Capital Investment Analysis for Engineering and Management

by Canada, John R.; Sullivan, William G.; White, John A.

• ISBN13: 9780133110364
• ISBN10: 0133110362
• Edition: 2nd
• Format: Hardcover
• Copyright: 1996-01-01
• Publisher: PRENTICE HALL

Summary

This guide enables engineers and engineering managers to communicate effectively with financial professionals, while offering a balanced presentation of the basics of engineering economic analysis. Focuses on real management situations. Provides accounting/cost accounting fundamentals to measure results. Introduces the concept of " options analysis" applied to capital investment decisions. Aids in conducting economic analyses with liberal use of spreadsheets. Introduces tax considerations and their consequences. For those interested in learning more about capital investment decision methodologies, particularly engineers and engineering managers.

Table of Contents

Preface	xvii
PART ONE Basic Capital Project Evaluation Techniques	1	(268)
1 Introduction and Cost Concepts	1	(18)
1.1 Recognition of a Problem Opportunity	1	(1)
1.2 Systems Analysis	2	(1)
1.3 Generation of Alternatives	2	(1)
1.4 Importance of Estimates in Economic Analyses	2	(1)
1.5 Cost Concepts	3	(7)
1.6 Cost Factors	10	(1)
1.7 Objectives of Firm and Nonmonetary Factors	10	(1)
1.8 The Role of the Engineer and Manager in Economic Decision Making	11	(1)
1.9 Scope and Importance	11	(1)
Problems	11	(4)
Appendix 1-A: Accounting Fundamentals	15	(4)
2 Computations Involving Interest	19	(31)
2.1 Interest Calculations	20	(1)
2.2 Equivalence	21	(1)
2.3 Compound Interest Formulas	22	(9)
Solved Problems	31	(4)
2.4 Spreadsheets	35	(2)
2.5 Compounding Frequency; Nominal and Effective Rates	37	(1)
2.6 Continuous Compounding Interest Formulas	38	(3)
Solved Problems	41	(4)
Problems	45	(5)
3 Equivalent Worth Methods for Comparing Alternatives	50	(19)
3.1 Measures of Economic Effectiveness	50	(1)
3.2 Defining Investment Alternatives	51	(1)
3.3 A Systematic Procedure for Comparing Investment Alternatives	51	(2)
3.4 Judging the Economic Worth of Investment Opportunities	53	(1)
3.5 Present Worth (PW) Method	54	(2)
3.6 Annual Worth (AW) Method	56	(2)
3.7 Future Worth (FW) Method	58	(2)
3.8 Assumptions in Comparisons of Alternatives with Different Lives	60	(2)
3.9 Relationship of Various Analysis Methods	62	(1)
Problems	62	(7)
4 Rate of Return Methods for Comparing Alternatives	69	(34)
4.1 Computation of Internal Rate of Return (IRR) for a Single Investment Opportunity	70	(8)
4.2 External Rate of Return (ERR) Method	78	(3)
4.3 Using Spreadsheets to Perform IRR and ERR Analyses	81	(12)
Problems	93	(6)
Appendix 4-A: Use of the ERR Method to Overcome Multiple-Solutions Difficulty with the IRR Method	99	(2)
Appendix 4-B: Other Rate of Return and Investment Recovery Measures of Merit for Financial and Management Purposes	101	(2)
5 Estimating for Economic Analyses	103	(37)
5.1 Introduction	103	(1)
5.2 Estimating: Difficulty and Perspective	103	(1)
5.3 Estimation Accuracy	104	(1)
5.4 Sources of Data	105	(3)
5.5 Quantitative Estimating Techniques	108	(20)
5.6 Additional Examples of Cost Engineering	128	(5)
5.7 Summary	133	(1)
Problems	133	(7)
6 Consideration of Depreciation and Income Taxes	140	(50)
6.1 Introduction to Depreciation	140	(5)
6.2 The Tax Reform Act of 1986 and Its Depreciation Provisions	145	(6)
6.3 A Comprehensive Example	151	(3)
6.4 Introduction to Income Taxes	154	(9)
6.5 General Procedure for Making After-Tax Economic Analyses	163	(17)
6.6 Summary	180	(1)
References	180	(2)
Problems	182	(8)
7 Analyses for Government Agencies and Public Utilities	190	(26)
7.1 Investments by Government Agencies	190	(3)
7.2 Comparison of Alternatives: The Benefit-Cost Ratio Method	193	(4)
7.3 Investments by Privately Owned Utilities	197	(1)
7.4 Comparison of Alternatives: The Revenue Requirement Method	198	(6)
7.5 Immediate Versus Deferred Investment	204	(5)
7.6 Summary	209	(1)
References	209	(1)
Problems	209	(7)
8 Replacement Analyses	216	(28)
8.1 Introduction	216	(1)
8.2 Importance of Replacement Studies	216	(1)
8.3 Causes of Retirement	217	(1)
8.4 Replacement Considerations and Assumptions	217	(1)
8.5 Market Value of Old Asset	218	(1)
8.6 Specifying the Planning Horizon for a Replacement Study	218	(1)
8.7 Cash Flow Approach and Conventional Approach	219	(5)
8.8 Asset Life Types	224	(1)
8.9 Calculation of Economic Life	224	(4)
8.10 Calculation of Remaining Economic Life--Existing Asset	228	(4)
8.11 Intangibles in Replacement Problems	232	(1)
8.12 Replacement of Assets Subject to Sudden Failure	232	(4)
8.13 Summary	236	(1)
References	237	(1)
Problems	237	(7)
9 Capital Planning and Budgeting	244	(25)
9.1 Introduction	244	(1)
9.2 Sources of Funds	245	(1)
9.3 Identification and Evaluation of Opportunities	245	(1)
9.4 Minimum Requirements of Acceptability	246	(2)
9.5 Project Selection	248	(4)
9.6 Postmortem Review	252	(1)
9.7 Budget Periods	253	(1)
9.8 Timing of Capital Investments and Management Perspective	253	(1)
9.9 Leasing Decisions	254	(2)
9.10 Capital Expenditure Practices in the United States	256	(2)
9.11 Capital Budgeting Forms Used by a Large Corporation	258	(8)
Problems	266	(3)
Part Two Capital Investment Evaluation Under Risk and Uncertainty	269	(132)
10 Introduction to Risk and Uncertainty	269	(20)
10.1 The Difference Between Risk and Uncertainty	269	(1)
10.2 Causes of Risk and Uncertainty	270	(3)
10.3 Weakness in Probabilistic Treatment of Project Analyses Involving Risk	273	(1)
10.4 Ways to Change or Influence Degree of Uncertainty	273	(1)
10.5 Return, Risk, and Choice	273	(1)
10.6 Decision Guides on When and How Much to Consider Risk and Uncertainty	274	(4)
10.7 General Model for Risk and Uncertainty Problems	278	(1)
10.8 Estimating in Terms of Probability Distributions	279	(5)
10.9 Human Problems in Reflecting Degree of Uncertainty in Estimates	284	(1)
10.10 Responses to Risk and Uncertainty	284	(1)
Problems	285	(4)
11 Sensitivity Analysis	289	(25)
11.1 Introduction	289	(1)
11.2 One-at-a-Time Procedure and Break-Even Analysis	289	(7)
11.3 Multiparameter Procedures	296	(4)
11.4 Summary	300	(1)
Problems	300	(8)
Appendix 11-A: Tabular and Graphical Illustrations of Sensitivity Analysis for the Comparison of Alternatives	308	(6)
12 Analytical and Simulation Approaches to Risk Analysis	314	(27)
12.1 Introduction	314	(1)
12.2 Analytical Methods of Risk Analysis	314	(11)
12.3 Monte Carlo Simulation of Risk	325	(10)
12.4 Method for Determining Required Number of Monte Carlo Trials and Limitations	335	(1)
Problems	336	(5)
13 Decision Criteria and Methods for Risk and Uncertainty	341	(22)
13.1 Introduction	341	(1)
13.2 General Model for Risk Problems	341	(1)
13.3 Dominance Criterion or Elimination Check	342	(1)
13.4 Aspiration-Level Criterion	342	(1)
13.5 Most Probable Future Criterion	343	(1)
13.6 Expected Value Criterion	344	(1)
13.7 Expectation-Variance Criterion	345	(2)
13.8 Certain Monetary Equivalence Criterion	347	(1)
13.9 Expected Utility Criterion	348	(5)
13.10 Expectation and Variance Criteria Applied to Investment Projects	353	(2)
13.11 Miscellaneous Decision Rules for Complete Uncertainty	355	(3)
Problems	358	(5)
14 Decision Tree Analysis	363	(24)
14.1 Introduction	363	(1)
14.2 A Deterministic Decision Tree	363	(2)
14.3 A Deterministic Decision Tree Considering Timing	365	(1)
14.4 Consideration of Random Outcomes	365	(2)
14.5 A Classical Decision Tree Problem	367	(1)
14.6 Constructing a Decision Tree	368	(2)
14.7 Use of Bayesian Statistics to Evaluate the Worth of Further Investigative Study	370	(4)
14.8 Alternate Method of Analysis	374	(1)
14.9 Examples of Decision Tree Applications	375	(1)
14.10 Advantages and Disadvantages of Decision Tree Analysis	376	(2)
14.11 Summary	378	(1)
Problems	378	(7)
Appendix 14-A: Bayes's Theorem and Tabular Format for Calculation of Posterior Probabilities	385	(2)
15 Statistical Decision Techniques	387	(14)
15.1 Introduction	387	(1)
15.2 Bayesian Statistics	387	(4)
15.3 Expected Value of Perfect Information	391	(7)
Problems	398	(3)
Part Three Additional Topics in Capital Investment Decision Analysis	401	(112)
16 Mathematical Programming for Capital Budgeting	401	(26)
16.1 Introduction	401	(1)
16.2 Indivisible, Independent Investment Opportunities	401	(1)
16.3 Indivisible, Dependent Investment Opportunities	402	(3)
16.4 Independent Collections of Mutually Exclusive Opportunities	405	(4)
16.5 Divisible Investment Opportunities	409	(1)
16.6 The MARR Controversy	410	(1)
16.7 Capital Rationing	411	(3)
16.8 Portfolio Selection	414	(2)
16.9 Goal Programming	416	(6)
16.10 Summary	422	(1)
References	422	(1)
Problems	422	(5)
17 Activity-Based Costing	427	(20)
17.1 Introduction	427	(1)
17.2 What Is Activity-Based Costing?	428	(1)
17.3 Traditional Versus Activity-Based Costing Systems	429	(6)
17.4 ABC as a Tool for the 1990s and Beyond	435	(5)
17.5 Current Issues in the Use of ABC Systems	440	(2)
17.6 PC-Based and Activity-Based Cost Accounting Software	442	(1)
17.7 Summary	443	(1)
Problems	443	(4)
18 Dealing with Inflation in Capital Investment Analysis	447	(18)
18.1 Introduction	447	(1)
18.2 Actual Dollars Versus Real Dollars	448	(1)
18.3 Real Interest Rate, Combined Interest Rate, and Inflation Rate	448	(1)
18.4 What Interest Rate to Use in Economy Studies	449	(1)
18.5 Summary of Formulas for Relating Single Sum A$ and R$ Over Time	450	(1)
18.6 Manipulating Series That Are Uniform in R$	451	(1)
18.7 Manipulating Series That Inflate (Escalate) at Rate Different from General Inflation	452	(1)
18.8 Effect of Inflation on Before-Tax and After-Tax Economic Studies	453	(4)
18.9 Deflation	457	(1)
18.10 Summary	457	(3)
Problems	460	(5)
19 Multiple Attribute Decision Making	465	(18)
19.1 Introduction	465	(1)
19.2 Choice of Criteria	466	(1)
19.3 Selection of a Measurement Scale	467	(1)
19.4 Dimensionality of the Decision Problem	467	(1)
19.5 Selected Analysis Techniques	468	(10)
19.6 Summary	478	(1)
References	478	(1)
Problems	478	(5)
20 The Analytic Hierarchy Process	483	(30)
20.1 Introduction	483	(1)
20.2 Construction of the Decision Hierarchy	484	(3)
20.3 Determining the Importance of Attributes and Subattributes	487	(2)
20.4 Determining the Relative Standing of Alternatives with Respect to Attributes	489	(3)
20.5 Determining the Consistency of Judgments	492	(2)
20.6 Determining the Overall Priority Weights of Alternatives	494	(2)
20.7 Added Explanation Regarding Example	496	(2)
20.8 Hierarchies with More Than Three Levels	498	(6)
20.9 Problems of Which to be Aware When Applying the AHP	504	(2)
20.10 Other AHP-Based Tools for Multicriteria Decision Problems	506	(1)
20.11 Summary	507	(1)
References	507	(1)
Problems	508	(5)
Appendix A Tables of Discrete Compounding Interest Factors (for Various Common Values of i from (1)(4)% to 25%))	513	(22)
Appendix B Tables of Continuous Compounding Interest Factors (for Various Common Values of r from 2% to 25%)	535	(7)
Appendix C Table of Random Numbers	542	(1)
Appendix D Table of Random Normal Deviates	543	(1)
Appendix E The Standardized Normal Distribution Function, F(S)	544	(1)
Bibliography	545	(7)
Glossary	552	(1)
Index	553