment to instructor and TAs.

3. Unless otherwise stated, each question carries 4 points.

The number in the parentheses is the problem number in the textbook (Engineering

Economy, by William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling, 15th

edition, Pearson Education, Inc.).

1. (7-29) Your company has just signed a three-year nonrenewable contract with the city of New Orleans for earthmoving work. You are investigating the purchase of

heavy construction equipment for this job. The equipment costs $200,000 (adjusted

cost basis) and qualifies for five-year MACRS depreciation. At the end of the

three-year contract, you expect to be able to sell the equipment for $70,000. If the

project operating expense for the equipment is $65,000 per year, what is the after

tax equivalent uniform annual cost (EUAC) of owning and operating this

equipment under this three-year contract? The effective income tax rate is 40%,

and the after-tax MARR is 12% per year.

2. (7-44) A firm is considering buying a new machine and has to choose between two options. The specifications of each are given below:

Machine I Machine II

Initial cost (Adjusted cost

basis) at time 0 ($)

100,000 80,000

Operating cost at the end of

year k (1 k useful life) ($)

20,000 25,000

Useful life (years) 5 5

Market value at the end of the

useful life ($)

40,000 15,000

For each machine, assume a three-year MACRS (GDS) recovery property and

depreciation class (i.e. recovery period = 3 years), with an effective income tax rate

of 50% and after tax MARR of 15% per year. Based on the after-tax PW analysis,

find the alternative that should be selected.

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3. Assume the base period b is at the end of year 1 (i.e. b = 1). Let Ak and Rk be the

actual dollar and real dollar at the end of year k where 1 k N respectively. Define the PW of the actual dollar and real dollar cash flows at the end of year 1 as

follows:

N

k

ckcA kiFPAiPW1

11%,,/% ;

N

k

rkrR kiFPRiPW1

11%,,/% .

Prove that PWA(ic%) = PWR(ir%).

4. (8-6) Assuming today is time 0. Annual expenses for two alternatives have been estimated a project manager as follows:

EOY Project A

(Estimated in Actual Dollars)

Project B

(in todays purchasing power)

1 $100,000 $ 80,000

2 112,000 100,000

3 136,000 120,000

4 150,000 140,000

If the average general price inflation rate is expected to be 4% per year and the real

rate of interest is 9% per year, show which alternative has the least negative

present worth in the base period.

5. (8-40) Your company must obtain some laser measurement devices for the next six years and is considering leasing. You have been directed to perform an actual-

dollar after-tax study of the leasing approach. The pertinent information for the

study is as follows:

Lease costs: First year, $80,000; second year, $60,000; third through sixth years,

$50,000 per year. Assume that a six-year contract has been offered by the lessor

that fixes these costs over the six-year period.

Other costs (not covered under contract): $4,000 in year-zero dollars, and the total

increase rate is estimated to be 10% each year.

Effective income tax rate: 40%.

a. Develop the actual-dollar ATCF for the leasing alternative.

b. If the real MARR (ir) after taxes is 5% per year and the annual inflation rate (f) is 9.524% per year, what is the actual-dollar after-tax equivalent annual cost for

the leasing alternative?

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6. (10-13) A nonprofit government corporation is considering two alternatives for generating power (must choose one of them):

Alternative A

Build a coal-powered generating facility at a cost of $20,000,000. Annual power

sales are expected to be $1,000,000 per year. Annual operating and maintenance

costs are $200,000 per year. A benefit of this alternative is that it is expected to

attract new industry, worth $500,000 per year, to the region.

Alternative B

Build a hydroelectric generating facility. The capital investment, power sales, and

operating costs are $30,000,000, $800,000, and $100,000 per year, respectively.

Annual benefits of this alternative are as follows:

Food-control savings $600,000

Irrigation $200,000

Recreation $100,000

Ability to attract new industry $400,000

Suppose that the facilities in both Alternatives A and B have the zero salvage value.

The useful life of both alternatives is 50 years. Using an interest rate of 5%,

determine which alternative (if either) should be selected according to the AW

version of the conventional B-C ratio method. Include DN as one of the possible

alternatives in your analysis.

7. (10-20) The city of Oak Ridge is evaluating three mutually exclusive landscaping plans for refurbishing a public greenway. Benefits to the community have been

estimated by a landscaping committee, and the costs of planting trees and

shrubbery, as well as maintaining the greenway, are summarized below. The citys discount rate is 8% per year, and the planning horizon is 10 years.

Plan

A B C

Initial planting cost at time 0 ($) 75,000 50,000 65,000

Annual maintenance expense at the

end of year k (1 k useful life) ($)

4,000 5,000 4,700

Annual community benefits at the

end of year k (1 k useful life) ($)

20,000 18,000 20,000

a. Assume the city also considers DN as one of the possible alternatives. Use the PW version of the modified B-C ratio method to recommend the best plan.

b. Repeat (a) with the AW version of the conventional B-C ratio method. Which plan is the best?

c. Should the recommendation in (a) and (b) be the same? Why or Why not?

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