CE394 Module 2

1. CE394 Module 2 EVALUATION OF ALTERNATIVE INVESTMENTS

2. EVALUATION OF ALTERNATIVE INVESTMENTS • “Alternative” … means “mutually exclusive”. In other words, if 2 projects are described as “alternative”, the occurrence of one project completely precludes the occurrence of another: Either you do one project or you do the other. You cannot do both.

3. EVALUATION OF ALTERNATIVE INVESTMENTS • “Investment” - An undertaking that is associated with a cost and is expected to yield some benefits. - Also referred to as a “project”.

4. EVALUATION OF ALTERNATIVE INVESTMENTS • “Evaluation” means … … comparing the positive impacts (benefits) with the negative impacts (costs) as a basis of deciding whether or not to undertake the project.

5. EVALUATION OF ALTERNATIVE INVESTMENTS • Evaluation of Investments-The General Picture COSTS BENEFITS • Construction costs ($) • Maint./Ops Costs ($) • Air/Noise Pollution • Environ. Degradation • Increased Energy Use, etc. • - • Income/Revenue ($) • Increased Safety • Decreased Congestion • Public Welfare • Salvage Value ($), etc.

6. EVALUATION OF ALTERNATIVE INVESTMENTS This course deals only with those benefits and costs that are quantifiable (i.e., can be expressed in monetary terms ($)) • An advanced course (CE561) deals with the evaluation of both quantifiable and non-quantifiable costs and benefits of civil engineering investments

7. EVALUATION OF ALTERNATIVE INVESTMENTS • Single Project Evaluation - Assessing the benefits and costs of only 1 project, and deciding whether or not to undertake that project. • Examples: - Should a traffic light be installed at a certain intersection? - Should a new treatment plant be built to replace an existing one?

8. EVALUATION OF ALTERNATIVE INVESTMENTS • Multi Project Evaluation - Assessing the benefits and costs of several alternative projects, and deciding which one to undertake. - Note that all alternatives in a given problem address the same objective. • Examples: - What type of traffic light should be installed at a certain intersection? - Which design should be selected for a new treatment plant? - Which location should a new bridge be sited? - What size of bus should a transit company purchase?

9. EVALUATION OF ALTERNATIVE INVESTMENTS • Actually, single-project evaluation is a special case of multi-project evaluation where the number of alternative projects = 2, and one of these is the null alternative (Do Nothing).

10. EVALUATION OF ALTERNATIVE INVESTMENTS • For multi-project evaluation, the “best” project is also … … “most economically feasible” … “optimal” … “Most economically viable” … “most preferred”, etc

11. EVALUATION OF ALTERNATIVE INVESTMENTS • Example: Evaluation of Alternative Bridge Locations ALT 2 ALT 3 ALT 1 OLD Evaluation Criteria The best alternative is the one with the highest Evaluation Criterion.

12. EVALUATION OF ALTERNATIVE INVESTMENTS • Do we always use both benefits and costs in evaluation? No! (1) If all alternative projects have the same cost, then evaluation can be done on the basis of their benefits only

13. EVALUATION OF ALTERNATIVE INVESTMENTS (2) If all alternative projects have the same benefit, then evaluation can be done on the basis of their costs only

14. EVALUATION OF ALTERNATIVE INVESTMENTS (3) If all alternative projects have different benefits and different costs, then evaluation can be done on the basis of both benefits and costs.

15. EVALUATION OF ALTERNATIVE INVESTMENTS METHODS OF ECONOMIC ANALYSIS • Present Worth of all Costs (P) • Equivalent Uniform Annual Costs (EUAC) • Net Present Value (NPV) • Equivalent Uniform Annual Return (EUAR) • Benefit/Cost Ratio (BCR) • Internal Rate of Return (IRR)

16. EVALUATION OF ALTERNATIVE INVESTMENTS • Example: John considers buying an old used car (1988 Oldsmobile) for a part-time pizza delivery business. He expects the following costs and benefits over a 5-year period: Initial Cost (car purchase)= $5,000 Car maintenance cost = $1,000 in year 2 and $1,800 in Year 4 Annual Income from Pizza deliveries = $10,000 Salvage value of the car after Year 5 = $2,000

17. EVALUATION OF ALTERNATIVE INVESTMENTS • Jeff (John’s friend) tries to convince John to buy a fast new small car (Ford Escort 2000) for the pizza delivery business. With the is new car, the following costs and benefits over a 5-year period, are expected: Initial Cost (car purchase)= $13,000 Car maintenance cost = $500 in Year 3 Annual Income from Pizza deliveries = $12,000 Salvage value of the car after Year 5 = $7,000

18. EVALUATION OF ALTERNATIVE INVESTMENTS • Which alternative investment is better? Use each of the following 4 methods of economic evaluation: - Net Present Value - Equivalent Uniform Annual Revenue - Benefit Cost Ratio - Internal Rate of Return Method • Assume 5% interest rate.

19. EVALUATION OF ALTERNATIVE INVESTMENTS 1K 5K 10K 2K 10K 10K 1.8K 10K 10K Alt 1: Alt 2: 1 2 3 0 4 5 13K 12K 0.5K 12K 12K 12K 7K 12K 0 1 2 3 4 5

20. EVALUATION OF ALTERNATIVE INVESTMENTS • The Net Present Value (NPV) Method Alternative 2 is more attractive

21. EVALUATION OF ALTERNATIVE INVESTMENTS • The Equivalent Uniform Annual Return (EUAR) Method Alternative 1 Alternative 2 Alternative 2 is better

22. (III) The BENEFIT/COST RATIO METHOD • B/C Alternative 1 is more attractive

23. (iv) The Rate of Return Method • Internal Rate of Return (IRR) is the interest rate at which … PWB = PWC … NPV = 0 … BCR = 1 • IRR can be found be trial and error or by using the Solver Tool in MS Excel

24. (iv) The Rate of Return Method (Cont’d) • MARR Marginal, or minimum attractive rate of return. Value is dictated by the national economy. If project IRR > MARR, project is attractive If project IRR < MARR, project is unattractive Typically used for single-project evaluations (To do or not to do).