Economic Comparisons of Mutually Exclusive Alternatives

Objective: To evaluate and compare mutually exclusive alternatives and select the most economical. The comparison is based on the lifecycle benefits and costs of each alternative over a specified study period.

The Minimum Attractive Rate of Return (MARR)

The lowest interest rate acceptable to the investor.

Comparing Mutually Exclusive Alternatives

The most common evaluation techniques include
1. Present worth analysis,
2. Annual (periodic) worth analysis,
3. Future worth analysis,
4. Internal rate-of-return,
5. Benefit-cost ratio, and
6. Payback period method.

Below is a discussion of each of these techniques.

Present Worth (PW) Analysis

Objective: To evaluate and compare mutually exclusive alternatives based on the equivalent netpresent worth of the lifecycle cash flows for each alternative at a given minimum attractive rate of return (MARR).

• The net present worth is computed as

Net PW = PW(Revenues) – PW(Costs)

• The cash flows include all life-cycle revenues and costs, i.e., all revenues and costs over the service life of the project or investment.

• A zero or positive “Net PW” indicates a “profitable” or “economical” project or investment.

• A positive “Net PW” indicates that the investment or project has an annual rate of return greater than the MARR.

• A zero “Net PW” indicates that the investment or project has an annual rate of return exactly equal to MARR.

• Similarly, a negative “Net PW” indicates that the investment/project has an annual rate of return less than MARR, hence, not preferable.

• When comparing alternatives, the alternative with a higher “Net PW” is preferred over one with a lower “Net PW”.

• Comparing alternatives using the “Net PW” criteria has to be done based on the same analysis period or lifetime for the alternatives.