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engineering economy book mc graw hill higher education part 1
Glossary of Common Terms Term Symbol Annual amount or wonh A or AW Annual opemling cost AOC BIC Breakeren point Q, Book value BV crpira1 budget b capical recovery CR orA Capifrlized cost CC Or P Description (with initial section reference in p a r e n t h e s e s ) Equivalent unilorm annual worth of all cash inflows and outflows over csiimatedlife l1.7.6.l) Estimated annuul costs to maintain and support an ultemrtivc (1.3) Ratio of apmjecc's benefits to costs exprerscd in PW AW or FW terms (9.2) Quantiry at which revenuesandcosts are equal, or two alternatives are equivalent (13.1) Reindining -pita1 investment in an asset after depreciation is accounted for (16.1) An~ount money available for capital iavcrtmenc of projects (12.1) Equivrlcnt annual cost of oivnillg an asset plus the required rctum on the initial invesmn?enr(6.2) present worth of an alternrtivc h a t will last forwcr (or 31 long time) (5.5) Acaal cash amounu which are icceipu (inflow) and disbursements (outflow) (1.10) Cash flow CFBT or CFAT Cash flaw amount before relevant rlxcs or after taxes are npplicd (17.2) Compo~ite rare of return ? rate Unique rate of return when a reinvesf~~~ent c in applied to a multiple~rrre ciqh flow series (7.5) Cost estimating rclstionihips c, or c, Relrtions chat use design variables and changing costs over time to estimrte current and future costs (13.34) Cost of capirri i or WACC Cash flow before or after ,TICS D-E D Ecoilomic service life I ' ESL or n Expccfcd value J(,l~ or E(X) (a\,errge) Expenses E First cos, P Percentages of debt and equity invesment cupilal used by ucorporrfion (1.9, 10.3) Reduction iil the value of asscts "sing specific modcls and rules: there are book and tux deprecisrion mehodn (16.1) Antlurl r r r for reducing thc value of assets using dcpicciaion models (16.1) Number of yeam at which rhe AW of uosrs is n rninilnurn (11.2) Long-mn expected avemgc if a randam wrirblc is sampled m a y limes (18.3, 19.4) transacting business (17.11 All c o ~ w n i c c o r t s i n c u i r c d i n TorN initial costGpurchnre, constmcrion setup, erc (1.3 16.1) ENGINEERING ECONOMY I McGraw-Hill Series in Industrial Engineering and Management Science ENGINEERING ECONOMY Consulting Editors Kennellr E Cose, Depamnent of rndusrriai Engineel-ing oiid Mnsa~tnieer, Oklahorrm State University Philip M Wol/e, Dqannrenl of Indusrrinl nndMriniigement Sy.~re,ns Engineerink Arizona Sfore UniversiQ Blank and Tarquin: Engineering Economy Chapra: Applied Numerical MeUlads with MATLAB for Engineers md Scientists Grant and Leavenworth: Statistical Quality Control Gryna: Quality Planning and Analysis: From Product Development trough Use Harrell, Ghosh, and Bowden: Simulntion Using PROMODEL Hiliicr and Lieberman: Introduction to Operations Research Kelton, Sadowski, and Sturmck: Simulation with Arena Law and Kclton: Simulation Modeling and AnuIyris Navidi: Statistics for Engineers and Scientists Nicbel and Freivalds: Methods, Standards, and Work Design Leland Blank, P E Anterican U~iiiierrii) ofSlla?jcth, UnitedA,ab E!rirorer orid TexosA & M Univcrsiy Anthony Tarquin, P E University of Terns nf El Puso ~ ~ - ~ Higher Education Boston Burr Ridge, lL Dubuque lA Madison WI NewYoik San Francisco St Louis Bangkok BogotA Caracas KualaLumpur Lisbon London Madrid MexicoCity Milan Montreal NewDelhi Sanfiago Seoul Singapore Sydney Taipei Toronto Higher Education ENGINEERING ECONOMY, SIXTH EDITION hblished by ~ c C ~ r ~ r business unitolnls M'GnvHlll Compmies Inc 1221 nvenlio ofthe Amencar NEWYwk,NY ~ i i i , 10020 Copyn:hio ZOOS 2W2.1998, 1989, 1983, 1976byThe M ~ ~ n ~ w H i l l companies I n s ~ lrights reserved No pan of Ulrs l publication may br repraluccd or distnbuiid in any form or by my mcans, or rtorcd in r daabr,oor rclrisvjll rysttlem withoutthe ahor wrioen conicnt ofThs hlcFirivHill Compm,cs Inc., iucluding, but notllm~icdto.in any netwakoioiherdcclronic Elongs or tcm,~lussial or brordcrY for dirtmcc I c m b g notbprvuiirb,c to ~ u s t o n ~ r r ~ o u c r i d ~ thc united stst= somemnilm,, including eicciionic printcompoena, This book is p n l s d on acid-tree pripcr I234567X90QPF/QPFOY876j4 ISBN WO7-lIISS8-7 This book is dedicated to our mothers for their ever-present encouragement to succeed in all aspects of life - , II I Foundations of Engineering Economy 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 L.12 Chapter Why ~ ~ ~ i n e e r~i o n o m y ~ " ~ 1s lmpomnt to ~ n g i n e e n (and Olher Profcsrionrls) Role of Engineering Economy in Decision Mallng Performing m Engineering Econorny Study Interest Rate and Rate of Return Ruivalencc Simple m d Compound lnteresl Terminology und Symbols lnmdvction to solution by Computer Minimum Amctivc Rate of Rclurn Cash Flows: Thcir Estimation and Diagramming Rule 01 72: &timating Doubling Time and Interest R a k Spmdsheet ApplicvtionSimple and Comp~pond Inkrest, and Changing Cash Flow Estimates AdditionalEwmpler ChapterSummary Problems FE Review Pmblems Extended Exercis-Efrects of Compound Interest Case Study-Dcsctibing Alremrtives for Producing Refrigcralor Shells 12 I5 17 23 26 28 30 35 36 39 41 42 45 45 46 Chapter Factors: M o w T i m e : a n d - l n t e r e s t A f f e d M o n e y Y Y Y Y Y Y ~ ~ 2.1 2.5 2.6 Single-Paymc"rFucto~(F/PandPln Uniformseries Present Wonh Factor and Capital Recovely Factor (PIA and AIP) Sinbng Fund Factor and Uniform-Series Compound Amount Faclor (AlF and FIA) Interpalalion in hfenslTables Atihmetic cradient Factors (PIC and AIC) Geometric Gndient Scties Facton l 2.7 2.8 Defermina~ion un unknown IntcrPst R*W of Detcrminrtioo of Unknown Nvmbci of Y e a I 2.9 ! S p ~ a d s h e e~ ~ p l i ~ ~ t i ~ ~ -Sensitivity Analysis t Brsic Additional Example Chapter Summary Pmbleme k'E Review Pmblcms case study-what a Difference the Yean and Compound lntciest Can Make 2.2 2.3 iI i I i i i 2.4 CONTEhTS Vlll Chapter Combining Factors 3.1 3.2 3.3 3.4 3.5 Chapter 92 Chapter 94 103 LO8 110 114 I15 115 121 123 4.5 4.6 4.7 4.8 4.9 Farmulaling Mutually Erclurive Altcmvtiver Present Wonh Analysis of EqurlbLifc Alremuti\,~~ Present Wonh Analysis oIDiffem1-Life Alcernaiver Future Wonh Analysis Capiralized Cost Calculation andAnalysis Payback Peiiod Analysis Life-cycle Cost Presenl Worth of Bonds Sprrndshecl Applicrtions-PWAnvlyris undPayb;ok P c r i ~ d ChapterSummary Problenls F E Review Prohiems cs~ Extended Exercise Evaluation of Social Security ~ e t i r e ~ nEstimates Case Study-Payback Evaluation of Ulsalow-Flush Toiler Program problem^ Chapter Chapter Rate of Return Analysis: Single Alternative 170 172 Chapter Inteiprc~alionofa Rate of Return Value Role of Retum Calculation Using a PW or AW Equation Cautions When Using t h t ROR Method Multiple Ra~cofReturn Valucs Colnposilc Rate of Returh: Removing Multiplc i Values ' Rvteof Return o f a ~ i l lnvesmcnt d Chapter Summary Problems FE Review Pmbloms ' ~ x t e n d o d x e r e i s e he c o s t of u ~ o n Credit ~ n t i n g ~ Ir Extended Erercirc2-When Is It Bcrt t o s e l l >Business? Case Study-Bob Levins Aboul Multiple Rates of Return Rate of Return Analysis: Multiple Alternatives 8.1 8.2 8.3 8.4 8.5 8.6 8.7 168 174 177 179 185 190 194 197 202 202 210 212 213 Advantages m d Uses of Annual Worth Anvlysis Calculation of Capital Recovery and AW Values Evaluilling Alfemstivcs by Anllual Worth Anvlysis AW of a Pcrmrncnl Investment Chapter Summary F E Review Problems Csrc Study-The Changing Scene of an Annual Worth Allalysis 7.1 7.2 7.3 7.4 7.j 7.6 Nominal m d Effective Inlercn Rate Staremcntr EffcicctiveAnnual lntereit R l e s Elfecliue Interest Rates for Any Time Period Equivalence Relations: Cnmpvring Paymcnt Pcnod tmd Compounding Period Lengths (PP versus CP) Equivalence Rehnians: Single Amounts with PP CP Equivale~~cc Relations: Series with P P z CP Equivrlencc Relulions: Single Amounts and Series with PP c CP Effective Inteicst Ratc for Continuous Compounding Interest Rates Thrt V a q over Time ChaptcrSummary Problems F E Rcvicw Pmblemr Case Study-Financing a House Present Worth Analysis 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 Annual Worth Analysis 6.1 6.2 6.3 6.4 98 Nominal and Effective Interest Rates 4.1 4.2 4.3 4.4 Chapter Calculations for Uniform Series That Arc Shifted Calculations Involving Unifoim-Series and Randomly Piaced Single Amounts Calcc~lations Shifted Gradients for Sliificd Decreasing Arithmeric Gradients Spreadsheet Application-Using Difierenr Functions Additional Example Chaptersummary Problems E'E Revicw Problems Extended ExercBcPrcseiving Land for h b l i c Use CONTENTS Why Incremental Analysis is Necersvv Cvlculvlion of lncrerncntvl Cash Flows for RDRAnalysin lntcrpietation of Rate of Rcmm on ihr Enrrv lnvertiiient Rate of Return Evaluarion Using PW Increlnenrvl ;md Brekikcven Rofc of Return E\,aluntion Using AW Incremental RORAnalysis of Multiple Mutually Exclusive Alternatives Spreadsheet Appliceinn-PW, r W and ROR Anslyrcs All in O n e C h a p a r Summary Problems FE Review Problems Extended Exercis+lncnmentul ROR Analysis When Estin~vtsd Alfernalivc Lives are Uncenain Case Study 1-So Many Options C a New Engincerhg Gmduatc ; m HelpHis Father? Case Study L P W A n a l y s i s When Multiple Interest Rates Are Present BenefitICost Analysis and Public Sector Economics 91 92 Publlc Sccfur Prqeclr BenefitiCosLAnvlyils of a Singlc Prolrct 9.3 9.4 Chapter ~ Making Choices: The Method, MARR, and Multiple Attributes 10.1 lo2 10.3 10.4 10.5 10.6 10.7 10.8 ~ ~ Alrehativve Sclcctian Using Incremental BIC Andyris lncremenral BIC h v l y s i s of Multiple, Muluvlly Exclusive Alremativor Chapter Summary Problems F E Review Problems extended Exercis&ona io Provide Ladder Truck Service for Fire Proleetionn Case Study-Freeway Lighting Chapter 13 348 351 354 357 359 362 364 369 371 372 381 382 131 13.2 13.3 Chapter 14 ~-~ - Economic Service Life Performing aReplacemenf Study Additional Considerations in a Replacement Sludy Replacement Study overa Specified Study Period Chapter Summary Problems FE~ e v i e w Pmblams !3aended Erereis-Economic ServiceLifc llnder Varying Conditions C u e Study-Replacement A ~ d y s i s Q u q Equipmen, for Chapter Selection from Independent Projects Under Budget Limitation 12.1 12.2 ~n~verviewofc~~i~al~arioning~mongPr~j~c~r Capital Rationing Using PW Analysis of Equal-Life Pmjecrs ~~ Chapter 15 Underitandme &e l~novct Innruon of Chsptcrsummary I'mblcmn F E Review Pmblcmr Extended E x e r c i r t F i r e d ~ l n c o m c Invci~mcas versus the Forces of Innaionn -~ ~ ~ ~~ ~~~ ~ ~ ~ ~ Cost Estimation and Indirect Cost Allocation 15.1 15.2 15.3 15.4 15.5 15.6 428 432 436 437 440 442 Breakeven Analysis for r Single Projcct Breakeven Analysis Between Two Altcmutives Spreadshecl Applicalion-Using Encci's SOLVER for Breakeven Analysis Chapter Summary Prohhms Case Study-Water Tream~oit Pisnt Process Costs Effects of Inflation 14 I - Capild Ra~ioning Using PWAnalysis of UnequvlLLife Projects Capital Budgeting Problem Forlnulrtion Usillg Linear Programming Ch~ptersummary Problems Case Sludy-Lifelong Engiaceting Educ8tiorl in it Web Enriran~~ient Breakeven Analysis M A K I N G DECISIONS O N REAL-WORLD PROJECTS 11.2 11.3 11.4 11.5 ' 342 343 346 ComprringMuturlly E X ~ I ~ Allenlalives by Different EvuluvtiooMethodd S~V~ MARRRelative to the Cart of Capital Debt-Equity Mix and Weighted A t t a g c Cod of Capital Determination of the Cost of Debt Crpirai Determination of the Cost of Equity Capilal and the MARR Effcclaf Debt-Equity Mix (I" 11111tmttt Risk Mul"1e Alltibute Analysis: Identification m d Importance of Each Atiribute Evaluation Mcaure for MnItiple A~wibbttt Chapter Summary Problems ~ x t e n d e d ~ ~ ~ i ~ ~ the Right Things ~ ~ i ~ i ~ ~ E - E ~ ~ h c a s e Study-Which Way l Go Debt or Equity Financing? o Chapter 1 Replacement and Retention Decisions sa~,cTOfKOx~P1~came"tSL"dYYYYYYY 11,1 ~ I 12.3 12.4 324 327 333 333 341 Understanding How Cost Esrimatian 1s Accomplished Cost Indexes Cost Eslinlsting Relaionships: Cost-Capacity Eqvsrions Cost &timating Relationships: Factor Method Trrdilionvl Indirect CoslRrtes m d Alloartion Activity-Based Costing (ABC) for Indirect Cascs Chaptcrsummar) Problems FE Review Problems Care Study-Tufrl Cost Escimrrei for Olltimiling Coogulrn~ Dosage Cane Study-lndirccr Cost Comparison of Medics1 Equipmcnl s,cn1iZanio,, unit 444 451 455 459 459 464 xii CONTENTS Chapter CONTENTS 19.3 19.4 19.5 Depreciation Methods 16.1 16.2 16.3 16.4 16.5 16.6 DepreciationTerminology Staighr Linc (SL) Depreciation Declining Balance (DB) and Double Declining Balance (DDB) Depreciation Modificd Accelerated Cost R R R O D D ' ~ System (MACRS) Determining Lhe MACRS Recovery Period DepletianMethods Chapter Summary Problems F E Review Problcms 16A.I Sum-of-Year D i g i s (SYD) Depreciation 16A.2 Switching Between DcpreciaLion Methods 16A.3 Determination of MACRS Rates Appendix Pmblems Chapter Formalized Sensitivity Analysis and Expected Value Decisions 18.1 18.2 18.3 18.4 18.5 Chapter 19 Illcome Tar Terminoiogy m d Rclrrions for Corporations (and Individuals) Before-Tax and Afrer-Tax Cash Flow Effect on Tvres of Different Deprecivtio~ Methods and Recovery Periods Depreciation Recapture and Cnpirai Grins b o s s e s ) : for Corporario~>r After-Tux PW, AW,md ROR Evaluation Spread:heer Applicarions-After-Tax Incremental ROR Analysis AffeiTrx Replrccment Study After-Tux Value-Added Analysis After-Tux Analysis far International Projects Chapter Summary Problems Case Study-After-Tax Evaluation of Debt m d Equity Financing Determining sensitivi,y to Panmeler Vrrirtion Formalized Sensitivity Analysis Using Three brimarcs Economic Variability and ihc Expccred Value Expected Value Computations for Alamariver Staged Evaluation ofAlfernrtives Using a Decision Trec ChapterSummsry Problcms Extended Exercis-Looking Altemarivcs from Different Angles Care Study-Sensitivity Aclvlysis of Public Sccfor Proj~~t~-Waler Supply Phlls More on Variation and Decision Making Under Risk 19.1 19.2 lnlerprer~tion oiCcnuinv, Risk, and Uncenainty ElrmenL~ m p a m l to Dccision Making Under Risk l Using Spreadsheets and Microsoft Excel" Al A2 A.3 A4 A.5 A.6 After-Tax Economic Analysis 17.1 17.2 17.3 17.4 17.5 17.6 17.7 17.8 17.9 Chapter Appendix A Appendix B Rmdom Samples Expected Value and Standard Deviation Monte Carlo Sampling and Simulation Analysis Additional Examples Chapter Summary Probiamr Extended Exercis-Using Simulation and rile Excci RNG for Sensitivity Analysis lntrduction to Using Excel Organization (Layout) of rhc Spreadsheet Excel Fahnctions Imponant to Engineering Economy (alphubeticd order) SOLVER-An Excel Tool far Breakcven and "What IWAnalysis List of Excel Financial Funcrioos ErrorMesrnges Basics of Accounting Reports and Business Ratios 8.1 8.2 8.3 Tho Bainncc Sheet Income Starernelit and Cost of Goods Sold Statement Busincas Ratios Problems -palvpdn uaaq ansq sauapu! 1sa3 p w sale, xel sc qms slc"a~wu paseq-am!& -ua!i!pa s!qlloj paa!~a110MaII a1e sma[qold~a~deq~~jo-pnaa~jo %ogmq32~o~q :apnpu! sa%mq= u c ~ ! ~ !seq e ~ n q 'suapc[nqeJ aql puelsrapun 0% Lms - s a ~ a u s! sn[n3[e> u puna~8~m.q smalqo~d l o ixapo3 Supaau!Zua am $00 ! y aql ~le!sa~dde rallaq uea Laqi lcql on '8u!punls ~o!uo!jo Llquaja~d '{anal a ~ o m pue -oqdos ayl ie lscal le aq plnoqs sluapnls ma!naI IueM K[dw!s oqfi s[enp!n!p -u! 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