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Fundamentals of Engineering Economics, Second Edition

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Fundamentals of Engineering Economics, Second Edition

by Chan S. Park

Publisher: Prentice Hall

Copyright Year: 2008

Publishing Date: 2007/12/28

eText ISBN-10: 0-13-604373-9

eText ISBN-13: 978-0-13-604373-7

Print ISBN-10: 0-13-220960-8

Print ISBN-13: 978-0-13-220960-1

Course: Biomedical Engineering, Industrial Engineering, Civil Engineering

Pages: 629

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Table of Contents | Description

Instructor Resources | Student Resources

ABOUT THIS TITLE - TABLE OF CONTENTS

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 Engineer’s 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

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

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

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, 140

4.3.1 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

Part 2. Evaluating Business and Engineering 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

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

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

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

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

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

Part 4. Special Topics in Engineering Economics, 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

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 Sponsor’s 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

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

Appendix A. Self-Test Questions with Answers, 551

Appendix B. Interest Factors for Discrete Compounding, 581

Appendix C. The Cumulative Standardized Normal Distrubution Function, 611

Formula Summary Table, EP-1

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ABOUT THIS TITLE - DESCRIPTION

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.

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