This paper presents a method for incorporating equipment reliability considerations into the optimal design of cogeneration systems for power and desalination. Design optimization is carried out using thermoeconomic theory using exergy as the transferable material while equipment reliability is carried out using the state-space method that uses the Markov process. Procedure for cost allocation of power and water is described. The procedure is applied in an example cogeneration plant using a simple gas turbine, heat recovery steam generator and MSF seawater desalination plant.