146 PRESENTWORTH ANALYSIS
Income Taxes
This aspect of economic analyses, like inflationand deflation,must be considered to findthe
real payoff of a project. However,taxes will often affect alternativessimilarly,allowingus to
compare our choices without considering income taxes. So, we will defer our introduction
of income taxes into economic analyses until later.
Economic Criteria
We have shown how to manipulate cash flows in a variety of ways, and in so doing we
can now solve many kinds of compound interest problems. But engineering economic
analysis is more than simply solving interestproblems.The decisionprocess (seeFigure 1-1)
requires that the outcomes of feasible alternativesbe arranged so that they may be judged
for economic efficiency in terms of the selection criterion. The economic criterion will be
one of the following, depending on the situation1:
Situation
For fixed input
For fixed output
Neither input nor output fixed
Criterion
Maximize output
Minimize input
Maximize (output- input)
We will now examine ways to resolve engineering problems, so that criteria for economic
efficiency can be applied.
Equivalenceprovides the logic by which we may adjust the cash flow for a given alter-'
native into some equivalent sum or series.To apply the selection criterion to the outcomes of
the feasible alternatives, we must first resolve them into comparable units. The question is,
How should they be compared? In this chapter we'll learn how analysis can resolve alterna-
tives intoequivalent present consequences,referred to simply as present worth analysis.
Chapter 6 will show how given alternativesare convertedinto anequivalentuniform annual
cashflow,and Chapter 7 solves for the interest rate at which favorableconsequences-that
is,benefits-are equivalent to unfavorable consequences--orcosts.
As a general rule, any economic analysis problem may be solved by the methods
presented in this and in the two following chapters. This is true becausepresent worth,
annual cash flow,andrate of returnare exact methods that will always yield the same
solution in selectingthe best alternativefrom amonga set of mutually exclusivealternatives.2
Some problems, however, may be more easily solved by one method than by another. For"
this reason, we now focus on the kinds of problems that are most readily solved by preseJ?-t
worth analysis.
IThe short table summarizes the discussion on selection of criteria in Chapter 1 (see item 5, select
the criterion to determine the best alternative, page 9).
2"Mutually exclusive" means that selecting one alternative precludes selecting any other alternative.
For example, constructing a gas station and constructing a drive-in restaurant on a particular piece of
vacant land are mutually exclusive alternatives.
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