9780471799894

Advanced Engineering Economics

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  • ISBN13:

    9780471799894

  • ISBN10:

    0471799890

  • Format: Paperback
  • Copyright: 1990-02-01
  • Publisher: Wiley
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Summary

Describes important and useful project evaluation and selection concepts and techniques that have developed over the past twenty years. These concepts and techniques--essential in making individual, corporate and public investment decisions--are presented in an integrated framework based upon traditional engineering economics principles. Four main sections--Basic Concepts and Techniques in Economics Analysis, Deterministic Analysis, Stochastic Analysis, Special Topics--cover a wide variety of subjects, including: accounting income, interest, inflation, the use of tranforms in cash-flow modeling, depreciation and corporate taxation, investment worth, utility theory, decision tree analysis and much more. A number of analysis techniques for public investments are described and decision rules for selecting among multiple alternatives are given. Features numerous case studies, illustrative examples, tables and end-of-chapter questions.

Table of Contents

PART ONE BASIC CONCEPTS AND TECHNIQUES IN ECONOMIC ANALYSIS
Accounting Income and Cash Flow
3(35)
What Is Investment?
3(1)
The Corporate Investment Framework
4(4)
The Objective of the Firm
4(1)
The Functions of the Firm
5(1)
The Analysis Framework
6(1)
Accounting Information
7(1)
The Balance Sheets
8(6)
Reporting Format
8(3)
Cash versus Other Assets
11(1)
Liabilities versus Stockholders' Equity
11(1)
Inventory Valuation
12(1)
Depreciation
13(1)
Working Capital
13(1)
The Income Statement
14(5)
Methods of Reporting Income
14(1)
Reporting Format
14(2)
Measurement of Revenue
16(1)
Measurement of Expenses
17(1)
Retained Earnings, Cash Dividends, and Earnings per Share
18(1)
The Funds Flow Statement
19(6)
The Cash Flow Cycle
20(1)
Basic Relationship
20(1)
Funds Statement on a Cash Basis
21(2)
Funds Statement as Working Capital
23(2)
Tax Accounting and Business Accounting
25(4)
Deferred Income Taxes
25(1)
Computing Deferred Income Taxes
25(2)
Estimating Cash Flows from Income Statement
27(1)
Use of Cash Flows in Evaluating Investments
28(1)
Investment Project and Its Cash Flows
29(4)
The Cash Flow Statement
29(3)
Cash Flows over the Project Life
32(1)
Summary
33(5)
Problems
33(5)
Interest and Equivalence
38(51)
Introduction
38(1)
Cash Flow Profile
38(1)
Time Preference and Interest
39(6)
Time Preference
39(1)
Types of Interest
39(2)
Nominal and Effective Interest Rates
41(4)
Discrete Compounding
45(14)
Comparable Payment and Compounding Periods
45(12)
Noncomparable Payment and Compounding Periods
57(2)
Continuous Compounding
59(6)
Discrete Payments
59(2)
Continuous Cash Flows
61(4)
Equivalence of Cash Flows
65(5)
Concept of Equivalence
65(2)
Equivalence Calculations with Several Interest Factors
67(3)
Effect of Inflation on Cash Flow Equivalence
70(13)
Measure of Inflation
70(2)
Explicit and Implicit Treatments of Inflation in Discounting
72(6)
Home Ownership Analysis during Inflation
78(5)
Summary
83(6)
Problems
83(6)
Transform Techniques in Cash Flow Modeling
89(40)
Introduction
89(1)
Z-Transforms and Discrete Cash Flows
89(19)
The Z-Transform and Present Value
89(2)
Properties of the Z-Transform
91(6)
Development of Present Value Models
97(4)
Extension to Future and Annual Equivalent Models
101(2)
Applications of Z-Transforms
103(5)
Laplace Transforms and Continuous Cash Flows
108(17)
Laplace Transform and Present Value
109(3)
Properties of Laplace Transforms
112(4)
Development of Continuous Present Value Models
116(6)
Extension to Future and Annual Equivalent Models
122(1)
Application of the Laplace Transform
122(3)
Summary
125(4)
Problems
126(3)
Depreciation and Corporate Taxation
129(38)
Introduction
129(1)
Corporate Tax Rates
129(5)
Tax Structure for Corporations
129(2)
Depreciation and Its Relation to Income Taxes
131(2)
Use of Effective and Marginal Income Tax Rates in Project Evaluations
133(1)
Depreciation Methods and Regulations
134(18)
Depreciation Regulations, Notation
134(1)
Conventional Methods
135(5)
Multiple-Asset Depreciation
140(1)
1981 Accelerated Cost Recovery System (ACRS)
141(3)
Tax Reform Act of 1986 (MACRS)
144(4)
Adjustments to Income Taxes
148(1)
Depreciation Strategies
149(3)
After-Tax Cash Flow Analysis
152(10)
Generalized Cash Flows
152(3)
Effects of Depreciation Methods
155(1)
Effects of Financing Costs
155(3)
Effects of Inflation
158(4)
Cash Flow Analysis for Tax-Exempt Corporations
162(1)
Summary
162(5)
Problems
163(4)
Selecting a Minimum Attractive Rate of Return
167(34)
Introduction
167(1)
Investment and Borrowing Opportunities
167(3)
Future Investment Opportunities
168(1)
Financing Sources
168(2)
Capital Rationing
170(1)
Costs of Capital from Individual Sources
170(11)
Debt Capital
171(8)
Equity Capital
179(2)
Use of a Weighted-Average Cost of Capital
181(4)
Net Equity Flows
182(2)
After-Tax Composite Flows
184(1)
Specifying the Weighted-Average Cost of Capital
185(10)
Basic Valuation Forms
186(1)
Valuation with Debt and Taxes
187(1)
The Firm's Capitalization Rate
188(3)
Obtaining a Cutoff Rate
191(2)
Other Issues
193(1)
Effect of Inflation
194(1)
Summary
195(6)
Problems
196(5)
PART TWO DETERMINISTIC ANALYSIS
Measures of Investment Worth-Single Project
201(42)
Introduction
201(1)
Initial Assumptions
201(1)
Notation
202(1)
The Net Present Value Criterion
202(8)
Mathematical Definition
202(5)
Economic Interpretation Through Project Balance
207(3)
Internal Rate-of-Return Criterion
210(16)
Definition of IRR
210(3)
Classification of Investment Projects
213(3)
IRR and Pure Investments
216(2)
IRR and Mixed Investments
218(4)
Modified Rate of Return
222(4)
Benefit--Cost Ratios
226(4)
Benefit--Cost Ratios Defined
227(1)
Equivalence of B/C Ratios and PV
228(2)
Payback Period
230(1)
Payback Period Defined
230(1)
Popularity of the Payback Period
231(1)
Time-Dependent Measure of Investment Worth
231(5)
Areas of Negative and Positive Balances
232(1)
Investment Flexibility
233(3)
Summary
236(7)
Problems
238(5)
Decision Rules for Selecting among Multiple Alternatives
243(36)
Introduction
243(1)
Formulating Mutually Exclusive Alternatives
243(3)
Application of Investment Worth Criteria
246(14)
Total Investment Approach
246(5)
Incremental Analysis
251(9)
Reinvestment Issues
260(4)
Net Present Value
260(2)
Internal Rate of Return
262(2)
Benefit-Cost Ratio
264(1)
Comparison of Projects with Unequal Lives
264(9)
Common Service Period Approach
265(3)
Estimating Salvage Value of Longer-Lived Projects
268(4)
Reinvestment Issues When Revenues Are Unknown
272(1)
Summary, Treatment of Unequal Lives
272(1)
Decisions on the Timing of Investments
273(1)
Summary
274(5)
Problems
275(4)
Deterministic Capital Budgeting Models
279(74)
Introduction
279(1)
The Use of Linear Programming Models
280(7)
Criterion Function to Be Optimized
280(2)
Multiple Budget Periods
282(1)
Project Limits and Interdependencies
282(1)
LP Formation of Lorie-Savage Problem
283(1)
Duality Analysis
283(4)
Pure Capital Rationing Models
287(5)
Criticisms of the NPV Model
287(2)
Consistent Discount Factors
289(3)
Net Present Value Maximization with Lending and Borrowing
292(2)
Inclusion of Lending Opportunities
292(1)
Inclusion of Borrowing Opportunities
293(1)
Weingartner's Horizon Model
294(11)
Equal Lending and Borrowing Rates
294(5)
Lending Rates Less Than Borrowing Rates
299(2)
Inclusion of Borrowing Limits, Supply Schedule of Funds
301(3)
Duality Analysis with Project Interdependencies
304(1)
Bernhard's General Model
305(5)
Model Formulation
305(2)
Major Results
307(3)
Discrete Capital Budgeting
310(5)
Number of Fractional Projects in LP Solution
310(1)
Branch-and-Bound Solution Procedure
311(2)
Duality Analysis for Integer Solution
313(2)
Capital Budgeting with Multiple Objectives
315(4)
Goal programming
316(2)
Interactive Multiple-Criteria Optimization
318(1)
Summary
319(34)
Problems
321(8)
Appendix 8.A---A Dividend-Terminal-Wealth Capital Budgeting Model: A Case Study
329(24)
PART THREE STOCHASTIC ANALYSIS
Utility Theory
353(25)
Introduction
353(4)
The Concept of Risk
353(3)
Role of Utility Theory
356(1)
Alternative Approaches to Decision Making
356(1)
Preference and Ordering Rules
357(3)
Bernoulli Hypothesis
357(1)
Axioms of Utility Theory
358(2)
Properties of Utility Functions
360(5)
Risk Attitudes
360(3)
Types of Utility Functions
363(2)
Empirical Determination of Utility Functions
365(4)
General Procedure
365(2)
Sample Results
367(2)
Mean--Variance Analysis
369(5)
Indifference Curves
369(1)
Coefficient of Risk Aversion
370(2)
Justification of Certainty Equivalent Method
372(2)
Summary
374(4)
Problems
375(3)
Measures of Investment Worth under Risk--Single Project
378(66)
Introduction
378(3)
The Common Measures of Project Risk
378(1)
How Businesspeople Perceive Risk in Project Evaluation
379(2)
Estimating Values in Probabilistic Terms
381(18)
Statistical Moments of a Single Random Variable
381(5)
Statistical Moments of Linear Combinations of Random Variables
386(3)
Products of Random Variables
389(3)
Quotients of Random Variables
392(2)
Powers of Independent Random Variables
394(4)
General Approximation Formulas
398(1)
Statistical Moments of Discounted Cash Flows
399(18)
Expected Net Present Value
399(1)
Variance of Net Present Value
399(4)
Mixed Net Cash Flows
403(1)
Net Cash Flows Consisting of Several Components
404(2)
Cash Flows with Uncertain Timing: Continuous Case
406(8)
Cash Flows with Uncertain Timing: Discrete Case
414(3)
Statistical Distributions of Net Present Value
417(5)
Discrete Cash Flows Described by a Probability Tree
418(1)
Use of the First Two Statistical Moments
418(3)
Use of the First Four Statistical Moments
421(1)
Estimating Risky Cash Flows
422(9)
Beta-Function Estimators for Single Cash Flows
423(5)
Hillier's Method for Correlated Cash Flows
428(3)
Summary
431(13)
Problems
433(11)
Methods for Comparing Risky Projects
444(53)
Introduction
444(1)
Comparative Measures of Investment Worth
444(6)
Mean--Variance, E--V
444(3)
Mean--Semivariance, E--S
447(2)
Safety First
449(1)
Stochastic Dominance
450(10)
First-Degree Stochastic Dominance
450(3)
Second-Degree Stochastic Dominance
453(4)
Third-Degree Stochastic Dominance
457(2)
Relationship Between Dominance and Mean-Variance Criterion
459(1)
Portfolio Theory
460(10)
Efficiency Frontier
461(2)
Diversification of Risk
463(1)
Full Covariance Model
464(1)
Index Model
465(2)
Capital Market Theory
467(3)
Discrete Capital-Rationing Models under Risk
470(3)
Hillier's Method for Partially Correlated Projects
471(1)
Stochastic Programming
472(1)
Multiperiod Index Model for Project Portfolio
473(5)
Model Structure and Assumptions
473(2)
Procedure
475(3)
Uncertainty Resolution
478(2)
Summary
480(17)
Problems
482(8)
Appendix 11.A Example of Use of Multiperiod Index Model for Selecting Project Portfolio
490(7)
Risk Simulation
497(54)
Introduction
497(1)
An Overview of the Logic of Simulation
497(2)
Monte Carlo Sampling
497(1)
Using the Simulation Output
498(1)
Selecting Input Probability Distributions
499(11)
Selecting a Distribution Based on Observed Data
500(7)
Selecting a Distribution in the Absence of Data
507(3)
Sampling Procedures for Independent Random Variables
510(5)
Inverse Transformation Techniques
510(3)
Other Frequently Used Random Deviates
513(2)
Sampling Procedures for Dependent Random Variables
515(17)
Assessment of Conditional Probabilities
515(2)
Sampling a Pair of Dependent Random Samples
517(3)
Sampling Based on Regression Equation
520(4)
Conditional Sampling in the Absence of Data
524(3)
Normal Transformation Method
527(5)
Output Data Analysis
532(5)
Replication and Precision of Results
532(2)
Comparison of Two Projects
534(3)
Programming Risk Simulation Model on Computers
537(7)
Decision Problem
537(2)
Description of the Simulation Model
539(4)
Replication Results
543(1)
Summary
544(7)
Problems
548(3)
Decision Tree Analysis
551(34)
Introduction
551(1)
Sequential Decision Process
551(5)
Structuring the Decision Tree
552(3)
Expected Value as a Decision Criterion
555(1)
Obtaining Additional Information
556(9)
The Value of Perfect Information
556(3)
Determining Revised Probabilities
559(5)
Expected Monetary Value after Receiving Sample Information
564(1)
Value of the Market Survey
565(1)
Decision Tree and Risk
565(4)
Sensitivity Analysis
566(1)
Decision Based on Certainty Equivalents
567(2)
Investment Decisions with Replication Opportunities
569(6)
The Opportunity To Replicate
569(1)
Experiment Leading to Perfect Information
569(5)
Sampling Leading to Imperfect Information
574(1)
Summary
575(10)
Problems
576(9)
PART FOUR SPECIAL TOPICS IN ENGINEERING ECONOMIC ANALYSIS
Evaluation of Public Investments
585(39)
Introduction
585(1)
Benefit--Cost Analysis
585(8)
The Nature of Public Activities
585(1)
Why Benefit--Cost Analysis?
586(1)
The Procedure of Benefit--Cost Analysis
586(1)
Valuation of Benefits and Costs
587(3)
Decision Criteria
590(3)
The Benefit--Cost Concept Applied to a Mass Transit System
593(14)
The Problem Statement
594(2)
User's Benefits and Disbenefits
596(7)
Sponsor's Costs
603(2)
Benefit--Cost Ratio for Project
605(2)
Risk and Uncertainty in Benefit--Cost Analysis
607(11)
Exact Distribution of Benefit--Cost Ratio
607(2)
Exact Distribution of Incremental Benefit--Cost Ratio
609(9)
Summary
618(6)
Problems
619(5)
Economic Analysis in Public Utilities
624(30)
Introduction
624(1)
Capital Costs
625(3)
Debt and Equity Financing for Public Utilities
625(1)
Weighted After-Tax Cost of Capital
626(1)
Capital Recovery Cost Based on Book Depreciation Schedule
627(1)
The Revenue Requirement Method
628(8)
Assumptions of the Revenue Requirement Method
629(1)
Determination of Annual Revenue Requirements
630(4)
Effect of Inflation in Revenue Requirements
634(2)
Equivalence of the Present Value and Revenue Requirement Methods
636(5)
The A/T Equity Cash Flows and Revenue Requirement Series
636(2)
Important Results Regarding the Equivalence of the PV and RR Methods
638(3)
Flow-Through and Normalization Accounting
641(8)
Flow-Through Method
641(3)
Normalizing Method
644(5)
Summary
649(5)
Problems
650(4)
Procedures for Replacement Analysis
654(45)
Introduction
654(8)
Quantifying Obsolescence and Deterioration
654(6)
Forecasting Future Data
660(2)
Basic Concepts in Replacement Analysis
662(11)
Sunk Costs
662(1)
Outsider Point of View
663(6)
Economic Life of an Asset
669(4)
Infinite Planning Period Methods
673(7)
No Technology or Cost Changes, AE Method
673(3)
Geometric Changes in Purchasing Costs and O&M Costs, PV Method
676(4)
Finite Planning Period Methods
680(7)
Sensitivity Analysis of PV with Respect to Inflation
680(2)
Dynamic Programming Method
682(5)
Building a Data Base
687(4)
Summary
691(8)
Problems
693(6)
APPENDIX A: Discrete Interest Compounding Tables 699(28)
APPENDIX B: Statistical Tables 727(5)
Table B.1 Cumulative Standard Normal Distribution
728(2)
Table B.2 Percentage Points of the χ2 Distribution
730(2)
Index 732

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