Quiz 6 Solution

56:054 Engineering Economy

1. (15 points, 5 points each)

What is Metcalf’s Law

The total value of the network of a technology is proportional to n^2

Give an example of the application of Metcalf’s Law

The value of AOL rests on the substantial empire that AOL has created by managing access to their network. AOL users can see if their friends are on-line and can interact with them using Instant Messaging, where text messages appear in a window. The famous chat capabilities of AOL allow multiple users in a virtual chat room to send messages that all those in the chat room can see. The more subscribers that AOL has, the more useful that these messaging and chat capabilities are.

Why does a "winner takes all" market often take place with information products?

For information products, "network effect" amplifies the value of the product, potentially resulting in a rapidly growing level of sales. As a result the product become dominant in a market as customers rush to this dominant product (tipping effect) and the winning product takes over the market.

2. (10 points)

An investment has a NPV of 100 at an interest rate of 8% and a NPV of –50 at 16%. Use interpolation to calculate the internal rate of return.
(16% - x %)/(16%-8%) = (0-(-50))/(100-(-50))
x = 13.3%

3. Two machines are being compared with a view to purchase. Which machine should be purchased? (15 points)

A B B-A

Initial Cost 200,000 750,000 550,000

Annual benefit 75,000 130,000 75,000

Salvage Value 50,000 150,000 100,000

Useful Life 5 10

Use incremental rate of return to decide the answer. Note: you need only show your working as an equation showing the shorthand form of the economic analysis (e.g. with terms in the form (P/F, i, n) ).

Year	A	B	B-A
0	-200,000	-750,000	-550,000
1	+75,000	+130,000	+55,000
2	+75,000	+130,000	+55,000
3	+75,000	+130,000	+55,000
4	+75,000	+130,000	+55,000
5	+75,000 +50,000 -200,000	+130,000	+55,000 +150,000
6	+75,000	+130,000	+55,000
7	+75,000	+130,000	+55,000
8	+75,000	+130,000	+55,000
9	+75,000	+130,000	+55,000
10	+75,000 +50,000	+130,000 +150,000	+55,000 100,000

PW of cost = PW of benefits

550,000 = 55,000(P/A, i, 10) + 150,000(P/F,i,5) + 100,000(P/F,i,10) or other equivalent representations..

[ Professor O'Grady ]