Engineering Economy / Edition 15

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Overview

Engineering Economy, 15e, is ideal for undergraduate, introductory courses in Engineering Economics. It also is a useful reference for engineers interested in reviewing the basic principles of engineering economy.

Used by engineering students worldwide, this best-selling text provides a sound understanding of the principles, basic concepts, and methodology of engineering economy. Built upon the rich and time-tested teaching materials of earlier editions, it is extensively revised and updated to reflect current trends and issues, with an emphasis on the economics of engineering design throughout. It provides one of the most complete and up-to-date studies of this vitally important field.

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Editorial Reviews

Booknews
The new edition of a textbook for engineering students on the economic factors of the design process. Topics include comparing alternatives, depreciation and income taxes, replacement analysis, probabilistic risk analysis, and capital financing and allocation. Annotation c. Book News, Inc., Portland, OR (booknews.com)
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Product Details

  • ISBN-13: 9780132554909
  • Publisher: Prentice Hall
  • Publication date: 1/10/2011
  • Edition number: 15
  • Pages: 672
  • Sales rank: 312,200
  • Product dimensions: 7.40 (w) x 9.20 (h) x 1.10 (d)

Read an Excerpt

Chapter 1: What are the Principles of Engineering Economy

The objectives of Chapter I are to (1) introduce the subject ofengineering economy, (2) discuss its critical role in engineering design and analysis, (3) discuss the basic principles of the subject, and (4) provide an overview of the book.

The following topics are discussed in this chapter: The importance of this subject in engineering practice
Origins of engineering economy
The principles of engineering economy
Engineering economy and the design process
Accounting and engineering economy studies
Overview of the book

Introduction

The technological and social environments in which we live continue to change at a rapid rate. In recent decades, advances in science and engineering have made space travel possible, transformed our transportation systems, revolutionized the practice of medicine, and miniaturized electronic circuits so that a computer can be placed on a semiconductor chip. The list of such achievements seems almost endless. In your science and engineering courses you will learn about some of the physical laws that underlie these accomplishments.

The utilization of scientific and engineering knowledge for our benefit is achieved through the design of things we use, such as machines, structures, products, and services. However, these achievements don't occur without a price, monetary or otherwise. Therefore, the purpose of this book is to develop and illustrate the principles and methodology required to answer the basic economic question of any design: Do its benefits exceed its costs?

The Accreditation Board for Engineering and Technology states that engineering "isthe profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practice is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind." In this definition the economic aspects of engineering are emphasized as well as the physical aspects. Clearly, it is essential that the economic part of engineering practice be accomplished well.

Engineering Economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems. To be economically acceptable (i.e., affordable), solutions to engineering problems must demonstrate a positive balance of long-term benefits over long-term costs, and they must also

  • promote the well-being and survival of an organization,
  • embody creative and innovative technology and ideas,
  • permit identification and scrutiny of their estimated outcomes, and
  • translate profitability to the "bottom line" through a valid and acceptable measure of merit.
Therefore, engineering economy is the dollars-and-cents side of the decisions that engineers make or recommend as they work to position a firm to be profitable in a highly competitive marketplace. Inherent to these decisions are tradeoffs among different types of costs and the performance (response time, safety, weight, reliability, etc.) provided by the proposed design or problem solution. The mission of engineering economy is to balance these tradeoffis in the most economical manner. For instance, if an engineer at Ford Motor Company invents a new transmission lubricant that increases fuel mileage by 10% and extends the life of the transmission by 30,000 miles, how much can the company afford to spend to implement this invention? Engineering economy can provide an answer.

A few more of the myriad situations in which engineering economy plays a crucial role come to mind:

1. Choosing the best design for a high-efficiency gas furnace.
2. Selecting the most suitable robot for a welding operation on an automotive assembly line.
3. Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased.
4. Determining the optimal staffing plan for a computer help desk.

From these illustrations it should be obvious that engineering economy includes significant technical considerations. Thus, engineering economy involves technical analysis, with emphasis on the economic aspects, and has the objective of assisting as they progress through this book. However, in engineering economic analysis, experience has shown that most errors can be traced to some violation or lack of adherence to the basic principles. Once a problem/need has been clearly defined, the foundation of the discipline can be discussed in terms of seven principles.

Principle 1 -Develop The Alternatives: The choice (decision) is among alternatives. The alternatives need to be identified and then defined for subsequent analysis.

A decision situation involves making a choice among two or more alternatives. Developing and defining the alternatives for detailed evaluation is important because of the resulting impact on the quality of the decision. Engineers and managers should place a high priority on this responsibility. Creativity and innovation are essential to the process.

One alternative that may be feasible in a decision situation is making no change to the current operation or set of conditions (i.e., doing nothing). If you judge this option feasible, make sure it is considered in the analysis. However, do not focus on the status quo to the detriment of innovative or necessary change.

Priniciple 2 -Focus On The Differences: Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision.

If all prospective outcomes of the feasible alternatives were exactly the same, there would be no basis or need for comparison. We would be indifferent among the alternatives and could make a decision using a random selection.

Obviously, only the differences in the future outcomes of the alternatives are important. Outcomes that are common to all alternatives can be disregarded in the comparison and decision. For example, if your feasible housing alternatives were two residences with the same purchase (or rental) price, price would be inconsequential to your final choice. Instead, the decision would depend on other factors such as location and annual operating and maintenance expenses. This example illustrates, in a simple way, Principle 2, which emphasizes the basic purpose of an engineering economic analysis: to recommend a future course of action based on the differences among feasible alternatives.

Principle 3 -Use A Consistent Viewpoint: The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective)....

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Table of Contents

Preface xi
Green Content xviii

CHAPTER 1 Introduction to Engineering Economy 1
1.1 Introduction 2
1.2 The Principles of Engineering Economy 3
1.3 Engineering Economy and the Design Process 7
1.4 Using Spreadsheets in Engineering Economic Analysis 15
1.5 Summary 15

CHAPTER 2 Cost Concepts and Design Economics 20
2.1 Cost Terminology 21
2.2 The General Economic Environment 28
2.3 Cost-Driven Design Optimization 38
2.4 Present Economy Studies 43
2.5 Case Study–The Economics of Daytime Running Lights 49
2.6 Summary 51 Appendix 2-A Accounting Fundamentals 59

CHAPTER 3 Cost-Estimation Techniques 67
3.1 Introduction 68
3.2 An Integrated Approach 70
3.3 Selected Estimating Techniques (Models) 78
3.4 Parametric Cost Estimating 83
3.5 Case Study–Demanufacturing of Computers 94
3.6 Summary 96

CHAPTER 4 The Time Value of Money 103
4.1 Introduction 104
4.2 Simple Interest 105
4.3 Compound Interest 106
4.4 The Concept of Equivalence 106
4.5 Notation and Cash-Flow Diagrams and Tables 109
4.6 Relating Present and Future Equivalent Values of Single Cash Flows 113
4.7 Relating a Uniform Series (Annuity) to Its Present and Future Equivalent Values 119
4.8 Summary of Interest Formulas and Relationships for Discrete Compounding 129
4.9 Deferred Annuities (Uniform Series) 131
4.10 Equivalence Calculations Involving Multiple Interest Formulas 133
4.11 Uniform (Arithmetic) Gradient of Cash Flows 139
4.12 Geometric Sequences of Cash Flows 144
4.13 Interest Rates that Vary with Time 149
4.14 Nominal and Effective Interest Rates 151
4.15 Compounding More Often than Once per Year 153
4.16 Interest Formulas for Continuous Compounding and Discrete Cash Flows 156
4.17 Case Study–Understanding Economic “Equivalence” 159
4.18 Summary 162

CHAPTER 5 Evaluating a Single Project 178
5.1 Introduction 179
5.2 Determining the Minimum Attractive Rate of Return (MARR) 180
5.3 The Present Worth Method 181
5.4 The Future Worth Method 188
5.5 The Annual Worth Method 189
5.6 The Internal Rate of Return Method 194
5.7 The External Rate of Return Method 205
5.8 The Payback (Payout) Period Method 207
5.9 Case Study–A Proposed Capital Investment to Improve Process Yield 209
5.10 Summary 211 Appendix 5-A The Multiple Rate of Return Problem with the IRR Method 222

CHAPTER 6 Comparison and Selection among Alternatives 226
6.1 Introduction 227
6.2 Basic Concepts for Comparing Alternatives 227
6.3 The Study (Analysis) Period 231
6.4 Useful Lives Are Equal to the Study Period 233
6.5 Useful Lives Are Unequal among the Alternatives 250
6.6 Personal Finances 263
6.7 ; Case Study–Ned and Larry’s Ice Cream Company 267
6.8 Post evaluation of Results 270
6.9 Summary 270

CHAPTER 7 Depreciation and Income Taxes 288
7.1 Introduction 289
7.2 Depreciation Concepts and Terminology 289
7.3 The Classical (Historical) Depreciation Methods 292
7.4 The Modified Accelerated Cost Recovery System 297
7.5 A Comprehensive Depreciation Example 304
7.6 Introduction to Income Taxes 308
7.7 The Effective (Marginal) Corporate Income TaxRate 311
7.8 Gain (Loss) on the Disposal of an Asset 314
7.9 General Procedure for Making After-Tax Economic Analyses 315
7.10 Illustration of Computations of ATCFs 319
7.11 Economic Value Added 331
7.12 Summary 333

CHAPTER 8 Price Changes and Exchange Rates 344
8.1 Introduction 345
8.2 Terminology and Basic Concepts 346
8.3 Fixed and Responsive Annuities 352
8.4 Differential Price Changes 357
8.5 Spreadsheet Application 359
8.6 Foreign Exchange Rates and Purchasing Power Concepts 361
8.7 Case Study–Selecting Electric Motors to Power an Assembly Line 366
8.8 Summary 369

CHAPTER 9 Replacement Analysis 379
9.1 Introduction 380
9.2 Reasons for Replacement Analysis 380
9.3 Factors that Must Be Considered in Replacement Studies 381
9.4 Typical Replacement Problems 384
9.5 Determining the Economic Life of a New Asset (Challenger) 387
9.6 Determining the Economic Life of a Defender 391
9.7 Comparisons in Which the Defender’s Useful Life Differs from that of the Challenger 394
9.8 Retirement without Replacement (Abandonment) 397
9.9 After-Tax Replacement Studies 398
9.10 Case Study–Replacement of a Hospital’s Emergency Electrical Supply System 406
9.11 Summary 409

CHAPTER 10 Evaluating Projects with the Benefit−Cost Ratio Method 419
10.1 Introduction 420
10.2 Perspective and Terminology for Analyzing Public Projects 421
10.3 Self-Liquidating Projects 422
10.4 Multiple-Purpose Projects 422
10.5 Difficulties in Evaluating Public-Sector Projects 425
10.6 What Interest Rate Should Be Used for Public Projects? 426
10.7 The Benefit−Cost Ratio Method 428
10.8 Evaluating Independent Projects by B−C Ratios 434
10.9 Comparison of Mutually Exclusive Projects by B−C Ratios 436
10.10 Case Study–Improving a Railroad Crossing 441
10.11Summary 443

CHAPTER 11 Breakeven and Sensitivity Analysis 451
11.1 Introduction 452
11.2 Breakeven Analysis 452
11.3 Sensitivity Analysis 459
11.4 Multiple Factor Sensitivity Analysis 465
11.5 Summary 469

CHAPTER 12 Probabilistic Risk Analysis 478
12.1 Introduction 479
12.2 Sources of Uncertainty 480
12.3 The Distribution of Random Variables 480
12.4 Evaluation of Projects with Discrete Random Variables 484
12.5 Evaluation of Projects with Continuous Random Variables 493
12.6 Evaluation of Risk and Uncertainty by Monte Carlo Simulation 498
12.7 Performing Monte Carlo Simulation with a Computer 502
12.8 Decision Trees 506
12.9 Real Options Analysis 511
12.10 Summary 514

CHAPTER 13 The Capital Budgeting Process 522
13.1 Introduction 523
13.2 Debt Capital 525
13.3 Equity Capital 526
13.4 The Weighted Average Cost of Capital (WACC) 529
13.5 Project Selection 533
13.6 Postmortem Review 537
13.7 Budgeting of Capital Investments and Management Perspective 538
13.8 Leasing Decisions 539
13.9 Capital Allocation 541
13.10 Summary 547

CHAPTER 14 Decision Making Considering Multiattributes 551
14.1 Introduction 552
14.2 Examples of Multiattribute Decisions 552
14.3 Choice of Attributes 554
14.4 Selection of a Measurement Scale 554
14.5 Dimensionality of the Problem 555
14.6 Noncompensatory Models 555
14.7 Compensatory Models 560
14.8 Summary 568

Appendix A Using Excel to Solve Engineering Economy Problems 574
Appendix B Abbreviations and Notation 591
Appendix C Interest and Annuity Tables for Discrete Compounding 595
Appendix D Interest and Annuity Tables for Continuous Compounding 614
Appendix E Standard Normal Distribution 618
Appendix F Selected References 621
Appendix G Answers to Selected Problems 624
Index 628

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Introduction

About Engineering Economy

Engineering economy—what is it, and why is it important? The initial reaction of many engineering students to these questions is "Money matters will be handled by someone else. It is not something I need to worry about." In reality, any engineering project must be not only physically realizable, but also economically affordable. For example, a child's tricycle could be built with an aluminum frame or a composite frame. Some may argue that because the composite frame will be stronger and lighter, it is a better choice. However, there is not much of a market for thousand dollar tricycles! One might suggest that this argument is ridiculously simplistic and that common sense would dictate choosing aluminum for the framing material. Although the scenario is an exaggeration, it reinforces the idea that the economic factors of a design weigh heavily in the design process, and that engineering economy is an integral part of that process, regardless of the engineering discipline. Engineering, without economy, makes no sense at all.

In broad terms, for an engineering design to be successful, it must be technically sound and produce benefits. These benefits must exceed the costs associated with the design in order for the design to enhance net value. The field of engineering economy is concerned with the systematic evaluation of the benefits and costs of projects involving engineering design and analysis. In other words, engineering economy quantifies the benefits and costs associated with engineering projects to determine whether they make (or save) enough money to warrant their capital investments. Thus, engineering economy requires theapplication of engineering design and analysis principles to provide goods and services that satisfy the consumer at an affordable cost. As we shall see, engineering economy is as relevant to the design engineer who considers material selection as it is to the chief executive officer who approves capital expenditures for new ventures.

History of the Book

The original Introduction to Engineering Economy, authored by Woods and DeGarmo, appeared in 1942. The extensive use of this text for the past 60 years has encouraged the authors to continue building on the original purpose of the boo—kto teach lucidly the principles of engineering economy. In this spirit, the twelfth edition of Engineering Economy has built upon the rich and time-tested teaching materials of earlier editions, and its publication makes it the second-oldest book on the market that deals exclusively with engineering economy.

Twelfth Edition of Engineering Economy

New or Enhanced Features to This Edition

  • Design economics problems are expanded in Chapter 2. . Cost estimating has been clarified and given expanded coverage. . A number of new and updated end-of-chapter problems are included.
  • A Web site devoted to electronic media to support an engineering economy course is fully operational (and maintained by Prentice Hall).
  • Spreadsheet templates appear throughout the text.
  • An extra supplement dealing with development and use of spreadsheets is available.
  • An Instructor's Manual containing full solutions to all problems in the book is available.
  • Suggestions for using "student portfolios" to facilitate the integrated learning of topics in engineering economy are presented in this Preface.
  • "Economic value added" by an engineering project is explained in terms of an after-tax cash-flow analysis.
  • The cost of equity and debt capital and the weighted average cost of capital and its relationship to rate of return concepts are explained.
  • Replacement Analysis (Chapter 9) has been rewritten to clarify concepts and principles of this important topic.
  • Chapter 15, which deals with multiattributed decision making, has been added.

Pedagogy of this Book

This book has two primary purposes: (1) to provide students with a sound understanding of the principles, basic concepts, and methodology of engineering economy; and (2) to help them develop proficiency with these methods and with the process for making rational decisions regarding situations they are likely to encounter in professional practice. Consequently, Engineering Economy is intended to serve as a text for classroom instruction and as a basic reference for use by practicing engineers in all specialty areas (e.g., chemical, civil, computer, electrical, industrial, and mechanical engineering). The book is also useful to persons engaged in the management of technical activities.

As a textbook, the twelfth edition is written principally for the first formal course in engineering economy. The contents of the book and the accompanying Instructor's Manual and Electronic Spreadsheets Supplement (both available from Prentice Hall) are organized for effective presentation and teaching of the subject matter. A three-credit-hour semester course should be able to cover the majority of topics in this edition, and there is sufficient depth and breadth to enable an instructor to arrange course content to suit individual needs. Representative syllabi for a three-credit and a two-credit semester course in engineering economy are provided in Table P-1. Moreover, because several advanced topics are included, this book can also be used for a second course in engineering economy.

Every chapter and the appendices have been revised and updated to reflect current trends and issues. Also, numerous exercises that involve open-ended problem statements and iterative problem-solving skills are included throughout the book. A large number of the 500+ end-of-chapter exercises are new, and many solved examples representing realistic problems that arise in various engineering disciplines are presented.

An engineering economy course may be classified, for Accreditation Board for Engineering and Technology (ABET) purposes, as part engineering science and part engineering design. It is generally advisable to develop and teach such a course at the upper division level. Here, an engineering economy course incorporates the accumulated knowledge students have acquired in other areas of the curriculum also dealing with iterative problem solving, open-ended exercises, creativity in formulating and evaluating feasible solutions to problems, and consideration of realistic constraints (economic, aesthetic, safety, etc.) in problem solving.

Instructional Features

The Instructor's Manual is designed as a comprehensive aid in teaching the text material. Full solutions of all problems at the end of each chapter are presented. Several comprehensive examples (case studies) have been included in the twelfth edition. These fairly complex examples and problems provide the instructor with essential material for teaching both the first formal course and a second, more advanced course in engineering economy. They also integrate the principles, basic concepts, and methodologies that are needed by engineers in typical real-world situations, and also serve as a bridge from the classroom to professional practice.

Spreadsheet Supplement

A second supplement entitled Spreadsheet Modeling to Accompany Engineering Economy, Twelfth Edition is authored by James A. Alloway, Jr. Electronic spreadsheets are a mainstay in many undergraduate engineering economy courses; the spreadsheet supplement ensures that the twelfth edition of Engineering Economy will maintain its leadership position by providing basic templates for all major topics in the text. In addition, it provides a concise summary of formulas and key concepts, which students will find invaluable for review and quick reference.

The greatest advantage is that it is no longer necessary to enter the spreadsheets by hand. The templates can be downloaded and opened directly in Excel for Windows. Most other spreadsheet software packages provide conversion utilities to convert these files into their respective native formats. Users can then modify the basic templates for the specific problem at hand. As a bonus, advanced templates have also been developed for such techniques as Monte Carlo simulation, three-factor simultaneous sensitivity analysis, and integer linear programming.

Engineering Economy Portfolio

In many engineering economy courses, students are required to design, develop, and maintain an "Engineering Economy Portfolio." The purpose of the portfolio is to demonstrate and integrate knowledge of engineering economy beyond the required assignments and tests. This is usually an individual assignment. Professional presentation, clarity, brevity, and creativity are important criteria that will be used to evaluate portfolios. Students are asked to keep the audience (i.e., the grader) in mind when constructing their portfolios.

The portfolio should contain a variety of content. To get credit for content, students must display their knowledge. Simply collecting articles in a folder demonstrates very little. To get credit for collected articles, students should read them and write a brief summary. The summary could explain how the article is relevant to engineering economy, it could critique the article, or it could check or extend any economic calculations in the article. The portfolio should include both the summary and the article itself. Annotating the article by writing comments in the margin is also a good idea. Other suggestions for portfolio content follows (note that students are encouraged to be creative):

  • Describe and set up or solve an engineering economy problem from your own discipline (e.g., electrical engineering or building construction).
  • Choose a project or problem in society or at your university and apply engineering economic analysis to one or more proposed solutions.
  • Develop proposed homework or test problems for engineering economy. Include the complete solution. Additionally, state which course objectives) this problem demonstrates (include text section).
  • Reflect upon and write about your progress in the class. You might include a self-evaluation against the course objectives.
  • Include a photo or graphic that illustrates some aspect of engineering economy. Include a caption that explains the relevance of the photo or graphic.
  • Include completely worked out practice problems. Use a different color pen to show these were checked against the provided answers.
  • Rework missed test problems, including an explanation of each mistake.

(The preceding list could reflect the relative value of the suggested items; that is, items at the top of the list are worth more than items at the bottom of the list.)

Develop an introductory section that explains the purpose and organization of the portfolio. A table of contents and clearly marked sections or headings are highly recommended. Cite the source (i.e., a complete bibliographic entry) of all material other than your own work. Remember, portfolios provide evidence that students know more about engineering economy than what is reflected in the assignments and exams. Focus on quality of evidence, not quantity.

WILLIAM G. SULLIVAN
ELM M. WICKS
JAMES T. LUXHOJ

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