Engineering Economy / Edition 12

Engineering Economy / Edition 12

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Prentice Hall


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Engineering Economy / Edition 12

This best-selling book 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.


  • NEW -- More design economics problems and cost estimating.
  • NEW -- A full chapter on Communicating Engineering Economy Study Results. Provides students with tips on how to "sell" their projects to decision-makers in management.
  • NEW -- Global issues are discussed in terms of exchange rate problems.
  • NEW -- Deflation effects on project economics highlighted.
  • NEW -- New and updated end-of-chapter problems.
  • NEW -- Test Companion Website Devoted to electronic media that supports engineering economy courses.
  • NEW -- Student portfolios. Offers suggestions for creating and using student portfolios to facilitate integrated learning of topics in engineering economy.
  • NEW -- Economic Value Added. Uses an after-tax cash flow analysis to explain the concept of "economic value added."
  • NEW -- Cost of capital. Explains the cost of equity and debt capital as well as the weighted average cost of capital and its relationship to rate of return concepts.
  • Real-world engineering economy analysis methodology.
  • Case studies demonstrate the integrated application of the principles, basic concepts, and methodology used by engineers in typical, real-world situations.
  • Cost estimating, design economics, and electronic spreadsheets.
  • Capital investments. Examines the theoretical and practical aspects of selecting among capital investments.
  • Internet-accessible electronic spreadsheets. Provides approximately 50 basic templates for all major topics in the text and summarizes formulas and key concepts.
  • Examples. Allows to students to more readily understand concepts and reinforces learning.

Product Details

ISBN-13: 9780130673381
Publisher: Prentice Hall
Publication date: 05/28/2002
Edition description: Older Edition
Pages: 736
Product dimensions: 7.50(w) x 9.40(h) x 1.30(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


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)....

Table of Contents

Part IFundamentals of Engineering Economy1
Chapter 1Introduction to Engineering Economy2
1.2Origins of Engineering Economy4
1.3What Are the Principles of Engineering Economy?4
1.4Engineering Economy and the Design Process8
1.5Accounting and Engineering Economy Studies17
1.6Overview of the Book18
Chapter 2Cost Concepts and Design Economics23
2.2Cost Estimating and Cost Terminology24
2.3The General Economic Environment37
2.4Cost-Driven Design Optimization46
2.5Present Economy Studies52
Chapter 3Money-Time Relationships and Equivalence67
3.2Why Consider Return to Capital?68
3.3The Origins of Interest69
3.4Simple Interest69
3.5Compound Interest70
3.6The Concept of Equivalence71
3.7Notation and Cash Flow Diagrams/Tables74
3.8Interest Formulas Relating Present and Future Equivalent Values of Single Cash Flows77
3.9Interest Formulas Relating a Uniform Series (Annuity) to Its Present and Future Equivalent Values82
3.10Interest Formulas for Discrete Compounding and Discrete Cash Flows89
3.11Deferred Annuities (Uniform Series)89
3.12Equivalence Calculations Involving Multiple Interest Formulas91
3.13Interest Formulas Relating a Uniform Gradient of Cash Flows to Its Annual and Present Equivalents95
3.14Interest Formulas Relating a Geometric Sequence of Cash Flows to Its Present and Annual Equivalents101
3.15Interest Rates That Vary with Time105
3.16Nominal and Effective Interest Rates106
3.17Interest Problems with Compounding More Often Than Once per Year108
3.18Interest Problems with Cash Flows Less Often Than Compounding Periods110
3.19Interest Formulas for Continuous Compounding and Discrete Cash Flows114
3.20Interest Formulas for Continuous Compounding and Continuous Cash Flows116
3.21Additional Solved Problems119
3.22Spreadsheet Applications124
Part IIBasic Topics in Engineering Economy143
Chapter 4Applications of Money-Time Relationships144
4.2Determining the Minimum Attractive Rate of Return145
4.3The Present Worth Method148
4.4The Future Worth Method153
4.5The Annual Worth Method154
4.6The Internal Rate of Return Method157
4.7The External Rate of Return Method168
4.8The Payback (Payout) Period Method170
4.9Investment Balance Diagrams171
4.10An Example of a Proposed Capital Investment to Improve Process Yield174
4.11Spreadsheet Applications175
Appendix 4-AThe Multiple Rate of Return Problem with the IRR Method186
Chapter 5Comparing Alternatives188
5.2Basic Concepts for Comparing Alternatives189
5.3The Study (Analysis) Period193
5.4Case 1: Useful Lives Are Equal to the Study Period194
5.5Case 2: Useful Lives Are Different Among the Alternatives211
5.6Comparison of Alternatives Using the Capitalized Worth Method220
5.7Defining Mutually Exclusive Investment Alternatives in Terms of Combinations of Projects222
5.8Spreadsheet Applications228
Chapter 6Depreciation and Income Taxes242
6.2Depreciation Concepts and Terminology243
6.3The Classical (Historical) Depreciation Methods246
6.4The Modified Accelerated Cost Recovery System252
6.5A Comprehensive Depreciation Example259
6.7Introduction to Income Taxes265
6.8The Effective (Marginal) Corporate Income Tax Rate267
6.9Gain (Loss) on the Disposal of an Asset271
6.10General Procedure for Making After-Tax Economic Analyses271
6.11Illustration of Computations of ATCFs276
6.12Economic Value Added284
6.13The After-Tax Effect of Depletion Allowances286
Chapter 7Cost Estimation Techniques296
7.2An Integrated Approach297
7.3Selected Estimating Techniques (Models)307
7.4Parametric Cost Estimating312
7.5Cost Estimation in the Design Process322
7.6Estimating Cash Flows for a Typical Small Project332
Appendix 7-A341
Chapter 8Price Changes and Exchange Rates349
8.1Price Changes350
8.2Terminology and Basic Concepts352
8.3Differential Price Inflation or Deflation362
8.4Application Strategy368
8.5A Comprehensive Example369
8.6Foreign Exchange Rates and Purchasing Power Concepts372
8.7Spreadsheet Applications377
Chapter 9Replacement Analysis388
9.2Reasons for Replacement Analysis389
9.3Factors That Must Be Considered in Replacement Studies390
9.4A Typical Replacement Problem394
9.5Determining the Economic Life of a New Asset (Challenger)398
9.6Determining the Economic Life of a Defender403
9.7Comparisons in Which the Defender's Useful Life Differs from That of the Challenger406
9.8Retirement without Replacement (Abandonment)410
9.9A Comprehensive Example412
9.10Spreadsheet Applications414
Chapter 10Dealing with Uncertainty424
10.2What Are Risk, Uncertainty, and Sensitivity?425
10.3Sources of Uncertainty426
10.4Sensitivity Analysis427
10.5Analyzing a Proposed Business Venture441
10.6Risk-Adjusted Minimum Attractive Rates of Return445
10.7Reduction of Useful Life446
10.8Spreadsheet Applications449
Part IIIAdditional Topics in Engineering Economy459
Chapter 11Evaluating Projects with the Benefit/Cost Ratio Method460
11.2Perspective and Terminology for Analyzing Public Projects461
11.3Self-Liquidating Projects463
11.4Multiple-Purpose Projects463
11.5Difficulties in Evaluating Public Sector Projects465
11.6What Interest Rate Should Be Used for Public Projects?467
11.7The Benefit/Cost Ratio Method469
11.8Evaluating Independent Projects by B/C Ratios475
11.9Comparison of Mutually Exclusive Projects by B/C Ratios477
11.10Criticisms and Shortcomings of the Benefit/Cost Ratio Method482
11.11Spreadsheet Applications484
Chapter 12Engineering Economy Studies in Investor-Owned Utilities492
12.2General Characteristics of Investor-Owned Utilities493
12.3General Concepts of Utility Economy Studies495
12.4Methods of Engineering Economy for Investor-Owned Utility Projects495
12.5Development of the Revenue Requirement Method497
12.6Assumptions of the Revenue Requirement Method498
12.7Utility Rate Regulation499
12.8Flow-Through and Normalized Accounting500
12.9Illustration of the Revenue Requirement Method: A Tabular Procedure505
12.10Immediate versus Deferred Investment505
12.11Revenue Requirement Analysis under Conditions of Inflation505
Chapter 13Probabilistic Risk Analysis514
13.2The Distribution of Random Variables515
13.3Evaluation of Projects with Discrete Random Variables519
13.4Evaluation of Projects with Continuous Random Variables526
13.5Evaluation of Uncertainty Using Monte Carlo Simulation531
13.6Performing Monte Carlo Simulation with a Computer535
13.7Decision Trees540
13.8Spreadsheet Applications548
Chapter 14Capital Financing and Allocation559
14.2Differences between Sources of Capital561
14.3Cost of Debt Capital563
14.4Cost of Equity Capital567
14.5Weighted Average Cost of Capital571
14.6Leasing as a Source of Capital572
14.7Capital Allocation575
14.8An Overview of a Typical Corporate Capital Budgeting Process583
Chapter 15Communicating Engineering Economy Study Results591
15.2Top Managers' Roles and Responsibilities592
15.3Management's Perspectives592
15.4Communication Strategies594
Part IVAppendixes597
AAccounting and Its Relationship to Engineering Economy598
BAbbreviations and Notation616
CInterest and Annuity Tables for Discrete Compounding621
DInterest and Annuity Tables for Continuous Compounding640
EStandardized Normal Distribution Function644
FSelected References647
GAnswers to Selected Even-Numbered Problems650


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.


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