Engineering Economy

417 Pages·2012·4.884 MB·English

by  Zahid A Khan, Arshad Noor Siddique, Brajesh Kumar

ENGINEERING
ECONOMY
Zahid A. Khan
Professor, Department of Mechanical Engineering
Jamia Milia Islamia
Arshad Noor Siddiquee
Associate Professor, Department of Mechanical Engineering
Jamia Milia Islamia
Brajesh Kumar
Associate Professor
National Institute of Financial Management
Delhi • Chennai • Chandigarh
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ABOUT THE AUTHORS
Zahid A. Khan is Professor in the Department of Mechanical Engineering,
Jamia Millia Islamia, New Delhi and has more than 20 years of teaching
and research experience. He has taught in overseas universities such as the
University Sains Malaysia, Malaysia, and the King Abdulaziz University,
Jeddah, Kingdom of Saudi Arabia. Apart from teaching, he is actively in-
volved in research and development activities. He has published more than
45 research papers in reputed national and international journals, and over
20 papers in the proceedings of conferences held in India and abroad.
In addition to one monogropah published in his name by a reputed Ger-
man publisher, he has contributed chapters on engineering subjects to three
books of reputed publishers. He has received international recognition—his
biography has been published in Marqui’s Who’s Who in Science and Engineering, Tenth edition, 2008–09.
He has received the International Scientist of the Year, 2008 award given by the International Bio-
graphical Centre, Cambridge, UK. He is also a member of the Emerald Literati Network, UK, and is
also on the panel of reviewers of international journals.
Arshad Noor Siddiquee has graduated from Government Engineering Col-
lege, Jabalpur. He completed his M.Tech. from the Indian Institute of Technol-
ogy Delhi, where he is currently pursuing his doctoral studies. He is presently
working as an Associate Professor in the Department of Mechanical Engineer-
ing, Jamia Millia Islamia. He played a key role in the developmental phase of
Glasgow University College in Oman during 1998–2001. He has had hands-
on experience in the establishment and accreditation of technical institutions
during his tenure at the All India Council for Technical Education (AICTE),
New Delhi, in the capacity of Assistant Director. He has contributed chapters on
engineering subjects to three books of reputed publishers and over 15 research
papers to international journals.
Brajesh Kumar has worked in the Department of Expenditure, Ministry
of Finance, Government of India, and is currently serving as an Associate
Professor at the National Institute of Financial Management (NIFM), Farid-
abad. His areas of interest are managerial economics, financial econometrics
and computer applications in economics. He has published several books on
managerial economics, macro- and micro-economics. He is associated with
various national and international organizations in different capacities; for
instance, agro-expert, Federation of Indian Chambers of Commerce and
Industry (FICCI); read group member, Centre for Trade and Devel-
opment (CENTAD)) and programme coordinator, civil servants from
North-East Cadre.
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CONTENTS
Foreword xi
Preface xv
1 Engineering Economy: A Prologue 1
1.1 Consumer and Producer Goods and Services 1
1.2 Necessities, Luxuries, and Relation Between Price
and Demand 2
1.3 Competition or Market Structure 3
1.4 Relation Between Total Revenue and Demand 4
1.5 Cost Concepts 5
1.6 Relationship between Cost and Volume 6
1.7 The Law of Supply and Demand 10
1.8 The Law of Diminishing Marginal Returns 10
2 Fundamentals of Mathematics and Engineering Economics 13
2.1 Introduction 13
2.2 Theory of Consumer Behaviour 14
2.2.1 Meaning of Utility 15
2.2.2 Meaning of Demand 18
2.3 Concepts of Elasticity 23
2.3.1 Own Price Elasticity 23
2.3.2 Determinants of Price Elasticity 25
2.3.3 Income Elasticity of Demand 25
2.3.4 Cross-price Elasticity of Demand 27
2.3.5 Engel Curve and Income Elasticity 28
2.3.6 Relationship Between Price Elasticity and Marginal Revenue 30
2.4 Laws of Diminishing Marginal Utility 31
2.5 Principle of Equimarginal Utility 33
2.6 Indifference Curves (ICs) Theory/Ordinal Utility Theory 34
2.6.1 Indifference Curves 34
2.6.2 Nature of Consumer Preferences 35
2.6.3 Indifference Map 36
2.7 Rate of Commodity Substitution 36
2.7.1 Properties of ICs 37
2.7.2 Budget Line 39
2.7.3 Consumer’s Equilibrium/Maximization of Utility 39
2.7.4 Alternative Method of Utility Maximization 41
2.8 Application and Uses of ICs 43
2.8.1 Income and Leisure Choice 43
2.8.2 Revealed Preference Hypothesis 44
2.8.3 Consumer’s Surplus 46
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vi | Contents
3 Elementary Economic Analysis 49
3.1 Theory of the Firm 49
3.2 Law of Supply 49
3.2.1 Concepts of Elasticity of Supply 52
3.3 Meaning of Production 53
3.3.1 Production Function and Its Types 55
3.3.2 General Production Function 56
3.3.3 Cobb-Douglas Production Function 57
3.3.4 CES Production Function 59
3.3.5 Producer’s Equilibrium 59
3.4 Concept of Isoquants 61
3.5 Marginal Rate of Technical Substitution 65
3.6 The Elasticity of Substitution 65
3.7 Iso-cost Line 66
3.8 Producer’s Surplus 67
3.9 Cost Minimization 67
3.9.1 Cost Function for the Cobb-Douglas Technology 68
3.9.2 The Cost Function for the CES Technology 69
3.9.3 The Cost Function for the Leontief Technology 71
3.9.4 The Cost Function for the Linear Technology 71
3.10 Returns to Scale and Returns to Factor 71
3.11 Cost Theory and Estimation 72
3.11.1 Concept of Costs and Its Types 72
3.12 Profits 73
3.12.1 Normal Profits 75
3.12.2 Economic Profits 75
3.12.3 Profit Maximization 75
3.13 Market Structure and Degree of Competition 75
3.13.1 Perfect Competition 76
3.13.2 Monopoly 78
3.13.3 Monopolistic Competition 79
3.13.4 Oligopoly Models 81
4 Interest Formulae and Their Applications 85
4.1 Introduction 85
4.2 Why Return to Capital is Considered? 85
4.3 Interest, Interest Rate and Rate of Return 85
4.4 Simple Interest 86
4.5 Compound Interest 87
4.6 The Concept of Equivalence 88
4.7 Cash Flow Diagrams 88
4.8 Terminology and Notations/Symbols 90
4.9 Interest Formula for Discrete Cash Flow and Discrete
Compounding 93
4.9.1 Interest Formulae Relating Present and Future Equivalent
Values of Single Cash Flows 93
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Contents | vii
4.9.2 Interest Formulae Relating a Uniform Series (Annuity) to
Its Present and Future Worth 96
4.10 Interest Formulae Relating an Arithmetic Gradient Series to
Its Present and Annual Worths 103
4.10.1 Finding P when given G 104
4.10.2 Finding A when given G 105
4.11 Interest Formulae Relating a Geometric Gradient Series to Its
Present and Annual Worth 109
4.12 Uniform Series with Beginning-of-period
Cash Flows 114
4.13 Deferred Annuities or Shifted Uniform Series 116
4.14 Calculations Involving Uniform Series and Randomly Placed
Single Amounts 118
4.15 Calculations of Equivalent Present Worth and Equivalent
Annual Worth for Shifted Gradients 121
4.16 Calculations of Equivalent Present Worth and Equivalent
Annual Worth for Shifted Decreasing Arithmetic
Gradients 124
4.17 Nominal and Effective Interest Rates 128
4.18 Interest Problems with Compounding More Often than Once
per Year 132
4.18.1 Single Amounts 132
4.18.2 Uniform Series and Gradient Series 134
4.18.3 Interest Problems with Uniform Cash Flows Less Often
than Compounding Periods 135
4.18.4 Interest Problems with Uniform Cash Flows More Often
than Compounding Periods 137
5 Methods for Making Economy Studies 144
5.1 Introduction 144
5.2 Basic Methods 144
5.3 Present Worth (P.W.) Method 145
5.4 Future Worth (F.W.) Method 147
5.5 Annual Worth (A.W.) Method 148
5.6 Internal Rate of Return (I.R.R.) Method 153
5.7 External Rate of Return (E.R.R.) Method 155
5.8 Explicit Reinvestment Rate of Return (E.R.R.R.)
Method 158
5.9 Capitalized Cost Calculation and Analysis 159
5.10 Payback (Payout) Method 161
6 Selection Among Alternatives 166
6.1 Introduction 166
6.2 Alternatives Having Identical Disbursements and Lives 166
6.3 Alternatives Having Identical Revenues and
Different Lives 174
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viii | Contents
6.3.1 Comparisons Using the Repeatability Assumption 174
6.3.2 Comparisons Using the Coterminated Assumption 178
6.4 Alternatives Having Different Revenues and
Identical Lives 180
6.5 Alternatives Having Different Revenues and
Different Lives 183
6.6 Comparison of Alternatives by the Capitalized
Worth Method 185
6.7 Selection Among Independent Alternatives 185
7 Replacement and Retention Decisions 192
7.1 Introduction 192
7.2 Reasons for Replacement 192
7.3 Terminologies Used in Replacement Study 193
7.4 Economic Service Life 193
7.5 Procedure for Performing Replacement Study 196
7.6 Replacement Study Over a Specified Study Period 197
8 Depreciation 204
8.1 Introduction 204
8.2 Depreciation Terminology 204
8.3 Methods of Depreciation 205
8.3.1 The Straight Line (SL) Method 205
8.3.2 The Declining Balance (DB) Method 207
8.3.3 Sum-of-the-Years’-Digits (SYD) Method 209
8.3.4 The Sinking Fund Method 210
8.3.5 The Service Output Method 211
9 Economic Evaluation of Public Sector Projects 214
9.1 Public Sector Projects 214
9.2 Benefit/Cost Analysis of a Single Project 215
9.3 Selection Between Two Mutually Exclusive Alternatives
Using Incremental B/C Analysis 217
9.4 Selection Among Multiple Mutually Exclusive Alternatives
Using Incremental B/C Analysis 218
10 Economy Study with Inflation Considered 223
10.1 Introduction 223
10.2 Effects of Inflation 223
10.3 Present Worth Calculations Adjusted for Inflation 224
10.4 Future Worth Calculations Adjusted for Inflation 227
10.5 Capital Recovery Calculations Adjusted for Inflation 229
11 Make or Buy Decision 232
11.1 Introduction 232
11.2 Feasible Alternatives for Launching New Products 232
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Contents | ix
11.3 Decisive Factors for Make or Buy Decision 233
11.3.1 Criteria for Make Decision 233
11.3.2 Criteria for Buy Decision 234
11.4 Techniques Used to Arrive at Make or Buy Decision 234
11.4.1 Simple Cost Analysis 234
11.4.2 Economic Analysis 235
11.4.3 Break-even Analysis 238
12 Project Management 242
12.1 Introduction 242
12.2 Phases of Project Management 242
12.2.1 Planning 242
12.2.2 Scheduling 243
12.2.3 Monitoring and Control 243
12.3 Bar or Gantt Charts 243
12.4 Network Analysis Technique 245
12.5 Critical Path Method (CPM) 245
12.5.1 Arrow Diagrams 246
12.5.2 Activity Description 249
12.5.3 Understanding Logic of Arrow Diagrams 250
12.5.4 Dummy Activities 251
12.6 Guidelines for Drawing Network Diagrams or Arrow
Diagrams 253
12.7 CPM Calculations 256
12.7.1 Critical Path 256
12.7.2 Critical Activities 257
12.7.3 Non-critical Activities 257
12.7.4 Earliest Event Time 257
12.7.5 Latest Event Time 257
12.8 Calculation of the Earliest Occurrence Time of Events 258
12.9 Calculation of the Latest Occurrence Time of Events 262
12.10 Activity Times 268
12.10.1 Earliest Start Time 268
12.10.2 Earliest Finish Time 269
12.10.3 Latest Finish Time 269
12.10.4 Latest Start Time 269
12.11 Float 273
12.11.1 Types of Float 274
12.11.2 Negative Float 280
12.12 Identification of Critical Path 282
12.13 Programme Evaluation and Review Technique (PERT) 283
12.13.1 PERT Activity Time Estimates 284
12.13.2 PERT Computations 285
12.13.3 Computation of Probabilities of Completion
by a Specified Date 292
12.14 Project Crashing 297
12.14.1 Cost Slope 298
12.14.2 Cost of Crashing 298
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