Engineering Economic Analysis

306 UNCERTAINTY IN FUTURE EVENTS

Use the data of Example 10-1 to compute the sensitivity of the decision to the Alt.Bsalvage

value by computing the breakeven value. For Alt.A,NPW=+319. For breakeven between the

alternatives,

NPWA= NPWB

+319 = -2000 +250(P/A,312%, 10) + SalvagevalueB(P/F,312%, 10)

= -2000 + 250(8.317) + Salvage valueB(0.7089)

At the breakeven point

319 + 2000- 2079= 240 =$339

Salvage valueB= 0.7089 0.7089

When Alt.Bsalvage value >$339,Bis preferred; when <$339,Ais preferred.

Breakeven analysis, as shown in Example 10-2, provides one means of examininJ

the impact of the variability of some estimate on the outcome. It helps by answering thl

question, How much variability can a parameter have before the decision will be affected'

While the preferred decision depends on whether the salvage value is above or below the

breakevenvalue,the economicdifferencebetween the alternativesis small when the salvage

value is "close" to breakeven. Breakeven analysis does not answer the basic problem 0

how to take the inherent variability of parameters into account in an economic analysis

This will be considered next.

A Range of Estimates

It is usuallymore realistic to describe parameters with a range of possible values, rather thar

a single value. A range could include an optimistic estimate, the most likely estinlMe7-ant

a pessimistic estimate. Then, the economic analysis can determine whether the decisioni~

sensitive to the range of projected values.

A firm is considering an investment.The most likely data values were found during the feasjbility

study. Analyzing past data of similar projects shows that optimistic values for the first cost and

the annual benefit are 5% better than most likely values. Pessimistic values are 15% worse. The

firm's most experienced project analyst has estimated the values for the useful life and salvage

value.

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