Matakuliah
Tahun
: D0762 – Ekonomi Teknik
: 2009
Selection Analysis Method
Course Outline 9
Outline
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Mutually Exclusive
Basic Concepts
Method for Comparing Mutually Exclusive Alternatives
Alternatives Selection
Choice of MARR
2
Mutually Exclusive
• Engineering projects can be accomplished by more than
one feasible design alternative
• Selection one of these alternatives excludes the choice
of any of the others, the alternatives are called mutually
exclusive.
• Sometimes alternatives may have different useful lives.
3
Basic Concepts For Comparing
• Develop the alternatives
– The choice (decision) is among alternatives. The Alternatives
need to be identified and then defined for subsequent analysis
• Focus on Differences
– Only the differences in expected future outcomes among the
alternatives are relevant to their comparison and should be
considered in the decision
• Use a Consistent Viewpoint
– The prospective outcomes of the alternatives, economic and
other, should be consistently developed from a defined viewpoint
• Use a Common Unit of Measure
– Using a common unit of measurement to enumerate as many of
the prospective outcomes as possible will simplify the analysis of4
the alternatives
Basic Concepts For Comparing
• Consider All Relevant Criteria
– Selection of a preferred alternative (decision making) requires
the use of a criterion (or several criteria). The decision process
should consider both the outcomes enumerated in the monetary
unit and those expressed in some other unit of measurement or
made explicit in a descriptive manner
• Make Risk and Uncertainty Explicit
– Risk and uncertainty are inherent in estimating the future
outcomes of the alternatives and should be recognized in their
analysis and comparison
• Revisit Your Decision
– Improved decision making result from an adaptive process; to
the extent practicable, the initial projected outcomes of the
5
selected alternative should be subsequently compared with
Choosing Analysis Method
We have now seen three major economic analysis techniques:
1.
present worth analysis (PW analysis),
2.
annual cash flow analysis (ACF analysis),
3.
rate of return analysis (ROR analysis).
Which method should be used for any particular problem?
The following points are important:
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
You must know the MARR to use PW analysis or ACF analysis.
PW analysis and ACF are often simpler than ROR analysis.
In some contexts, ROR is easiest to explain. In others, ACF analysis is easier to
explain
The company you work for may dictate the analysis method you must use.
ROR analysis is most often used in industry.
6
Comparing Mutually Exclusive
Alternatives
Evaluation
Period
Type of Alternatives
Recommended
Method
Series to evaluate
Equal lives of alternatives
Revenue or service
Public Sector
AW or PW
B/C based on AW or PW
Cash Flow
Incremental Cash Flow
Unequal lives of alternatives
Revenue or service
Public Sector
AW
B/C based on AW
Cash Flow
Incremental Cash Flow
Study period
Revenue or service
Public Sector
AW or PW
B/C based on AW or PW
Updated Cash Flow
Updated Incremental Cash
Flow
Long to infinite
Revenue or service
Public Sector
AW or PW
B/C based on AW
Cash Flow
Incremental Cash Flow
After choosing method, define interest rate best on evaluate method,
show on next table
7
Evaluation Method for Selecting Alternatives
Evaluation
Method
Equivalence
Relation
Lives of
Alternatives
Time Periods
for Analysis
Series to
Evaluate
Rate of Return;
Interest Rate
Decision
Guideline:
Select*
Present Worth
PW
Equal
Lives
Cash flow
MARR
Numerically
largest PW
PW
Unequal
LCM
Cash flow
MARR
Numerically
largest PW
PW
Study period
Study period
Updated cash
flow
MARR
Numerically
largest PW
CC
Long to infinite
Infinity
Cash flow
MARR
Numerically
largest CC
Future Worth
FW
Same as present worth for equal lives, unequal lives, and study period
Numerically
largest FW
Annual Worth
AW
Equal
Or unequal
Lives
Cash flow
MARR
Numerically
largest AW
AW
Study period
Study period
Updated cash
flow
MARR
Numerically
largest AW
AW
Long to infinite
Infinity
Cash flow
MARR
Numerically
largest AW
* Lowest equivalent cost or largest equivalent income
8
Evaluation Method for Selecting Alternatives
Evaluation
Method
Equivalence
Relation
Lives of
Alternatives
Time Periods
for Analysis
Series to
Evaluate
Rate of Return;
Interest Rate
Decision
Guideline:
Select*
Rate of Return
PW or AW
Equal
Lives
Incremental
cash flow
Find Di*
Last Di*>
MARR
PW or AW
Unequal
LCM of pair
Incremental
cash flow
Find Di*
Last Di*>
MARR
AW
Unequal
Lives
Cash flow
Find Di*
Last Di*>
MARR
PW or AW
Study period
Study period
Updated
Incremental
cash flow
Find Di*
Last Di*>
MARR
PW
Equal or
Unequal
LCM of pair
Incremental
cash flow
Discount rate
Last D B/C >
1.0
AW
Equal or
Unequal
Lives
Incremental
cash flow
Discount rate
Last D B/C >
1.0
AW or PW
Long to infinite
Infinity
Incremental
cash flow
Discount rate
Last D B/C >
1.0
Benefit / Cost
* Lowest equivalent cost or largest equivalent income
9
Choice of MARR
Or you can choose MARR based on:
• Choice of MARR when Project Financing is Known
• Choice of MARR when Project Financing is Unknown
• Choice of MARR under Capital Rationing
10
Choice of MARR when Project Financing is Known
Explicit accounts
For debt flows
When you find the
Net present worth of
the project, use cost
of equity (ie) as the
discount rate.
11
Choice of MARR as a Function of Budget
Project
AO
Cash Flow
A1
IRR
1
-$10,000
$12,000
20%
2
-10,000
11,500
15
3
-10,000
11,000
10
4
-10,000
10,800
8
5
-10,000
10,700
7
6
-10,000
10,400
4
Borrowing rate
(k) = 10%
Lending rate
(r) = 6%
Bina Nusantara
Rate of return (%)
An Investment Opportunity Schedule
24
22
20
18
16
14
12
10
8
6
4
2
Project 1
Project 2
Project 3
Project 4
Project 5
20%
0
15%
10%
8%
7%
$20,000
$40,000
Required capital budget
Bina Nusantara
Project 6
4%
$60,000
Rate of return (%)
A Choice of MARR under Capital Rationing
24
22
20
18
16
14
12
10
8
6
4
2
Borrowing rate (k) = 10%
Lending rate (r) = 6%
Project 1
Project 2
k = 10%
Project 3
MARR
Project 4
Project 5 Project 6
20%
0
15%
10%
8%
7%
$20,000
$40,000
Required capital budget
Bina Nusantara
4%
$60,000
r = 6%
Capital Budgeting
• Evaluation of Multiple Investment Alternatives
– Independent projects
– Dependent projects
• Capital Budgeting Decisions with Limited Budgets
Bina Nusantara
Independent Projects
Alternative
Bina Nusantara
Description
Xa
Xb
1
Reject A, Reject B
0
0
2
Accept A, Reject B
1
0
3
Reject A, Accept B
0
1
4
Accept A, Accept B
1
1
Mutually Exclusive Projects
Bina Nusantara
Alternative
(XA1, XA2)
(XB1,XB2)
1
(0,0)
(0,0)
2
(1,0)
(0,0)
3
(0,1)
(0,0)
4
(0,0)
(1,0)
5
(0,0)
(0,1)
6
(1,0)
(1,0)
7
(0,1)
(1,0)
8
(1,0)
(0,1)
9
(0,1)
(0,1)
Contingent Projects
Alternative
XA
XB
XC
1
0
0
0
2
1
0
0
3
1
1
0
4
1
1
1
Bina Nusantara
Four Energy Saving Projects under Budget Constraints
(Budget Limit = $250,000)
Project
Investment
Annual
O&M Cost
Annual Savings
(Energy)
Annual
Savings
(Dollars)
IRR
1
$46,800
$1,200
151,000 kWh
$11,778
15.43%
2
104,850
1,050
513,077 kWh
40,020
33.48%
3
135,480
1,350
6,700,000 CF
32,493
15.95%
4
94,230
942
385,962 kWh
30,105
34.40%
Bina Nusantara
Marginal Cost of Capital Schedule (MCC) and Investment
Opportunity Schedule (OSC)
Bina Nusantara
Optimal Capital Budget
Bina Nusantara