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Session 2139

Didactic Dimensions of the Future Total Worth Model John H. Ristroph, Ph.D., P.E. University of Louisiana at Lafayette

Abstract The future total worth (FTW) model [1] offers a new method for teaching engineering econo m- ics. It is easy to integrate into existing syllabi, and it provides the theoretical foundation for in- structors to address commonly occurring, practical questions such as: 1. Why is the minimum attractive rate of return (MARR) used to compute present worth (PW) and equivalent annual worth (EAW)? 2. What is the definition of equivalence within an industrial context? 3. How are PW and EAW interpreted? 4. Why does choosing the largest PW or EAW maximize a company’s FTW? 5. How should alternatives with different lives be compared? The next section briefly reviews the FTW model, and following sections provide the answers to the above questions. FTW Model A firm’s FTW is its total capital at the end of the planning horizon. The FTW model computes this capital as a function of project selection, thereby enabling the decision maker to select the project that maximizes FTW. Maximizing FTW is an intuitively appealing investment objective, and the FTW model leads to the use of popular criteria such as PW or EAW. There is ample precedent for the use of FTW as an economic criterion. Oakford and Theusen [2] explain the basic investment logic of the FTW model presented below, and then use a different analytical process to reach similar conclusions. Swalm and Lopez-Leautaud base a textbook [3] on this criterion, but their modeling approach does not consider capital budgeting. This leads to the recommendation that the average internal rate of return (IRR) of all future in- vestments should be used as the discount rate, rather than some form of marginal rate, such as the minimum attractive rate of return (MARR). This section explains the effect of capital budget- ing on the investment process, and then it summarizes theoretical results available elsewhere [1]. Investment Process Suppose that the mutually exclusive investments shown in Table 1 are Table 1. Cash Flows under consideration by a firm having $100 of investment capital at time 0. The objective is to chose the alternative that maximizes the Time A B Null capital at the end of the planning horizon, time 3, the firm’s FTW. 0 -10 -9 0 Alternative A initially requires $10, leaving $90 available for 1 7 3 0 other investments, as shown in Table 2. Similarly, alternative B al- 2 5 4 0 lows $91 for other investments, and the null alternative results in all 3 0 5 0 $100 remaining available. All alternatives have a common funding base of at least $90 for other currently unknown investments, and it is assumed this first $90 will

Proceedings of the 2002 American Society for Engineering Education Annual Conference & Exposition Copyright © 2002, American Society for Engineering Education

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Ristroph, J. (2002, June), Didactic Dimensions Of The Future Total Worth Model Paper presented at 2002 Annual Conference, Montreal, Canada. 10.18260/1-2--10105