Engineering economics for aviation and aerospace

619 Pages·2017·9.48 MB·English

by  Gorjidooz

Engineering Economics for
Aviation and Aerospace
For all engineers and practitioners, it is essential to have a fundamental under-
standing of cost structure, estimating cash flows, and evaluating alternative projects
and designs on an economic basis. Engineering Economics for Aviation and Aerospace
provides the tools and techniques necessary for engineers to economically evaluate
their projects and choices.
The focus of this book is on a comprehensive understanding of the theory and
practical applications of engineering economics. It explains and demonstrates the
principles and techniques of engineering economics and financial analysis as applied
to the aviation and aerospace industries. Time value of money, interest factors, and
spreadsheet functions are used to evaluate the cash flows associated with a single
project or multiple projects. The alternative engineering economics tools and tech-
niques are utilized in separate chapters to evaluate the attractiveness of a single
project or to select the best of multiple alternatives.
Most of the engineering economics and financial mathematics books available in
the market take either a pure theoretical approach or offer limited applications. This
book incorporates both approaches, providing students of aviation and industrial
economics, as well as practitioners, with the necessary mathematical knowledge to
evaluate alternatives on an economic basis.
Bijan Vasigh is Professor of Economics and Finance in the College of Business at
Embry-Riddle Aeronautical University, Daytona Beach, Florida, USA.
Javad Gorjidooz is the Chair of the Business Administration Program and Professor
of Finance in the School of Business at Embry-Riddle Aeronautical University,
Prescott, Arizona, USA.

Engineering Economics
for Aviation and
Aerospace
Bijan Vasigh and Javad Gorjidooz
First published 2017
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
711 Third Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2017 Bijan Vasigh and Javad Gorjidooz
The right of Bijan Vasigh and Javad Gorjidooz to be identified as
authors of this work has been asserted by them in accordance with
sections 77 and 78 of the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or
reproduced or utilized in any form or by any electronic, mechanical,
or other means, now known or hereafter invented, including
photocopying and recording, or in any information storage or
retrieval system, without permission
in writing from the publishers.
Trademark notice: Product or corporate names may be trademarks or
registered trademarks, and are used only for identification and
explanation without intent to infringe.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging in Publication Data
Names: Vasigh, Bijan, author. | Gorjidooz, Javad, 1951- author.
Title: Engineering economics for aviation and aerospace /
Bijan Vasigh and Javad Gorjidooz.
Description: Abingdon, Oxon; New York, NY : Routledge is an
i mprint of the Taylor & Francis Group, an Informa Business,
[2017] | Includes bibliographical references and index.
Identifiers: LCCN 2016027665| ISBN 9781138185777 (hardback) |
ISBN 9781138185784 (pbk.) | ISBN 9781315644257 (ebook)
Subjects: LCSH: Aerospace engineering—Cost control. | Engineering
economy.
Classification: LCC TL872 .V37 2017 | DDC 338.4/76291—dc23
LC record available at https://lccn.loc.gov/2016027665
ISBN: 978-1-138-18577-7 (hbk)
ISBN: 978-1-138-18578-4 (pbk)
ISBN: 978-1-315-64425-7 (ebk)
Typeset in Palatino
by RefineCatch Limited, Bungay, Suffolk
Contents
List of Figures ........................................................xiii
List of Tables ........................................................xvii
Preface ..............................................................xxi
Foreword by Brian Pearce .............................................. xxii
Foreword by Zane Rowe ...............................................xxiv
Foreword by Dr Barry Humphreys CBE ...................................xxvi
Acknowledgments .................................................. xxviii
List of Abbreviations ..................................................xxix
1 Introduction to the Air Transport Industry ............................... 1
Airline Industry before Deregulation .................................... 2
Airline Industry after Deregulation ...................................... 3
Airline Profitability .................................................... 6
Air Transport Industry ................................................. 8
Aircraft Manufacturers ........................................... 10
Jet Engine Manufacturers ......................................... 14
Aircraft Leasing Companies ...................................... 16
Service Providers (MRO, Ground Handling, Catering) ............... 17
Airports ........................................................ 18
Air Navigation Service Providers (ANSP) .......................... 19
Global Distribution System (GDS) and Computer Reservation
System (CRS) ................................................ 19
Freight Forwarders and Integrators ................................ 22
Airline Mergers and Bankruptcies ...................................... 23
Summary ........................................................... 25
Discussion Questions and Problems .................................... 27
2 Foundations of Engineering Economics and Finance ..................... 31
Definition of Engineering Economics ................................... 32
Interest and Time Value of Money ...................................... 33
Simple Interest .................................................. 34
Compound Interest .............................................. 36
The Connection between Interest Rates and Their Determinations .......... 38
Short- term Interest Rates ......................................... 39
Long-term Debt and Interest Rates ................................. 42
Future Value of a Single Present Amount ................................ 47
Present Value of a Single Future Sum ................................... 49
Future Value of an Unequal Cash Flow Series ............................ 52
The Rule of 72 ....................................................... 53
The Rule of 100 ...................................................... 54
Summary ........................................................... 55
Discussion Questions and Problems .................................... 55
vi ◆ Contents
3 Annuities and Gradient Series ........................................ 58
Annuities or Uniform Series ........................................... 59
Future Value of an Annuity ....................................... 61
Annuity of a Future Value ........................................ 63
Present Value of an Annuity ...................................... 64
Annuity of a Present Value ....................................... 68
Amortization and Amortization Schedule ............................... 69
Annuity Due ........................................................ 71
Capitalized Cost ..................................................... 71
Arithmetic Gradient Series ............................................ 73
Present Value of an Arithmetic Gradient Series ...................... 73
Annuity of an Arithmetic Gradient Series ........................... 76
Future Value of an Arithmetic Gradient Series ....................... 78
Geometric Gradient Series ............................................. 79
Present Value of a Geometric Gradient Series ........................ 79
Annuity of a Geometric Gradient Series ............................ 81
Future Value of a Geometric Gradient Series ........................ 81
Shifted Cash Flow Series .............................................. 82
Using Spreadsheets for Equivalences Computation ....................... 84
Summary ........................................................... 87
Discussion Questions and Problems .................................... 88
4 Nominal and Effective Interest Rates .................................. 92
Nominal Versus Effective Interest Rates ................................. 93
Calculating Effective Interest Rate ...................................... 94
Continuous Compounding ....................................... 95
Effective Rate to Nominal Rate .................................... 97
Comparing Compounding Periods and Payment Periods .................. 99
Computing Equivalences Involving Only Single-Amount Factors ...... 99
Computing Equivalences when Payment Period Equals
Compounding Period ........................................ 101
Computing Equivalences when Payment Period Exceeds
Compounding Period ........................................ 102
Computing Equivalences when Payment Period is Less Than
Compounding Period ........................................ 104
Using Spreadsheets for Effective Rate and Equivalences Computation ..... 105
Summary .......................................................... 108
Discussion Questions and Problems ................................... 109
5 Analysis of Present Worth ............................................112
Measuring Project Cash Flows .........................................113
First Cost (P) ....................................................113
Net Annual Cash Flow (NACF) ...................................114
Terminal Cash Flow (TCF) .......................................115
Evaluation of Single Projects ...........................................116
Bond Valuation ..................................................... 120
Types of Project Alternatives .......................................... 127
Mutually Exclusive (ME) Projects ................................ 127
Contents ◆ vii
Independent Projects (IP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
Do-nothing Alternative ......................................... 128
Evaluation of Mutually Exclusive Equal- life Alternatives ................. 128
Evaluation of Mutually Exclusive Different- life Alternatives .............. 130
Study Period Approach ......................................... 131
Least Common Multiple or Replacement Chain Approach ........... 132
Capitalized Cost or Equivalent Annual Annuity Approach ..............133
Evaluation of Independent Projects .................................... 135
Using Spreadsheets for Present Worth Computation ..................... 137
Life Cycle Costing (LCC) ............................................ 138
Summary .......................................................... 140
Discussion Questions and Problems ................................... 141
6 Analysis of Annual Worth ........................................... 146
Motivation for Using Annual Worth Analysis ........................... 147
Evaluation of Single Projects .......................................... 148
Capital Recovery ............................................... 152
Annuity of Net Annual Cash Flows ............................... 153
Evaluation of Mutually Exclusive Projects .............................. 154
Annual Worth Analysis of Equal- life Alternatives ................... 155
Annual Worth Analysis of Non-Equal- life Alternatives .............. 155
Evaluation of Independent Projects .................................... 157
Annual Worth of Permanent Projects .................................. 159
Using Spreadsheets for Annual Worth Computation ..................... 160
Summary .......................................................... 161
Discussion Questions and Problems ................................... 162
7 Analysis of Rate of Return ........................................... 167
Rate of Return Calculation ........................................... 168
Interpretation of Rate of Return Values ............................ 170
Trial and Error Method .......................................... 170
Rate of Return of Bonds .............................................. 173
Evaluating Mutually Exclusive Projects ................................ 175
Incremental Cash Flows ......................................... 176
Cost- based Alternatives ......................................... 178
Revenue- based Alternatives ..................................... 180
Equal- life Service Requirement ................................... 181
Evaluating Independent Projects ...................................... 184
Complications with Rate of Return .................................... 186
Multiple Rates of Return Scenario ................................ 187
ROR Reinvestment Rate Assumption ............................. 188
Modified Rate of Return Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188
Using Spreadsheets for Rate of Return Computation ..................... 189
Summary .......................................................... 191
Discussion Questions and Problems ................................... 191
8 Public Sector Projects and Benefit to Cost Analysis ..................... 195
Public Sector versus Private Sector Projects ............................. 196
viii ◆ Contents
Benefit/Cost Analysis of Single Projects ................................ 200
Evaluation of Cost- based Mutually Exclusive Alternatives ................ 202
Evaluation of Benefit- based Mutually Exclusive Alternatives .............. 204
Evaluation of Independent Projects .................................... 208
Modified Benefit and Cost Analysis .................................... 210
Using Spreadsheets for Benefit/Cost Ratio Computation ................. 212
Summary .......................................................... 213
Discussion Questions and Problems ................................... 214
9 Analysis of Break- even and Payback Period ........................... 219
Introduction to Break- even Analysis ................................... 220
Elements of Break- even Analysis ...................................... 221
Break- even Analysis of a Single Project when Interest is Equal
to Zero .........................................................223
Break- even Analysis between Two Alternatives with Interest Rate
of Zero ..................................................... 225
Break- even Analysis of a Single Project with Interest Rate Greater
than Zero ................................................... 226
Break- even Analysis of Mutually Exclusive Alternatives with
Interest Rate Greater than Zero ................................ 228
Airline Break- even Load Factor ....................................... 229
Introduction to Payback Period Analysis ............................... 231
Conventional Payback Period Analysis ............................ 232
Discounted Payback Period Analysis .............................. 234
Using Spreadsheets for Break- even Analysis and Payback Periods ......... 235
Summary .......................................................... 237
Discussion Questions and Problems ................................... 238
10 Uncertainty, Risk Analysis, and Simulation ........................... 242
Decision Making .................................................... 243
Probability and Business Decisions .................................... 244
Cumulative Probability Distribution .............................. 246
Joint Probability Distribution .................................... 246
Measuring Risk and Reward .......................................... 249
Sample Space .................................................. 250
Expected Return or Mean ....................................... 251
Variance ...................................................... 253
Standard Deviation ............................................. 253
Calculating Variance and Standard Deviation Using Spreadsheets .... 254
Normal Distribution ................................................. 258
Calculating Normal Distribution Probability Using Spreadsheets ..... 260
Standard Normal Distribution ................................... 260
Portfolios .......................................................... 265
Portfolio Beta .................................................. 266
Capital Asset Pricing Model (CAPM) .................................. 267
Security Market Line (SML) ..................................... 269
Sensitivity Analysis ................................................. 272
Break- even Analysis ............................................ 272
Monte Carlo Analysis (Simulation) ............................... 275
Contents ◆ ix
Summary .......................................................... 279
Discussion Questions and Problems ................................... 279
11 Analysis of Depreciation, Replacement, and Abandonment ............. 283
Introduction ........................................................ 284
Depreciation Methodologies .......................................... 285
Straight Line Depreciation (SL) Method ........................... 286
Declining Balance Depreciation (DB) .............................. 289
Modified Accelerated Cost Recovery System (MACRS) ............. 290
Sum- of-the-Years Digits (SYD) Method ........................... 292
Comparison of Different Approaches to Depreciation .................... 294
Using Spreadsheets for Depreciation Computations ..................... 297
Basics of a Replacement Decision ...................................... 303
Impairment ........................................................ 306
Abandonment ...................................................... 308
Summary ...........................................................311
Discussion Questions and Problems ................................... 312
12 Engineering Cost Estimation ......................................... 317
Definition of Cost ................................................... 319
Fixed Costs (FC) ............................................... 319
Variable Costs (VC) ............................................. 320
Total Costs (TC) ................................................ 321
Cubic Cost Function ............................................ 324
Marginal Costs (MC) ........................................... 324
Average Total Cost (ATC) ....................................... 325
Average Fixed Cost (AFC) ....................................... 328
Average Variable Cost (AVC) .................................... 329
Sunk Costs .................................................... 331
Opportunity Costs .............................................. 332
Relationship between Economic and Accounting Cost ................... 334
Cost of Debt ................................................... 335
Cost of Equity ................................................. 335
Weighted Average Cost of Capital (WACC) ........................ 335
ROIC vs WACC ............................................... 335
Cost Divisions and Categories ........................................ 336
Direct Costs ................................................... 337
Indirect Costs .................................................. 338
Learning Curve ..................................................... 338
Estimating Costs .................................................... 341
Cost Estimation Techniques .......................................... 343
Unit Cost Method .............................................. 344
Cost Index Method ............................................. 346
Cost Capacity Equation ......................................... 349
Cost Factor Method ............................................. 351
Indirect Cost Estimation and Allocation ........................... 352
Airline Cost Structure ................................................ 354
Operating Costs (OC) ........................................... 354
Non-operating Costs (NOC) ..................................... 358