Section 6.2: CALCULATION OF CAPITAL RECOVERY & AW VALUES

1. What to care about ?i. Initial Investment (P) : The total first cost of all assets and services required

to initiate the alternative.ii. Salvage Value (S): The terminal estimated value of assets at the end of their

useful life.iii. Annual Worth (A): The equivalent annual amount ( costs only for service

alternatives, costs & receipts for revenue alternatives), usually operating cost..

iv. Capital recovery (CR): The equivalent annual cost of owning the asset plus the return on the initial investment.

2. Calculation of CR and AW:

i. Calculating Capital Recovery: CR = - P(A/P,I,n) + S(A/F,I,n)Or CR = - (P-S) (A/P,I,n) - S(i)

ii. Calculating Annual Worth: AW = - CR - A

(“-“ represent costs)

3. Example: Lockheed Martin is increasing its booster thrust power in order to win more satellite launch contracts from European companies interested in opening up new global communications markets. A piece of earth-based tracking equipment is expected to require an investment of $13 million of dollars, with $8 million committed now and the remaining $5 million expended at the end of year 1 of the project. Annual operating cost for the system are expected to start at the first year at $0.9 million, second year at 1 million, increasing 0,1 million per year due to year 8, which is the last year of its useful life. At the end of year 8, the system can be sold for $ 0.5 million. Calculate the AW value for the system, is the corporate MARR is currently 12% per year.

Solution:

CR = - [8.0 + 5.0(P/F, 12%, 1)] (A/P,12%,8) + 0.5 (A/F,12%,8) = $ -2.47( CR = - [8.0 – 0.5 + 5.0(P/F,12%,1)] (A/P,12%,8) - 0.5 (12%) = $ -2.47 )

A = - 0.9 – 0.1 (A/G,12%,8) = $ -1.19

AW = -2.47 - 1.19 = $ 3.66 (million per year )

# Comments:

- Lockheed Martin must earn the equivalent revenue of $ 2.47 million each year from the system just to recover the initial present worth investment plus the required return of 12% per year.

- To prevent getting lost for running the system, it must make at least $ 3.66 million per year .