Engineering Economic Analysis

Applying PresentWorthTechniques 159

An investor paid $8000 to a consulting firm to analyze what he might do with a small parcel of

land on the edge of town that can be bought for $30,000. In their report, the consultants suggested

four alternatives:

*Includes the land and structures but does not include the $8000 fee to the consulting .finn.

Assuming 10% is the minimum attractive rate pf retlirn, what should the investor. do?

AlternativeArepresents the "do-nothing" alternative. Generally, one feasible alternative in any

situation is to remain in the present status and do nothing. In this problem, the investor could

decide that the most attractive alternative is notto purchase the property ~d develop it. Thisis

clearly a do-nothing decision.

We note, however,that if he does nothing, the total venture wouldnot be a very satisfactory

one. Thisis because the investor spent $8000 for professional advice"on the possible uses of the

property. But because the $8000 is a past cost, it is a sunk cost. The only relevant costs in an

economic analysis arepresentandfilJurecosts; past events and past, or sunk, costs are gone and

cannot be allowedto affect future planning. (Past costs may be relevan.tincomputingdepreciation

charges and income taxes, but 110whereelse.) The past should not deter the investor from making

the best decision now, regardless of the costs that brought him to this situatipn arid point of

time.

This problemis one of neitherfixed input nor fixedoutput,so our criterion will be tomaxiIni:z:e

the present worth of benefitsminu~the present worth of cost; Or,simply stated, maxirni:z:enet

present Worth.

I Alter!lativeA,Do Nothing

I

r Alternative B,Vegetable Market

NPW= -50,000 +5100(Pj A, 1O%i4(» +30,000(P/F, 10%, 2Q)

= """"50,0~0--I-Q10Z~85~4)+ 30,000(<l1~86)j! :

= ~50,OOO+ 43,420 + 4460

;;; -~212Q "= = ;;:"" ~ !I'==:'=&_ <=: ==;t =: ~

1:1

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NPW- 0

- ..........-..... _ u..__...

Total Investment Uniform Net Terminal Value

Alternatives Including Land* Annual Benefit at End of 20 yr

A Do nothing $^0 $^0 $^0

B Vegetable market 50,000 5,100 30,000

C Gas station 95,000 10,500 30,000

D Small motel 350,000 36,000 150,000