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PART 1 BASICS OF FINANCIAL DECISIONS 1
Chapter 1 Engineering Economic Decisions
1.1 Role of Engineers in Business
1.1.1 Types of Business Organization
1.1.2 Engineering Economic Decisions
1.1.3 Personal Economic Decisions
1.2 What Makes the Engineering Economic Decision Difficult?
1.3 Economic Decisions Versus Design Decisions
1.4 Large-Scale Engineering Projects
1.4.1 How a Typical Project Idea Evolves
1.4.2 Impact of Engineering Projects on Financial Statements
1.4.3 A Look Back in 2009: Did Toyota Make the Right Decision?
1.5 Common Types of Strategic Engineering Economic Decisions
1.6 Fundamental Principles of Engineering Economics
Summary
Short Case Studies
Chapter 2 Accounting and Financial Decision-Making
2.1 Accounting: The Basis of Decision Making
2.2 Financial Status for Businesses
2.2.1 The Balance Sheet
2.2.2 The Income Statement
2.2.3 The Cash Flow Statement
2.3 Using Ratios to Make Business Decisions
2.3.1 Debt Management Analysis
2.3.2 Liquidity Analysis
2.3.3 Asset Management Analysis
2.3.4 Profitability Analysis
2.3.5 Market Value Analysis
2.3.6 Limitations of Financial Ratios in Business Decisions
Summary
Problems
Short Case Studies
Chapter 3 Interest Rate and Economic Equivalence
3.1 Interest: The Cost of Money
3.1.1 The Time Value of Money
3.1.2 Elements of Transactions Involving Interest
3.1.3 Methods of Calculating Interest
3.1.4 Simple Interest versus Compound Interest
3.2 Economic Equivalence
3.2.1 Definition and Simple Calculations
3.2.2 Equivalence Calculations: General Principles
3.3 Development of Formulas for Equivalence Calculations
3.3.1 The Five Types of Cash Flows
3.3.2 Single-Cash-Flow Formulas
3.3.3 Uneven Payment Series
3.3.4 Equal-Payment Series
3.3.5 Linear-Gradient Series
3.3.6 Geometric Gradient Series
3.4 Unconventional Equivalence Calculations
3.4.1 Composite Cash Flows
3.4.2 Determining an Interest Rate to Establish Economic Equivalence
3.4.3 Unconventional Regularity in Cash Flow Pattern
Summary
Problems
Short Case Studies
Chapter 4 Understanding Money and Its Management
4.1 Nominal and Effective Interest Rates
4.1.1 Nominal Interest Rates
4.1.2 Effective Annual Interest Rates
4.1.3 Effective Interest Rates per Payment Period
4.1.4 Continuous Compounding
4.2 Equivalence Calculations with Effective Interest Rates
4.2.1 When Payment Period is Equal to Compounding Period
4.2.2 Compounding Occurs at a Different Rate than That at Which Payments are Made
4.2.4 Compounding is Less Frequent than Payments
4.3 Equivalence Calculations with Continuous Payments
4.3.1 Single-Payment Transactions
4.3.2 Continuous-Funds Flow
4.4 Changing Interest Rates
4.4.1 Single Sums of Money
4.4.2 Series of Cash Flows
4.5 Debt Management
4.5.1 Commercial Loans
4.5.2 Loan versus Lease Financing
4.5.3 Home Mortgage
4.6 Investing in Financial Assets
4.6.1 Investment Basics
4.6.2 How to Determine Your Expected Return
4.6.3 Investing in Bonds
Summary
Problems
Short Case Studies
PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS 207
Chapter 5 Present-Worth Analysis
5.1 Describing Project Cash Flows
5.1.1 Loan versus Project Cash Flows
5.1.2 Independent versus Mutually Exclusive Investment Projects
5.2 Initial Project Screening Method
5.2.1 Payback Period: The Time It Takes to Pay Back
5.2.2 Benefits and Flaws of Payback Screening
5.2.3 Discounted Payback Period
5.2.4 Where Do We Go from Here?
5.3 Discounted Cash Flow Analysis
5.3.1 Net-Present-Worth Criterion
5.3.2 Meaning of Net Present Worth
5.3.3 Basis for Selecting the MARR
5.4 Variations of Present-Worth Analysis
5.4.1 Future-Worth Analysis
5.4.2 Capitalized Equivalent Method
5.5 Comparing Mutually Exclusive Alternatives
5.5.1 Meaning of Mutually Exclusive and “Do Nothing”
5.5.2 Analysis Period
5.5.3 Analysis Period Matches Project Lives
5.5.4 Analysis Period Differs from Project Lives
5.5.5 Analysis Period Is Not Specified
Summary
Problems
Short Case Studies
Chapter 6 Annual Equivalent-Worth Analysis
6.1 Annual Equivalent-Worth Criterion
6.1.1 Fundamental Decision Rule
6.1.2 Annual-Worth Calculation with Repeating Cash Flow Cycles
6.1.3 Comparing Mutually Exclusive Alternatives
6.2 Capital Costs Versus Operating Costs
6.3 Applying Annual-Worth Analysis
6.3.1 Benefits of AE Analysis
6.3.2 Unit Profit or Cost Calculation
6.3.3 Make-or-Buy Decision–Outsourcing Decisions
6.3.4 Pricing the Use of an Asset
6.4 Life-Cycle Cost Analysis
6.5 Design Economics
Summary
Problems
Short Case Studies
Chapter 7 Rate-of-Return Analysis
7.1 Rate of Return
7.1.1 Return on Investment
7.1.2 Return on Invested Capital
7.2 Methods for Finding the Rate of Return
7.2.1 Simple versus Nonsimple Investments
7.2.2 Predicting Multiple i*’s
7.2.3 Computational Methods
7.3 Internal-Rate-of-Return Criterion
7.3.1 Relationship to PW Analysis
7.3.2 Net-Investment Test: Pure versus Mixed Investments
7.3.3 Decision Rule for Pure Investments
7.3.4 Decision Rule for Mixed Investments
7.4 Mutually Exclusive Alternatives
7.4.1 Flaws in Project Ranking by IRR
7.4.2 Incremental Investment Analysis
7.4.3 Handling Unequal Service Lives
Summary
Problems
Short Case Studies
PART 3 ANALYSIS OF PROJECT CASH FLOWS
Chapter 8 Cost Concepts Relevant to Decision Making
8.1 General Cost Terms
8.1.1 Manufacturing Costs
8.1.2 Nonmanufacturing Costs
8.2 Classifying Costs for Financial Statements
8.2.1 Period Costs
8.2.2 Product Costs
8.3 Cost Classification for Predicting Cost Behavior
8.3.1 Volume Index
8.3.2 Cost Behaviors
8.3.3 Cost-Volume-Profit Analysis
8.4 Future Costs for Business Decisions
8.4.1 Differential Cost and Revenue
8.4.2 Opportunity Cost
8.4.3 Sunk Costs
8.4.4 Marginal Cost
8.5 Estimating Profit from Production
8.5.1 Calculation of Operating Income
8.5.2 Sales Budget for a Manufacturing Business
8.5.3 Preparing the Production Budget
8.5.4 Preparing the Cost-of-Goods-Sold Budget
8.5.5 Preparing the Nonmanufacturing Cost Budget
8.5.6 Putting It All Together: The Budgeted Income Statement
8.5.7 Looking Ahead
Summary
Problems
Short Case Studies
Chapter 9 Depreciation and Corporate Taxes
9.1 Asset Depreciation
9.1.1 Economic Depreciation
9.1.2 Accounting Depreciation
9.2 Factors Inherent in Asset Depreciation
9.2.1 Depreciable Property
9.2.2 Cost Basis
9.2.3 Useful Life and Salvage Value
9.2.4 Depreciation Methods: Book and Tax Depreciation
9.3 Book Depreciation Methods
9.3.1 Straight-Line Method
9.3.2 Accelerated Methods
9.3.3 Units-of-Production Method
9.4 Tax Depreciation Methods
9.4.1 MACRS Depreciation
9.4.2 MACRS Depreciation Rules
9.5 Depletion
9.5.1 Cost Depletion
9.5.2 Percentage Depletion
9.6 Repairs or Improvements Made to Depreciable Assets
9.6.1 Revision of Book Depreciation
9.6.2 Revision of Tax Depreciation
9.7 Corporate Taxes
9.7.1 Income Taxes on Operating Income
9.8 Tax Treatment of Gains or Losses on Depreciable Assets
9.8.1 Disposal of a MACRS Property
9.8.2 Calculations of Gains and Losses on MACRS Property
9.9 Income Tax Rate to Be Used in Economic Analysis
9.9.1 Incremental Income Tax Rate
9.9.2 Consideration of State Income Taxes
9.10 The Need for Cash Flow in Engineering Economic Analysis
9.10.1 Net Income versus Net Cash Flow
9.10.2 Treatment of Noncash Expenses
Summary
Problems
Short Case Studies
Chapter 10 Developing Project Cash Flows
10.1 Cost—Benefit Estimation for Engineering Projects
10.1.1 Simple Projects
10.1.2 Complex Projects
10.2 Incremental Cash Flows
10.2.1 Elements of Cash Outflows
10.2.2 Elements of Cash Inflows
10.2.3 Classification of Cash Flow Elements
10.3 Developing Cash Flow Statements
10.3.1 When Projects Require Only Operating and Investing Activities
10.3.2 When Projects Require Working-Capital Investments
10.3.3 When Projects are Financed with Borrowed Funds
10.3.4 When Projects Result in Negative Taxable Income
10.3.5 When Projects Require Multiple Assets
10.4 Generalized Cash-Flow Approach
10.4.1 Setting up Net Cash-Flow Equations
10.4.2 Presenting Cash Flows in Compact Tabular Formats
10.4.3 Lease-or-Buy Decision
Summary
Problems
Short Case Studies
PART 4 HANDLING RISK AND UNCERTAINTY
Chapter 11 Inflation and Its Impact on Project Cash Flows
11.1 Meaning and Measure of Inflation
11.1.1 Measuring Inflation
11.1.2 Actual versus Constant Dollars
11.2 Equivalence Calculations under Inflation
11.2.1 Market and Inflation-Free Interest Rates
11.2.2 Constant-Dollar Analysis
11.2.3 Actual-Dollar Analysis
11.2.4 Mixed-Dollar Analysis
11.3 Effects of Inflation on Project Cash Flows
11.3.1 Multiple Inflation Rates
11.3.2 Effects of Borrowed Funds Under Inflation
11.4 Rate-of-Return Analysis Under Inflation
11.4.1 Effects of Inflation on Return on Investment
11.4.2 Effects of Inflation on Working Capital
Summary
Problems
Short Case Studies
Chapter 12 Project Risk and Uncertainty
12.1 Origins of Project Risk
12.2 Methods of Describing Project Risk
12.2.1 Sensitivity Analysis
12.2.2 Break-Even Analysis
12.2.3 Scenario Analysis
12.3 Probability Concepts for Investment Decisions
12.3.1 Assessment of Probabilities
12.3.2 Summary of Probabilistic Information
12.3.3 Joint and Conditional Probabilities
12.3.4 Covariance and Coefficient of Correlation
12.4 Probability Distribution of NPW
12.4.1 Procedure for Developing an NPW Distribution
12.4.2 Aggregating Risk over Time
12.4.3 Decision Rules for Comparing Mutually Exclusive Risky Alternatives
12.5 Risk Simulation
12.5.1 Computer Simulation
12.5.2 Model Building
12.5.3 Monte Carlo Sampling
12.5.4 Simulation Output Analysis
12.5.5 Risk Simulation with Oracle Crystal Ball
12.6 Decision Trees and Sequential Investment Decisions
12.6.1 Structuring a Decision-Tree Diagram
12.6.2 Worth of Obtaining Additional Information
12.6.3 Decision Making after Having Imperfect Information
Summary
Problems
Short Case Studies
Chapter 13 Real-Options Analysis
13.1 Risk Management: Financial Options
13.1.1 Features of Financial Options
13.1.2 Buy Call Options when You Expect the Price to Go Up
13.1.3 Buy Put Options when You Expect the Price to Go Down
13.2 Option Strategies
13.2.1 Buying Calls to Reduce Capital That Is at Risk
13.2.2 Protective Puts as a Hedge3
13.3 Option Pricing
13.3.1 Replicating-Portfolio Approach with a Call Option
13.3.2 Risk-Free Financing Approach
13.3.3 Risk-Neutral Probability Approach
13.3.4 Put-Option Valuation
13.3.5 Two-Period Binomial Lattice Option Valuation
13.3.6 Multiperiod Binomial Lattice Model
13.3.7 Black—Scholes Option Model
13.4 Real-Options Analysis
13.4.1 A Conceptual Framework for Real Options
in Engineering Economics
13.4.2 Types of Real-Option Models
13.5 Compound Options
13.6 Estimating Volatility at the Project Level
13.6.1 Mathematical Relationship between and
13.6.2 Estimating distribution
Summary
Problems
Short Case Studies
PART 5 SPECIAL TOPICS IN ENGINEERING ECONOMICS
Chapter 14 Replacement Decisions
14.1 Replacement Analysis Fundamentals
14.1.1 Basic Concepts and Terminology
14.1.2 Opportunity Cost Approach to Comparing Defender and Challenger
14.2 Economic Service Life VT
14.3 Replacement Analysis When the Required Service is Long
14.3.1 Required Assumptions and Decision Frameworks
14.3.2 Replacement Strategies under the Infinite Planning Horizon
14.3.3 Replacement Strategies under the Finite Planning Horizon
14.3.4 Consideration of Technological Change
14.4 Replacement Analysis With Tax Considerations
Summary
Problems
Short Case Studies
Chapter 15 Capital-Budgeting Decisions
15.1 Methods of Financing
15.1.1 Equity Financing
15.1.2 Debt Financing
15.1.3 Capital Structure
15.2 Cost of Capital
15.2.1 Cost of Equity
15.2.2 Cost of Debt
15.2.3 Calculating the Cost of Capital
15.3 Choice of Minimum Attractive Rate of Return
15.3.1 Choice of MARR when Project Financing Is Known
15.3.2 Choice of MARR when Project Financing is Unknown
15.3.3 Choice of MARR under Capital Rationing
15.4 Capital Budgeting
15.4.1 Evaluation of Multiple Investment Alternatives
15.4.2 Formulation of Mutually Exclusive Alternatives
15.4.3 Capital-Budgeting Decisions with Limited Budgets
Summary
Problems
Short Case Studies
Chapter 16 Economic Analysis in the Service Sector
16.1 What is the Service Sector?
16.1.1 Characteristics of the Service Sector
16.1.2 Diffculty of Pricing Service
16.2 Economic Analysis in Health-Care Service
16.2.1 Economic Evaluation Tools
16.2.2 Cost-Effectiveness Analysis
16.3 Economic Analysis in the Public Sector
16.3.1 What Is Benefit—Cost Analysis?
16.3.2 Framework of Benefit—Cost Analysis
16.3.3 Valuation of Benefits and Costs
16.3.4 Quantifying Benefits and Costs
16.3.5 Difficulties Inherent in Public Project Analysis
16.4 Benefit—Cost Ratios
16.4.1 Definition of Benefit—Cost Ratio
16.4.2 Relationship Among B/C Ratio, Profitability Index, and NPW
16.4.3 Comparing Mutually Exclusive Alternatives: Incremental Analysis
16.5 Analysis of Public Projects Based on Cost-Effectiveness
16.5.1 Cost-Effectiveness Studies in the Public Sector
16.5.2 A Cost-Effectiveness Case Study14