Engineering Economy - Applying Theory to Practice PDF
Preview Engineering Economy - Applying Theory to Practice
ENGINEERING ECONOMY APPLYING THEORY TO PRACTICE THIRD EDITION Ted G. Eschenbach University of Alaska Anchorage New York Oxford OXFORD UNIVERSITYPRESS 2011 Oxford University Press, Inc., publishes works that further Oxford University’s objective of excellence in research, scholarship, and education. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Copyright ©2011, 2003, 2002 by Oxford University Press, Inc. First edition ©1995 by Richard D. Irwin/McGraw-Hill. Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York 10016 http://www.oup.com Oxford is a registered trademark of Oxford University Press All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press. Library of Congress Cataloging-in-Publication Data Eschenbach, Ted. Engineering economy : applying theory to practice / Ted G. Eschenbach. — 3rd ed. p. cm. ISBN 978-0-19-976697-0 1. Engineering economy. I. Title. TA177.4.E833 2010 658.15—dc22 2010022161 Printing number: 9 8 7 6 5 4 3 2 1 Printed in the United States of America on acid-free paper C ASES IN nd ENGINEERING ECONOMY 2 William R. Peterson Minnesota State University, Mankato Ted G. Eschenbach University of Alaska Anchorage With cases contributed by Kate Abel Stevens Institute of Technology E. R. “Bear” Baker, IV University of Alaska Anchorage Michael Dunn Petrotechnical Resources of Alaska California Polytechnic State University – Daniel Franchi San Luis Obispo Joseph Hartman University of Florida Paul Kauffmann East Carolina University Neal Lewis University of Bridgeport Donald Merino Stevens Institute of Technology California Polytechnic State University – Lee McFarland San Luis Obispo Karen Schmahl Miami University Herb Schroeder University of Alaska Anchorage Andrés Sousa-Poza Old Dominion University William Truran Stevens Institute of Technology Oxford University Press New York Oxford 2009 Oxford University Press Oxford New York Auckland Bangkok Buenos Aires Cape Town Chennai Dar es Salaam Delhi Hong Kong Istanbul Karachi Kolkata Kuala Lumpur Madrid Melbourne Mexico City Mumbai Nairobi São Paulo Shanghai Taipei Tokyo Toronto Copyright © 2009, by Oxford University Press, Inc. Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York, 10016 http://www.oup-usa.org Oxford is a registered trademark of Oxford University Press All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press. Library of Congress Cataloging-in-Publication Data Eschenbach, Ted G. Cases in engineering economy / William R. Peterson & Ted G. Eschenbach. – 2nd ed. p. cm. ISBN 9780195397833 1. Engineering economy — case studies. I. Title. TA177.4.E83 2009 658.1'52—dc19 88-22764 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 Preface This text introduces the basic theory and application of engineering economy. It is suitable for a first course in engineering economy, for self-study by practicing engineers, and for reference during the practice of engineering. This text includes enough material so that in- structors have some choices for a first course at the undergraduate level. At the graduate level, instructors might add supplementary material, such as the cases which are found on the CD accompanying this text. Examples from all major engineering disciplines are in- cluded, with both private- and public-sector applications. HIGHLIGHTS OFTHIRD EDITION CHANGES Users of the first two editions, reviewers specifically chosen for this revision, and col- leagues and coauthors for other texts and articles in engineering economy have suggested the following improvements. • Cases in Engineering Economy 2nd by Peterson and Eschenbach, with contributed cases from 13 others, is on the student CD that comes with this text. Specific cases are suggested at the end of each chapter’s list of problems. • Anew Appendix B supports the use of financial calculators. This coverage concep- tually matches the use of the tabulated factors, but it allows students to focus more on concepts by reducing the time needed for financial arithmetic. • Ethics has been added to the material on decision-making in Chapter 1. • The use of uniform flow and gradient assumptions in feasibility and preliminary economic analysis has been emphasized in Chapter 3. • The flexibility of spreadsheets to more accurately model reality is emphasized in Chapter 4. • Chapter 4 introduces breakeven and what-if analyses. (If instructors need to skip parts of the book, this coverage makes it possible to skip Chapters 8 and 17 and to still include basic sensitivity analysis.) • Chapter 5 now includes a simple formula for a perpetual geometric gradient, as well as the formulas for a perpetual arithmetic gradient and a perpetual annual series. • Chapter 10 now includes a spreadsheet approach that greatly simplifies the task of finding the optimal economic life. • Chapter 11 now addresses one approach for including mutually exclusive alterna- tives in the investment opportunity schedule by breaking them into incremental investments. xxi xxii Preface • Chapter 12 now includes the 50% initial “bonus” depreciation that has been used to stimulate economic activity. • Chapter 13 now includes a 1-period example that provides a clearer and simpler introduction to leverage. • Chapter 14 now opens with an exhibit that provides multiple examples of benefits and disbenefits for public projects. • Chapter 17 now includes a section on creating tornado diagrams, and the student website includes the file TornadoTemplateEschenbach3rd.xls. • Chapter 18 now includes a section that provides an overview of real options. • Appendix Ahas completely revamped examples and problems that more realisti- cally reflect typical firms. • Appendix D has been added to provide a set of practice problems for the FE exam. • The addition of more and more difficult problems within most problem sets. • Numerous improvements in wording, in the numerical results of examples and prob- lems, and in the exhibits used to illustrate concepts. KEY FEATURES OFTHETEXT The first edition was based on studying what other texts have done well, surveying nearly 250 teachers of engineering economy, and responding to the comments of four sets of reviewers. Since then users and many reviewers have helped improve on the key features from the first edition. The following points are still the text's foundation: 1. Conceptually linking theory and practice. 2. Breadth and depth of coverage matched to introductory courses. 3. Emphasis on mutually exclusive alternatives while maintaining the discussion of constrained project selection. 4. Pedagogical support for the students. 5. Modern computational tools. 1. Conceptually Linking Theory and Practice. Often the realism of engineering economy texts stops with the numbers plugged into examples and problems. This text presents the theory, and then it examines common practical violations of theoretical assumptions. For example, most texts define payback period and demonstrate its inferiority to time value of money measures. This text also explains why payback continues to be used and why its use does not lead to bankruptcy. Similarly, this text, like most, explains the assumptions of repeated lives or salvage values that are needed for valid present worth comparisons. This text adds a thorough discussion of the impact of failing to satisfy the assumption of identical cost repetition while using equivalent annual techniques. I believe that understanding how and why basic principles are applied is more important and interesting than fine theoretical nuances. In practice and in this text, ranking on the inter- nal rate of return is used for constrained project selection, and present worth and equivalent annual cost are used for the selection of mutually exclusive alternatives. This text now includes complete coverage of incremental internal rate of return and benefit/cost ratios for mutually exclusive alternatives. Because students learn best when theory is clearly linked to real-world applications, the ex- amples and homework problems are specifically chosen to illustrate practical realities and to in- clude situations in which students can apply engineering economy concepts in their own lives. Preface xxiii 2. Coverage Matched to Introductory Engineering Economy Courses. Engineering economy relies on concepts and tools that are developed in accounting, finance, management science, probability, and statistics. Many topics have far more depth than can be included in an introductory course, and many engineering economy courses have no specific prerequisites. To best choose what to include here, I analyzed a list of needs established by a survey of nearly 250 faculty members in engineering economy. For example, depreciation methods, income taxes, the distinction between assets and income, and use of cost accounting data are covered, but more advanced accounting topics are not. Similarly, the weighted cost of capital is discussed, but finance models for risk and stock prices are not. Basic models for multiple criteria are included, while utility theory is not. The application of expected value and decision trees is included from probability, and learning-curve models for cost estimation from statistics; however, general forecasting models are omitted. The survey led to a text that has more material than most instructors will cover in one semester. Thus, instructors have choices in the topics they will cover. To support this flex- ibility, topics that were found to be “elective” were presented as independently as possible. For example, the text includes cost estimating, inflation, sensitivity analysis, multiple cri- teria evaluation, and economic decision trees, but each presentation is completely inde- pendent. Appendices of more advanced material are also included with several chapters. 3. Emphasis on Mutually Exclusive Alternatives while Maintaining Coverage of Constrained Project Selection. Engineering students will first apply the tools of engineering economy in engineering design. These problems require choices between mu- tually exclusive alternatives. More design examples have been included in Chapters 1 through 8, mutually exclusive alternatives are the subject of Chapter 9, and the special case of replacement analysis is the subject of Chapter 10. The discussion of mutually exclusive alternatives still focuses on the use of present worth and equivalent annual measures. However, incremental IRRs and B/C ratios are now covered completely, even though they are not the technique of choice. Constrained project selection is placed in Chapter 11, rather than the choice of many authors who relegate capital budgeting to the back of engineering economy texts, where the presentation focuses on theoretical models and advanced techniques that are rarely used. However, the capital budgeting problem is often solved in the real world by ranking on the internal rate of return. Discussing this constrained project selection problem in Chapter 11 provides a solid, intuitive foundation for selecting the interest rate for the time value of money. This is applied in the comparison of mutually exclusive alternatives. 4. Pedagogical Support. It is clear that students learn more when the presentation’s structure and the expectations are clear. Chapter objectives, key words and concepts, and lists of major points are used to facilitate student understanding. Realistic examples can engage student interest, and problems drawn from student life can motivate high performance. To support continuity of understanding and development of realistic problems, some examples and homework problems are carried through a se- quence of chapters. Exhibits are used liberally. It is possible and sometimes desirable to combine tables and graphics to form more powerful exhibits. Asingle numbering scheme for the exhibits is used to make it easier to find a referenced exhibit, whether table or figure. xxiv Preface 5. Modern Computational Tools. Spreadsheets enhance the student's analytical ca- pabilities, allow the inclusion of more realistic problems, and better prepare students to use engineering economy after graduation. For these reasons spreadsheets are used in the examples, and they can be applied to the homework problems. The power of spreadsheets allows students to learn more and to address problems in realistic detail. Real-world engi- neering economy almost universally relies on spreadsheets as an analytical tool. For simpler problems TVM calculators have been used for decades by engineering economy professors, but not by a large fraction of their students. As detailed in Appendix B, properly programmed scientific calculators can be used on the FE exam while classes can permit use of financial calculators or smart phones with a downloaded financial calcu- lator “app.” As shown in Appendix B, these TVM calculators require the same conceptual understanding as the tables, but they allow students to spend much less time on arithmetic. I believe that engineering economy students should understand and be able to use all of these tools: tables, TVM calculators, and spreadsheets. Then the choice of the tool can be matched to the situation, the instructor’s requirements, and the student’s preference. This text is designed to support use of spreadsheets and TVM calculators as instructors prefer. Spreadsheets and calculators can be (1) an integral part of the course, including in- struction on their use; (2) required or encouraged for homework without use in class; or (3) used by students on their own to do homework. Obviously each instructor will define what is permitted on exams. The spreadsheet instruction sections are placed at the ends of chap- ters, so that they may be skipped if desired. ORGANIZATION OFTHETEXT The overall flow of the material is shown in Exhibit P.1. The first three parts are included in most courses, but the last chapters in each part (Chapters 4, 8, 10, and 11) can be skipped without a loss of continuity. Of the chapters that can be skipped without a loss of continuity, 19 on multiple objectives is the most suitable for self-study. Chapters 10 on replacement analysis, 13 on income taxes, and 17 on sensitivity analysis are the most difficult for self- study. Some chapters or sections are more important for specific groups of engineers, such as Chapter 14 on public sector applications for civil engineers, Chapter 10 on replacement analysis for industrial engineers, and Section 16.7 on capacity functions for chemical engineers. Part One presents concepts that form the fundamental basis for engineering economic calculations. Part Two reinforces this material for increasingly complex cash flows. Part Three compares alternatives—those that are mutually exclusive and those that are con- strained by a limited budget. Part Four includes the effect of income taxes on the private sector, special concerns of the public sector, and inflation. Part Five explains tools that are needed to deal with the complexities of the real world. ACKNOWLEDGMENTS I have had an enormous amount of help in completing this text. The authors of the numer- ous other texts that I have used have provided fine examples and shaped my understanding of the subject. Similarly, students at the University of Alaska Anchorage, the University of Missouri—Rolla, and Merrimack College have endured classroom testing of drafts and pa- tiently pointed out where further work was needed. Preface xxv EXHIBIT P.1 Organization of the Text (Shaded material can be skipped) Part One Basic Concepts and Tools 1 Making Economic Decisions 2 The Time Value of Money 3 Equivalence—A Factor Approach Part Two Analyzing a Project 4 Arithmetic and Geometric 5 Present Worth Gradients and Spreadsheets 6 Equivalent Annual Worth 7 Rate of Return Part Three 8 Benefit/Cost Ratios and Other Comparing Alternatives and Measures Projects 9 Mutually Exclusive Choices 10 Replacement Analysis 11 Constrained Project Selection Part Four Part Five Appendix Enhancements for the Real Decision-Making Tools A Accounting Effects in World 16 Estimating Cash Flows Engineering Economics 12 Depreciation 17 Sensitivity Analysis B Time Value of Money (TVM) 13 Income Taxes 18 Uncertainty and Probability and Calculators 14 Public Sector Engineering 19 Multiple Objectives D Fundamentals of Engineering Economy (FE) Examination Problems 15 Inflation Nearly 250 faculty responded to a six-page survey about their current texts, courses, and desired material for an introductory text. Their responses directed me to the best and worst aspects of existing texts and provided great insight into their courses. Their responses specifically guided me in the addition and deletion of topics in my outline. Other faculty members have provided material, reviewed the manuscript, or tested it in class. They have provided many helpful comments and criticisms. I would like to thank the following individuals in particular for their help with the first edition: James A. Alloway, Jr., Syracuse University Daniel L. Babcock, University of Missouri—Rolla Susan Burgess, University of Missouri—Rolla John R. Canada, North Carolina State University Barry Clemson, Old Dominion University William J. Foley, Rensselaer Polytechnic Institute Timothy J. Gallagher, Colorado State University Carol S. Gattis, University of Arkansas, Fayetteville Jarad Golkar, Texas A&M University Joseph E. Gust, Jr., Northern Arizona University Kim Hazarvartian, Merrimack College Donald P. Hendricks, Iowa State University Ken Henkel, California State University, Chico Leonard Hom, California State University, Sacramento Robert G. Lundquist, Ohio State University Richard W. Lyles, Michigan State University W. J. Kennedy, Clemson University xxvi Preface Anthony K. Mason, California State Polytechnic University at San Luis Obispo Paul R. McCright, University of South Florida Nancy L. Mills, University of Southern Colorado Murl Wayne Parker, Mississippi State University Louis Plebani, Lehigh University Jang W. Ra, University of Alaska Anchorage James Rice, University of Illinois, Chicago Herbert P. Schroeder, University of Alaska Anchorage Jack W. Schwalbe, Florida Institute of Technology Paul L. Shillings, Montana State University Sanford Thayer, Colorado State University David Veshosky, Lafayette College Ed Wheeler, University of Tennessee, Martin Bob White, Western Michigan University Henry Wiebe, University of Missouri—Rolla For the second edition, the following individuals as users or reviewers provided spe- cific suggestions for improvement: David G. Alciatore, Colorado State University Richard Bernhard, North Carolina State University Ed Dodson, University of California at Santa Barbara William Girouard, California State Polytechnic University at Pomona Unknown,University of Arizona S. M. Gupta, Northeastern University Dennis Kroll, Bradley University Jerome Lavelle, North Carolina State University Gene H. Lee, University of Central Florida Robert G. Lundquist, Ohio State University Paul R. Munger, University of Missouri—Rolla Steven R. Maberry, University of New Mexico Donald G. Newnan David C. Slaughter, University of California at Davis Richard Monroe, Old Dominion University Bill Moor, Arizona State University William Peterson, Old Dominion University Karen Schmahl, Miami University Maureen Sevigny, Oregon Institute of Technology Alice Smith, Auburn University John Whittaker, University of Alberta Rochelle Young, University of Colorado at Boulder The following individuals provided insights, reviews, and contributed problems that have significantly improved this third edition:
The list of books you might like
