Contemporary Engineering Economics

by Park, Chan S.

• ISBN13: 9780131876286
• ISBN10: 0131876287
• Edition: 4th
• Format: Hardcover
• Copyright: 2011-01-01
• Publisher: Pearson College Div

Summary

This book is intended for undergraduate engineering students taking the introductory engineering economics course at the university level. The fourth edition ofContemporary Engineering Economicshas been thoroughly revised and updated while continuing to adopt a contemporary approach to the subject, and teaching, of engineering economics. This text aims not only to build a sound and comprehensive coverage of engineering economics, but also to address key educational challenges, such as student difficulty in developing the analytical skills required to make informed financial decisions.

Table of Contents

Preface	xix
PART 1 BASICS OF FINANCIAL DECISIONS	1	(202)
Engineering Economic Decisions	2	(16)
Role of Engineers in Business	4	(3)
Types of Business Organization	5	(1)
Engineering Economic Decisions	6	(1)
Personal Economic Decisions	6	(1)
What Makes the Engineering Economic Decision Difficult?	7	(1)
Economic Decisions versus Design Decisions	8	(1)
Large-Scale Engineering Projects	9	(4)
How a Typical Project Idea Evolves	9	(3)
Impact of Engineering Projects on Financial Statements	12	(1)
A Look Back in 2005: Did Toyota Make the Right Decision?	13	(1)
Common Types of Strategic Engineering Economic Decisions	13	(2)
Fundamental Principles of Engineering Economics	15	(3)
Summary	17	(1)
Understanding Financial Statements	18	(34)
Accounting: The Basis of Decision Making	21	(1)
Financial Status for Businesses	22	(11)
The Balance Sheet	24	(3)
The Income Statement	27	(3)
The Cash Flow Statement	30	(3)
Using Ratios to Make Business Decisions	33	(19)
Debt Management Analysis	34	(3)
Liquidity Analysis	37	(1)
Asset Management Analysis	38	(1)
Profitability Analysis	39	(2)
Market Value Analysis	41	(1)
Limitations of Financial Ratios in Business Decisions	42	(1)
Summary	43	(1)
Problems	44	(6)
Short Case Studies	50	(2)
Interest Rate and Economic Equivalence	52	(82)
Interest: The Cost of Money	54	(9)
The Time Value of Money	55	(1)
Elements of Transactions Involving Interest	56	(3)
Methods of Calculating Interest	59	(3)
Simple Interest versus Compound Interest	62	(1)
Economic Equivalence	63	(8)
Definition and Simple Calculations	63	(3)
Equivalence Calculations: General Principles	66	(5)
Looking Ahead	71	(1)
Development of Interest Formulas	71	(36)
The Five Types of Cash Flows	72	(1)
Single-Cash-Flow Formulas	73	(7)
Uneven Payment Series	80	(4)
Equal Payment Series	84	(12)
Linear Gradient Series	96	(6)
Geometric Gradient Series	102	(5)
Unconventional Equivalence Calculations	107	(27)
Composite Cash Flows	107	(7)
Determining an Interest Rate to Establish Economic Equivalence	114	(5)
Summary	119	(1)
Problems	119	(10)
Short Case Studies	129	(5)
Understanding Money and Its Management	134	(69)
Nominal and Effective Interest Rates	136	(7)
Nominal Interest Rates	136	(1)
Effective Annual Interest Rates	137	(3)
Effective Interest Rates per Payment Period	140	(1)
Continuous Compounding	141	(2)
Equivalence Calculations with Effective Interest Rates	143	(9)
When Payment Period Is Equal to Compounding Period	144	(1)
Compounding Occurs at a Different Rate than that at Which Payments Are Made	145	(7)
Equivalence Calculations with Continuous Payments	152	(4)
Single-Payment Transactions	152	(1)
Continuous-Funds Flow	152	(4)
Changing Interest Rates	156	(3)
Single Sums of Money	156	(2)
Series of Cash Flows	158	(1)
Debt Management	159	(16)
Commercial Loans	159	(8)
Loan versus Lease Financing	167	(4)
Home Mortgage	171	(4)
Investing in Financial Assets	175	(28)
Investment Basics	176	(1)
How to Determine Your Expected Return	176	(3)
Investing in Bonds	179	(8)
Summary	187	(1)
Problems	188	(11)
Short Case Studies	199	(4)
PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS	203	(182)
Present-Worth Analysis	204	(64)
Describing Project Cash Flows	207	(3)
Loan versus Project Cash Flows	207	(2)
Independent versus Mutually Exclusive Investment Projects	209	(1)
Initial Project Screening Method	210	(5)
Payback Period: The Time It Takes to Pay Back	210	(3)
Benefits and Flaws of Payback Screening	213	(1)
Discounted Payback Period	214	(1)
Where Do We Go from Here?	215	(1)
Discounted Cash Flow Analysis	215	(8)
Net-Present-Worth Criterion	216	(4)
Meaning of Net Present Worth	220	(2)
Basis for Selecting the MARR	222	(1)
Variations of Present-Worth Analysis	223	(9)
Future-Worth Analysis	223	(4)
Capitalized Equivalent Method	227	(5)
Comparing Mutually Exclusive Alternatives	232	(36)
Meaning of Mutually Exclusive and ``Do Nothing''	232	(3)
Analysis Period	235	(1)
Analysis Period Equals Project Lives	236	(2)
Analysis Period Differs from Project Lives	238	(8)
Analysis Period Is Not Specified	246	(3)
Summary	249	(1)
Problems	249	(16)
Short Case Studies	265	(3)
Annual Equivalent-Worth Analysis	268	(54)
Annual Equivalent-Worth Criterion	270	(7)
Fundamental Decision Rule	270	(3)
Annual-Worth Calculation with Repeating Cash Flow Cycles	273	(2)
Comparing Mutually Exclusive Alternatives	275	(2)
Capital Costs versus Operating Costs	277	(3)
Applying Annual-Worth Analysis	280	(7)
Benefits of AE Analysis	281	(1)
Unit Profit or Cost Calculation	281	(2)
Make-or-Buy Decision	283	(3)
Pricing the Use of an Asset	286	(1)
Life-Cycle Cost Analysis	287	(7)
Design Economics	294	(28)
Summary	303	(1)
Problems	304	(14)
Short Case Studies	318	(4)
Rate-of-Return Analysis	322	(63)
Rate of Return	324	(3)
Return on Investment	324	(2)
Return on Invested Capital	326	(1)
Methods for Finding the Rate of Return	327	(11)
Simple versus Nonsimple Investments	327	(2)
Predicting Multiple i*'s	329	(2)
Computational Methods	331	(7)
Internal-Rate-of-Return Criterion	338	(14)
Relationship to PW Analysis	338	(1)
Net-Investment Test: Pure versus Mixed Investments	339	(2)
Decision Rule for Pure Investments	341	(3)
Decision Rule for Mixed Investments	344	(8)
Mutually Exclusive Alternatives	352	(33)
Flaws in Project Ranking by IRR	352	(1)
Incremental Investment Analysis	353	(7)
Handling Unequal Service Lives	360	(3)
Summary	363	(1)
Problems	364	(17)
Short Case Studies	381	(4)
PART 3 ANALYSIS OF PROJECT CASH FLOWS	385	(156)
Cost Concepts Relevant to Decision Making	386	(42)
General Cost Terms	388	(2)
Manufacturing Costs	388	(2)
Nonmanufacturing Costs	390	(1)
Classifying Costs for Financial Statements	390	(4)
Period Costs	391	(1)
Product Costs	391	(3)
Cost Classification for Predicting Cost Behavior	394	(6)
Volume Index	394	(1)
Cost Behaviors	395	(5)
Future Costs for Business Decisions	400	(11)
Differential Cost and Revenue	400	(4)
Opportunity Cost	404	(2)
Sunk Costs	406	(1)
Marginal Cost	406	(5)
Estimating Profit from Production	411	(17)
Calculation of Operating Income	412	(1)
Sales Budget for a Manufacturing Business	412	(1)
Preparing the Production Budget	413	(2)
Preparing the Cost-of-Goods-Sold Budget	415	(1)
Preparing the Nonmanufacturing Cost Budget	416	(2)
Putting It All Together: The Budgeted Income Statement	418	(1)
Looking Ahead	419	(1)
Summary	420	(1)
Problems	421	(6)
Short Case Study	427	(1)
Depreciation and Corporate Taxes	428	(62)
Asset Depreciation	431	(2)
Economic Depreciation	432	(1)
Accounting Depreciation	432	(1)
Factors Inherent in Asset Depreciation	433	(4)
Depreciable Property	433	(1)
Cost Basis	434	(1)
Useful Life and Salvage Value	435	(1)
Depreciation Methods: Book and Tax Depreciation	436	(1)
Book Depreciation Methods	437	(9)
Straight-Line Method	437	(2)
Accelerated Methods	439	(6)
Units-of-Production Method	445	(1)
Tax Depreciation Methods	446	(7)
MACRS Depreciation	446	(1)
MACRS Depreciation Rules	447	(6)
Depletion	453	(3)
Cost Depletion	453	(1)
Percentage Depletion	454	(2)
Repairs or Improvements Made to Depreciable Assets	456	(3)
Revision of Book Depreciation	456	(1)
Revision of Tax Depreciation	457	(2)
Corporate Taxes	459	(3)
Income Taxes on Operating Income	459	(3)
Tax Treatment of Gains or Losses on Depreciable Assets	462	(5)
Disposal of a MACRS Property	462	(2)
Calculations of Gains and Losses on MACRS Property	464	(3)
Income Tax Rate to Be Used in Economic Analysis	467	(5)
Incremental Income Tax Rate	467	(3)
Consideration of State Income Taxes	470	(2)
The Need for Cash Flow in Engineering Economic Analysis	472	(18)
Net Income versus Net Cash Flow	472	(1)
Treatment of Noncash Expenses	473	(3)
Summary	476	(2)
Problems	478	(9)
Short Case Studies	487	(3)
Developing Project Cash Flows	490	(51)
Cost-Benefit Estimation for Engineering Projects	492	(2)
Simple Projects	493	(1)
Complex Projects	493	(1)
Incremental Cash Flows	494	(4)
Elements of Cash Outflows	494	(1)
Elements of Cash Inflows	495	(2)
Classification of Cash Flow Elements	497	(1)
Developing Cash Flow Statements	498	(18)
When Projects Require Only Operating and Investing Activities	498	(4)
When Projects Require Working-Capital Investments	502	(5)
When Projects Are Financed with Borrowed Funds	507	(2)
When Projects Result in Negative Taxable Income	509	(4)
When Projects Require Multiple Assets	513	(3)
Generalized Cash Flow Approach	516	(25)
Setting up Net Cash Flow Equations	517	(1)
Presenting Cash Flows in Compact Tabular Formats	518	(2)
Lease-or-Buy Decision	520	(4)
Summary	524	(1)
Problems	525	(12)
Short Case Studies	537	(4)
PART 4 HANDLING RISK AND UNCERTAINTY	541	(174)
Inflation and Its Impact on Project Cash Flows	542	(42)
Meaning and Measure of Inflation	544	(9)
Measuring Inflation	544	(6)
Actual versus Constant Dollars	550	(3)
Equivalence Calculations under Inflation	553	(5)
Market and Inflation-Free Interest Rates	553	(1)
Constant-Dollar Analysis	553	(1)
Actual-Dollar Analysis	554	(4)
Mixed-Dollar Analysis	558	(1)
Effects of Inflation on Project Cash Flows	558	(8)
Multiple Inflation Rates	562	(1)
Effects of Borrowed Funds under Inflation	563	(3)
Rate-of-Return Analysis under Inflation	566	(18)
Effects of Inflation on Return on Investment	566	(3)
Effects of Inflation on Working Capital	569	(3)
Summary	572	(2)
Problems	574	(8)
Short Case Studies	582	(2)
Project Risk and Uncertainty	584	(80)
Origins of Project Risk	586	(1)
Methods of Describing Project Risk	587	(9)
Sensitivity Analysis	587	(4)
Break-Even Analysis	591	(3)
Scenario Analysis	594	(2)
Probability Concepts for Investment Decisions	596	(9)
Assessment of Probabilities	596	(5)
Summary of Probabilistic Information	601	(2)
Joint and Conditional Probabilities	603	(2)
Covariance and Coefficient of Correlation	605	(1)
Probability Distribution of NPW	605	(13)
Procedure for Developing an NPW Distribution	605	(6)
Aggregating Risk over Time	611	(5)
Decision Rules for Comparing Mutually Exclusive Risky Alternatives	616	(2)
Risk Simulation	618	(15)
Computer Simulation	619	(1)
Model Building	620	(3)
Monte Carlo Sampling	623	(5)
Simulation Output Analysis	628	(2)
Risk Simulation with @RISK	630	(3)
Decision Trees and Sequential Investment Decisions	633	(31)
Structuring a Decision-Tree Diagram	634	(5)
Worth of Obtaining Additional Information	639	(3)
Decision Making after Having Imperfect Information	642	(5)
Summary	647	(1)
Problems	648	(10)
Short Case Studies	658	(6)
Real-Options Analysis	664	(51)
Risk Management: Financial Options	666	(4)
Buy Call Options when You Expect the Price to Go Up	669	(1)
Buy Put Options when You Expect the Price to Go Down	669	(1)
Option Strategies	670	(5)
Buying Calls to Reduce Capital That Is at Risk	670	(3)
Protective Puts as a Hedge	673	(2)
Option Pricing	675	(11)
Replicating-Portfolio Approach with a Call Option	675	(2)
Risk-Free Financing Approach	677	(2)
Risk-Neutral Probability Approach	679	(1)
Put-Option Valuation	680	(1)
Two-Period Binomial Lattice Option Valuation	681	(2)
Multiperiod Binomial Lattice Model	683	(1)
Black-Scholes Option Model	684	(2)
Real-Options Analysis	686	(11)
A Conceptual Framework for Real Options in Engineering Economics	687	(1)
Types of Real-Option Models	688	(9)
Estimating Volatility at the Project Level	697	(6)
Estimating a Project's Volatility through a Simple Deferral Option	697	(2)
Use the Existing Model of a Financial Option to Estimate σ2	699	(4)
Compound Options	703	(12)
Summary	708	(1)
Problems	709	(4)
Short Case Studies	713	(2)
PART 5 SPECIAL TOPICS IN ENGINEERING ECONOMICS	715	(154)
Replacement Decisions	716	(60)
Replacement Analysis Fundamentals	718	(5)
Basic Concepts and Terminology	718	(3)
Opportunity Cost Approach to Comparing Defender and Challenger	721	(2)
Economic Service Life	723	(5)
Replacement Analysis when the Required Service Is Long	728	(11)
Required Assumptions and Decision Frameworks	729	(1)
Replacement Strategies under the Infinite Planning Horizon	730	(5)
Replacement Strategies under the Finite Planning Horizon	735	(3)
Consideration of Technological Change	738	(1)
Replacement Analysis with Tax Considerations	739	(37)
Summary	755	(1)
Problems	756	(12)
Short Case Studies	768	(8)
Capital-Budgeting Decisions	776	(46)
Methods of Financing	778	(9)
Equity Financing	779	(1)
Debt Financing	780	(2)
Capital Structure	782	(5)
Cost of Capital	787	(8)
Cost of Equity	787	(5)
Cost of Debt	792	(2)
Calculating the Cost of Capital	794	(1)
Choice of Minimum Attractive Rate of Return	795	(8)
Choice of MARR when Project Financing Is Known	795	(2)
Choice of MARR when Project Financing Is Unknown	797	(2)
Choice of MARR under Capital Rationing	799	(4)
Capital Budgeting	803	(19)
Evaluation of Multiple Investment Alternatives	803	(1)
Formulation of Mutually Exclusive Alternatives	803	(2)
Capital-Budgeting Decisions with Limited Budgets	805	(4)
Summary	809	(1)
Problems	810	(6)
Short Case Studies	816	(6)
Economic Analysis in the Service Sector	822	(47)
What Is the Service Sector?	824	(2)
Characteristics of the Service Sector	825	(1)
How to Price Service	825	(1)
Economic Analysis in Health-Care Service	826	(6)
Economic Evaluation Tools	827	(1)
Cost-Effectiveness Analysis	828	(1)
How to Use a CEA	829	(3)
Economic Analysis in the Public Sector	832	(8)
What Is Benefit-Cost Analysis?	833	(1)
Framework of Benefit-Cost Analysis	833	(1)
Valuation of Benefits and Costs	834	(2)
Quantifying Benefits and Costs	836	(4)
Difficulties Inherent in Public-Project Analysis	840	(1)
Benefit-Cost Ratios	840	(6)
Definition of Benefit-Cost Ratio	840	(3)
Relationship between B/C Ratio and NPW	843	(1)
Comparing Mutually Exclusive Alternatives: Incremental Analysis	843	(3)
Analysis of Public Projects Based on Cost-Effectiveness	846	(23)
Cost-Effectiveness Studies in the Public Sector	847	(1)
A Cost-Effectiveness Case Study	847	(9)
Summary	856	(1)
Problems	857	(5)
Short Case Studies	862	(7)
Appendix A Interest Factors for Discrete Compounding	869	(30)
Index	899