Comparing alternatives is the central activity of engineering-economic analysis: given several candidate projects (or design options), pick the best one (or the best subset, if multiple can be done). Five standard methods, all built on the time-value-of-money framework:
| Method | Compute | Decision rule |
|---|---|---|
| Present worth method | Discount all cash flows to time 0, sum | Max PW; accept if PW > 0 |
| Future worth method | Compound all cash flows to time , sum | Max FW; accept if FW > 0 |
| Annual worth method | Amortise PW over project life | Max AW; accept if AW > 0 |
| Internal rate of return | Find rate where PW = 0 | Accept if IRR > MARR; incremental analysis for ME |
| External rate of return | Same idea, fixes multiple-IRR pathology | Accept if ERR > MARR |
| Payback period | Time to recover first cost | Accept if payback ≤ hurdle period |
Six general assumptions underlie the standard comparison machinery:
- Costs and benefits are measurable in dollars.
- Future cash flows are known with certainty (relaxed via Risk and uncertainty methods).
- Cash flows are not affected by Inflation (or inflation is handled explicitly).
- Taxes are not applicable (or handled explicitly via Capital cost allowance).
- There are sufficient funds available — not capital-rationed.
- All investments have a first cost (initial cash outflow at time 0) that is not zero — otherwise there’s nothing to evaluate against.
When two or more alternatives are mutually exclusive, the comparison reduces to “which one?” rather than “which ones?” The PW, FW, and AW methods agree: pick the highest. For IRR, the highest IRR is not the right answer — use incremental analysis (see Internal rate of return).
Common pitfalls:
- Comparing PW across alternatives with different lifespans without aligning them. Either align (repeated-lives / study-period) or use AW.
- Picking on highest IRR instead of incremental IRR for ME alternatives. IRR favours small high-return projects; the right ME choice may be a larger project with lower IRR but more total profit.
- Including sunk costs in the comparison. They wash out — drop them.
- Mixing real and actual dollars without using the matching MARR. See Inflation.
- Forgetting taxes when they’re a material part of the cash flow. See Capital cost allowance.
For specific methods, see the per-method notes. For the methodology of handling complications (inflation, taxes, replacements, risk), see Inflation, Capital cost allowance, Replacement decision, Risk and uncertainty.