Engineering Economic Analysis

246 INCREMENTAL ANALYSIS

We now see how to solve problems by each of three major methods, with one exception:

for three or more alternatives,no rate of return solution was given. The reason is that under

these circumstances, incremental analysis is required and it has not been djscussed. This

chapter will show how to solve that problem.

Incremental analysis can be defined as the examination of the differences between

alternatives.By emphasizing alternatives,we are really deciding whether or not differential

costs are justified by differential benefits.

In retrospect, we see that the simplest form of incremental analysis was presented

in Chapter 7. We did incremental analysis by the rate of return evaluation of the differ-

ences between two alternatives.We recognized that the two alternatives could be rela.tedas

follows:

[

Higher-~ost

]

=

[

Lower-~ost

]

+

[

Differences

alternatIve alternatIve between them]

We will see that incremental analysis can be examinedeither graphically or numerically.We

will first look at graphical representations of problems, proceed with numerical'solutionsof

rate of return problems, and see that a graphical representation may be useful in examining

problemswhetherusingincrementalanalysisor not. "

Graphical Solutions 8 INCREMENTALANALYSIS

In the last chapter, we examined problems with two alternatives. O~ method of solution

represented a form of incremental analysis. A graphical review of that situation will help

to introduceincrementalanalysis. "

This is a review of Example 7-6, featuring two mutually exclusive alternatives:

Year AIt.1 Alt. 2

o -$10 -$20

1 +15 +28

If 6% interest is assumed, which alternative should be selected?

For this problem, we will plot the two alternatives on a graph showingPW of benefits versus PW

of cost.

Alternative 1

PW of cost=$10

PW of benefits =$15(P/F,6%, 1) = 15(0.9434)

= $14.15:::I".. ~ = II' =11'I:II ill:a

---.. - - 11II.._ ___

T