For Engineering Economics courses, found in departments of Industrial, Civil, Mechanical, and Electrical Engineering. From the author of the best-selling Contemporary Engineering Economics text, Fundamentals of Engineering Economics offers a concise, but in-depth coverage of all fundamental topics of Engineering Economics.
PART 1 UNDERSTANDING MONEY AND ITS MANAGEMENT 1 Chapter 1 Engineering Economic Decisions 2 1.1 The Rational-Decision-Making Process 4 1.1.1 How Do We Make Typical Personal Decisions? 4 1.1.2 How Do We Approach an Engineering Design Problem? 7 1.1.3 What Makes Economic Decisions Different from Other Design Decisions? 10 1.2 The Engineers Role in Business 10 1.2.1 Making Capital-Expenditure Decisions 10 1.2.2 Large-Scale Engineering Economic Decisions 11 1.2.3 Impact of Engineering Projects on Financial Statements 13 1.3 Types of Strategic Engineering Economic Decisions 14 1.4 Fundamental Principles in Engineering Economics 18 Summary 19 Chapter 2 Time Value of Money 20 2.1 Interest: The Cost of Money 22 2.1.1 The Time Value of Money 22 2.1.2 Elements of Transactions Involving Interest 24 2.1.3 Methods of Calculating Interest 26 2.2 Economic Equivalence 28 2.2.1 Definition and Simple Calculations 28 2.2.2 Equivalence Calculations Require a Common Time Basis for Comparison 31 2.3 Interest Formulas for Single Cash Flows 33 2.3.1 Compound-Amount Factor 33 2.3.2 Present-Worth Factor 35 2.3.3 Solving for Time and Interest Rates 38 2.4 Uneven-Payment Series 40 2.5 Equal-Payment Series 42 2.5.1 Compound-Amount Factor: Find F, Given A, i, and N 43 2.5.2 Sinking-Fund Factor: Find A, Given F, i, and N 47 2.5.3 Capital-Recovery Factor (Annuity Factor): Find A, Given P, i and N 49 2.5.4 Present-Worth Factor: Find P, Given A, i, and N 52 2.5.5 Present Value of Perpetuities 57 2.6 Dealing with Gradient Series 57 2.6.1 Handling Linear Gradient Series 58 2.6.2 Handling Geometric Gradient Series 64 2.7 Composite Cash Flows 68 Summary 72 Problems 73 Chapter 3 Understanding Money Management 86 3.1 Market Interest Rates 87 3.1.1 Nominal Interest Rates 88 3.1.2 Annual Effective Yields 88 3.2 Calculating Effective Interest Rates Based on Payment Periods 91 3.2.1 Discrete Compounding 91 3.2.2 Continuous Compounding 92 3.3 Equivalence Calculations with Effective Interest Rates 94 3.3.1 Compounding Period Equal to Payment Period 94 3.3.2 Compounding Occurs at a Different Rate than That at Which Payments Are Made 97 3.4 Debt Management 100 3.4.1 Borrowing with Credit Cards 100 3.4.2 Commercial Loans--Calculating Principal and Interest Payments 102 3.4.3 Comparing Different Financing Options 106 Summary 111 Problems 111 Chapter 4 Equivalence Calculations under Inflation 126 4.1 Measure of Inflation 127 4.1.1 Consumer Price Index 128 4.1.2 Producer Price Index 129 4.1.3 Average Inflation Rate (f) 130 4.1.4 General Inflation Rate (f) versus Specific Inflation (fj) 132 4.2 Actual versus Constant Dollars 134 4.2.1 Conversion from Constant to Actual Dollars 135 4.2.2 Conversion from Actual to Constant Dollars 136 4.3 Equivalence Calculations under Inflation 1404.3.1 Market and Inflation-Free Interest Rates 141 4.3.2 Constant-Dollar Analysis 141 4.3.3 Actual-Dollar Analysis 141 4.3.4 Mixed-Dollar Analysis 146 Summary 149 Problems 150 PART 2 EVALUATIING BUSIINESS AND ENGIINEERIING ASSETS 159 Chapter 5 Present-Worth Analysis 160 5.1 Loan versus Project Cash Flows 162 5.2 Initial Project Screening Methods 163 5.2.1 Benefits and Flaws of Payback Screening 166 5.2.2 Discounted-Payback Period 167 5.3 Present-Worth Analysis 168 5.3.1 Net-Present-Worth Criterion 168 5.3.2 Guidelines for Selecting a MARR 172 5.3.3 Meaning of Net Present Worth 175 5.3.4 Net Future Worth and Project Balance Diagram 177 5.3.5 Capitalized-Equivalent Method 180 5.4 Methods to Compare Mutually Exclusive Alternatives 182 5.4.1 Doing Nothing Is a Decision Option 182 5.4.2 Service Projects versus Revenue Projects 183 5.4.3 Analysis Period Equals Project Lives 184 5.4.4 Analysis Period Differs from Project Lives 186 Summary 192 Problems 192 Chapter 6 Annual Equivalence Analysis 208 6.1 Annual Equivalent Worth Criterion 210 6.1.1 Benefits of AE Analysis 214 6.1.2 Capital (Ownership) Costs versus Operating Costs 214 6.2 Applying Annual-Worth Analysis 218 6.2.1 Unit-Profit or Unit-Cost Calculation 218 6.2.2 Make-or-Buy Decision 221 6.3 Comparing Mutually Exclusive Projects 224 6.3.1 Analysis Period Equals Project Lives 224 6.3.2 Analysis Period Differs from Project Lives 229 Summary 232 Problems 232 Chapter 7 Rate-of-Return Analysis 248 7.1 Rate of Return 250 7.1.1 Return on Investment 250 7.1.2 Return on Invested Capital 251 7.2 Methods for Finding Rate of Return 252 7.2.1 Simple versus Nonsimple Investments 252 7.2.2 Computational Methods 254 7.3 Internal-Rate-of-Return Criterion 260 7.3.1 Relationship to the PW Analysis 260 7.3.2 Decision Rule for Simple Investments 261 7.3.3 Decision Rule for Nonsimple Investments 265 7.4 Incremental Analysis for Comparing Mutually Exclusive Alternatives 267 7.4.1 Flaws in Project Ranking by IRR 267 7.4.2 Incremental-Investment Analysis 268 7.4.3 Handling Unequal Service Lives 274 Summary 276 Problems 277 Chapter 7A Resolution of Multiple Rates of Return 292 7A-1 Net-Investment Test 292 7A-2 The Need for an External Interest Rate 294 7A-3 Calculation of Return on Invested Capital for Mixed Investments 295 PART 3 DEVELOPMENT OF PROJECT CASH FLOWS 301 Chapter 8 Accounting for Depreciation and Income Taxes 302 8.1 Accounting Depreciation 304 8.1.1 Depreciable Property 304 8.1.2 Cost Basis 304 8.1.3 Useful Life and Salvage Value 305 8.1.4 Depreciation Methods: Book and Tax Depreciation 307 8.2 Book Depreciation Methods 307 8.2.1 Straight-Line Method 308 8.2.2 Declining-Balance Method 309 8.2.3 Units-of-Production Method 314 8.3 Tax Depreciation Methods 315 8.3.1 MACRS Recovery Periods 316 8.3.2 MACRS Depreciation: Personal Property 317 8.3.3 MACRS Depreciation: Real Property 321 8.4 How to Determine "Accounting Profit" 323 8.4.1 Treatment of Depreciation Expenses 323 8.4.2 Calculation of Net Income 323 8.4.3 Operating Cash Flow versus Net Income 326 8.5 Corporate Taxes 329 8.5.1 Income Taxes on Operating Income 329 8.5.2 Gain Taxes on Asset Disposals 331 Summary 334 Problems 336 Chapter 9 Project Cash-Flow Analysis 346 9.1 Understanding Project Cost Elements 348 9.1.1 Classifying Costs for Manufacturing Environments 348 9.1.2 Classifying Costs for Financial Statements 349 9.1.3 Classifying Costs for Predicting Cost Behavior 351 9.2 Why Do We Need to Use Cash Flows in Economic Analysis? 355 9.3 Income-Tax Rate to Be Used in Project Evaluation 356 9.4 Incremental Cash Flows from Undertaking a Project 358 9.4.1 Operating Activities 358 9.4.2 Investing Activities 358 9.4.3 Financing Activities 359 9.5 Developing Project Cash Flow Statements 359 9.5.1 When Projects Require Only Operating and Investing Activities 360 9.5.2 When Projects Are Financed with Borrowed Funds 364 9.6 Effects of Inflation on Project Cash Flows 366 9.6.1 Depreciation Allowance under Inflation 366 9.6.2 Handling Multiple Inflation Rates 370 9.7 Discount Rate to Be Used in After-Tax Economic Analysis: Cost of Capital 371 9.7.1 Cost of Equity 372 9.7.2 Cost of Debt 374 9.7.3 Calculating the Cost of Capital 375 9.7.4 Choice of a MARR in After-Tax Cash Flow Analysis 377 Summary 378 Problems 379 Chapter 10 Handling Project Uncertainty 398 10.1 Origins of Project Risk 400 10.2 Methods of Describing Project Risk 401 10.2.1 Sensitivity Analysis 401 10.2.2 Sensitivity Analysis for Mutually Exclusive Alternatives 405 10.2.3 Break-Even Analysis 408 10.2.4 Scenario Analysis 410 10.3 Including Risk in Investment Evaluation 412 10.3.1 Probabilistic Approach 413 10.3.2 Risk-Adjusted Discount Rate Approach 422 10.4 Investment Strategies under Uncertainty 423 10.4.1 Trade-Off between Risk and Reward 423 10.4.2 Broader Diversification Reduces Risk 424 10.4.3 Broader Diversification Increases Expected Return 424 Summary 427 Problems 428 PART 4 SPECIIAL TOPIICS IIN ENGIINEERIING ECONOMIICS 443 Chapter 11 Replacement Decisions 444 11.1 Replacement-Analysis Fundamentals 446 11.1.1 Basic Concepts and Terminology 446 11.1.2 Approaches for Comparing Defender and Challenger 449 11.2 Economic Service Life 453 11.3 Replacement Analysis when the Required Service Period Is Long 458 11.3.1 Required Assumptions and Decision Frameworks 458 11.3.2 Handling Unequal Service Life Problems in Replacement Analysis 459 11.3.2 Replacement Strategies under the Infinite Planning Horizon 460 11.4 Replacement Analysis with Tax Considerations 466 Summary 473 Problems 474 Chapter 12 Benefit--Cost Analysis 488 12.1 Evaluation of Public Projects 490 12.1.1 Valuation of Benefits and Costs 491 12.1.2 Users Benefits 491 12.1.3 Sponsors Costs 492 12.1.4 Social Discount Rate 492 12.2 Benefit--Cost Analysis 494 12.2.1 Definition of Benefit--Cost Ratio 494 12.2.2 Incremental B/C-Ratio Analysis 496 12.3 Case Study--Highway Benefit--Cost Analysis by the State of Minnesota 500 12.3.1 Define the Base Case and the Proposed Alternatives 501 12.3.2 Highway User Benefits 501 12.3.3 Sponsors Costs 502 12.3.4 Illustrating Case Example 502 Summary 508 Problems 509 Chapter 13 Understanding Financial Statements 516 13.1 Accounting: The Basis of Decision Making 518 13.2 Financial Status for Businesses 519 13.2.1 The Balance Sheet 521 13.2.2 The Income Statement 525 13.2.3 The Cash-Flow Statement 528 13.3 Using Ratios to Make Business Decisions 532 13.3.1 Debt Management Analysis 533 13.3.2 Liquidity Analysis 534 13.3.3 Asset Management Analysis 535 13.3.4 Profitability Analysis 537 13.3.5 Market-Value Analysis 538 13.3.6 Limitations of Financial Ratios in Business Decisions 540 13.3.7 Where We Get the Most Up-to-Date Financial Information 540 Summary 540 Problems