Contemporary Engineering Economics, 5/e, is intended for undergraduate engineering students taking introductory engineering economics while appealing to the full range of engineering disciplines for which this course is often required: industrial, civil, mechanical, electrical, computer, aerospace, chemical, and manufacturing engineering, as well as engineering technology. This edition has been thoroughly revised and updated while continuing to adopt a contemporary approach to the subject, and teaching, of engineering economics. This text aims not only to build a sound and comprehensive coverage of engineering economics, but also to address key educational challenges, such as student difficulty in developing the analytical skills required to make informed financial decisions.
Table of Contents
PART 1 BASICS OF FINANCIAL DECISIONS 1 Chapter 1 Engineering Economic Decisions 1.1 Role of Engineers in Business 1.1.1 Types of Business Organization 1.1.2 Engineering Economic Decisions 1.1.3 Personal Economic Decisions 1.2 What Makes the Engineering Economic Decision Difficult? 1.3 Economic Decisions Versus Design Decisions 1.4 Large-Scale Engineering Projects 1.4.1 How a Typical Project Idea Evolves 1.4.2 Impact of Engineering Projects on Financial Statements 1.4.3 A Look Back in 2009: Did Toyota Make the Right Decision? 1.5 Common Types of Strategic Engineering Economic Decisions 1.6 Fundamental Principles of Engineering Economics Summary Short Case Studies Chapter 2 Accounting and Financial Decision-Making 2.1 Accounting: The Basis of Decision Making 2.2 Financial Status for Businesses 2.2.1 The Balance Sheet 2.2.2 The Income Statement 2.2.3 The Cash Flow Statement 2.3 Using Ratios to Make Business Decisions 2.3.1 Debt Management Analysis 2.3.2 Liquidity Analysis 2.3.3 Asset Management Analysis 2.3.4 Profitability Analysis 2.3.5 Market Value Analysis 2.3.6 Limitations of Financial Ratios in Business Decisions Summary Problems Short Case Studies Chapter 3 Interest Rate and Economic Equivalence 3.1 Interest: The Cost of Money 3.1.1 The Time Value of Money 3.1.2 Elements of Transactions Involving Interest 3.1.3 Methods of Calculating Interest 3.1.4 Simple Interest versus Compound Interest 3.2 Economic Equivalence 3.2.1 Definition and Simple Calculations 3.2.2 Equivalence Calculations: General Principles 3.3 Development of Formulas for Equivalence Calculations 3.3.1 The Five Types of Cash Flows 3.3.2 Single-Cash-Flow Formulas 3.3.3 Uneven Payment Series 3.3.4 Equal-Payment Series 3.3.5 Linear-Gradient Series 3.3.6 Geometric Gradient Series 3.4 Unconventional Equivalence Calculations 3.4.1 Composite Cash Flows 3.4.2 Determining an Interest Rate to Establish Economic Equivalence 3.4.3 Unconventional Regularity in Cash Flow Pattern Summary Problems Short Case Studies Chapter 4 Understanding Money and Its Management 4.1 Nominal and Effective Interest Rates 4.1.1 Nominal Interest Rates 4.1.2 Effective Annual Interest Rates 4.1.3 Effective Interest Rates per Payment Period 4.1.4 Continuous Compounding 4.2 Equivalence Calculations with Effective Interest Rates 4.2.1 When Payment Period is Equal to Compounding Period 4.2.2 Compounding Occurs at a Different Rate than That at Which Payments are Made 4.2.4 Compounding is Less Frequent than Payments 4.3 Equivalence Calculations with Continuous Payments 4.3.1 Single-Payment Transactions 4.3.2 Continuous-Funds Flow 4.4 Changing Interest Rates 4.4.1 Single Sums of Money 4.4.2 Series of Cash Flows 4.5 Debt Management 4.5.1 Commercial Loans 4.5.2 Loan versus Lease Financing 4.5.3 Home Mortgage 4.6 Investing in Financial Assets 4.6.1 Investment Basics 4.6.2 How to Determine Your Expected Return 4.6.3 Investing in Bonds Summary Problems Short Case Studies PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS 207 Chapter 5 Present-Worth Analysis 5.1 Describing Project Cash Flows 5.1.1 Loan versus Project Cash Flows 5.1.2 Independent versus Mutually Exclusive Investment Projects 5.2 Initial Project Screening Method 5.2.1 Payback Period: The Time It Takes to Pay Back 5.2.2 Benefits and Flaws of Payback Screening 5.2.3 Discounted Payback Period 5.2.4 Where Do We Go from Here? 5.3 Discounted Cash Flow Analysis 5.3.1 Net-Present-Worth Criterion 5.3.2 Meaning of Net Present Worth 5.3.3 Basis for Selecting the MARR 5.4 Variations of Present-Worth Analysis 5.4.1 Future-Worth Analysis 5.4.2 Capitalized Equivalent Method 5.5 Comparing Mutually Exclusive Alternatives 5.5.1 Meaning of Mutually Exclusive and "Do Nothing" 5.5.2 Analysis Period 5.5.3 Analysis Period Matches Project Lives 5.5.4 Analysis Period Differs from Project Lives 5.5.5 Analysis Period Is Not Specified Summary Problems Short Case Studies Chapter 6 Annual Equivalent-Worth Analysis 6.1 Annual Equivalent-Worth Criterion 6.1.1 Fundamental Decision Rule 6.1.2 Annual-Worth Calculation with Repeating Cash Flow Cycles 6.1.3 Comparing Mutually Exclusive Alternatives 6.2 Capital Costs Versus Operating Costs 6.3 Applying Annual-Worth Analysis 6.3.1 Benefits of AE Analysis 6.3.2 Unit Profit or Cost Calculation 6.3.3 Make-or-Buy Decision--Outsourcing Decisions 6.3.4 Pricing the Use of an Asset 6.4 Life-Cycle Cost Analysis 6.5 Design Economics Summary Problems Short Case Studies Chapter 7 Rate-of-Return Analysis 7.1 Rate of Return 7.1.1 Return on Investment 7.1.2 Return on Invested Capital 7.2 Methods for Finding the Rate of Return 7.2.1 Simple versus Nonsimple Investments 7.2.2 Predicting Multiple i*'s 7.2.3 Computational Methods 7.3 Internal-Rate-of-Return Criterion 7.3.1 Relationship to PW Analysis 7.3.2 Net-Investment Test: Pure versus Mixed Investments 7.3.3 Decision Rule for Pure Investments 7.3.4 Decision Rule for Mixed Investments 7.4 Mutually Exclusive Alternatives 7.4.1 Flaws in Project Ranking by IRR 7.4.2 Incremental Investment Analysis 7.4.3 Handling Unequal Service Lives Summary Problems Short Case Studies PART 3 ANALYSIS OF PROJECT CASH FLOWS Chapter 8 Cost Concepts Relevant to Decision Making 8.1 General Cost Terms 8.1.1 Manufacturing Costs 8.1.2 Nonmanufacturing Costs 8.2 Classifying Costs for Financial Statements 8.2.1 Period Costs 8.2.2 Product Costs 8.3 Cost Classification for Predicting Cost Behavior 8.3.1 Volume Index 8.3.2 Cost Behaviors 8.3.3 Cost-Volume-Profit Analysis 8.4 Future Costs for Business Decisions 8.4.1 Differential Cost and Revenue 8.4.2 Opportunity Cost 8.4.3 Sunk Costs 8.4.4 Marginal Cost 8.5 Estimating Profit from Production 8.5.1 Calculation of Operating Income 8.5.2 Sales Budget for a Manufacturing Business 8.5.3 Preparing the Production Budget 8.5.4 Preparing the Cost-of-Goods-Sold Budget 8.5.5 Preparing the Nonmanufacturing Cost Budget 8.5.6 Putting It All Together: The Budgeted Income Statement 8.5.7 Looking Ahead Summary Problems Short Case Studies Chapter 9 Depreciation and Corporate Taxes 9.1 Asset Depreciation 9.1.1 Economic Depreciation 9.1.2 Accounting Depreciation 9.2 Factors Inherent in Asset Depreciation 9.2.1 Depreciable Property 9.2.2 Cost Basis 9.2.3 Useful Life and Salvage Value 9.2.4 Depreciation Methods: Book and Tax Depreciation 9.3 Book Depreciation Methods 9.3.1 Straight-Line Method 9.3.2 Accelerated Methods 9.3.3 Units-of-Production Method 9.4 Tax Depreciation Methods 9.4.1 MACRS Depreciation 9.4.2 MACRS Depreciation Rules 9.5 Depletion 9.5.1 Cost Depletion 9.5.2 Percentage Depletion 9.6 Repairs or Improvements Made to Depreciable Assets 9.6.1 Revision of Book Depreciation 9.6.2 Revision of Tax Depreciation 9.7 Corporate Taxes 9.7.1 Income Taxes on Operating Income 9.8 Tax Treatment of Gains or Losses on Depreciable Assets 9.8.1 Disposal of a MACRS Property 9.8.2 Calculations of Gains and Losses on MACRS Property 9.9 Income Tax Rate to Be Used in Economic Analysis 9.9.1 Incremental Income Tax Rate 9.9.2 Consideration of State Income Taxes 9.10 The Need for Cash Flow in Engineering Economic Analysis 9.10.1 Net Income versus Net Cash Flow 9.10.2 Treatment of Noncash Expenses Summary Problems Short Case Studies Chapter 10 Developing Project Cash Flows 10.1 Cost--Benefit Estimation for Engineering Projects 10.1.1 Simple Projects 10.1.2 Complex Projects 10.2 Incremental Cash Flows 10.2.1 Elements of Cash Outflows 10.2.2 Elements of Cash Inflows 10.2.3 Classification of Cash Flow Elements 10.3 Developing Cash Flow Statements 10.3.1 When Projects Require Only Operating and Investing Activities 10.3.2 When Projects Require Working-Capital Investments 10.3.3 When Projects are Financed with Borrowed Funds 10.3.4 When Projects Result in Negative Taxable Income 10.3.5 When Projects Require Multiple Assets 10.4 Generalized Cash-Flow Approach 10.4.1 Setting up Net Cash-Flow Equations 10.4.2 Presenting Cash Flows in Compact Tabular Formats 10.4.3 Lease-or-Buy Decision Summary Problems Short Case Studies PART 4 HANDLING RISK AND UNCERTAINTY Chapter 11 Inflation and Its Impact on Project Cash Flows 11.1 Meaning and Measure of Inflation 11.1.1 Measuring Inflation 11.1.2 Actual versus Constant Dollars 11.2 Equivalence Calculations under Inflation 11.2.1 Market and Inflation-Free Interest Rates 11.2.2 Constant-Dollar Analysis 11.2.3 Actual-Dollar Analysis 11.2.4 Mixed-Dollar Analysis 11.3 Effects of Inflation on Project Cash Flows 11.3.1 Multiple Inflation Rates 11.3.2 Effects of Borrowed Funds Under Inflation 11.4 Rate-of-Return Analysis Under Inflation 11.4.1 Effects of Inflation on Return on Investment 11.4.2 Effects of Inflation on Working Capital Summary Problems Short Case Studies Chapter 12 Project Risk and Uncertainty 12.1 Origins of Project Risk 12.2 Methods of Describing Project Risk 12.2.1 Sensitivity Analysis 12.2.2 Break-Even Analysis 12.2.3 Scenario Analysis 12.3 Probability Concepts for Investment Decisions 12.3.1 Assessment of Probabilities 12.3.2 Summary of Probabilistic Information 12.3.3 Joint and Conditional Probabilities 12.3.4 Covariance and Coefficient of Correlation 12.4 Probability Distribution of NPW 12.4.1 Procedure for Developing an NPW Distribution 12.4.2 Aggregating Risk over Time 12.4.3 Decision Rules for Comparing Mutually Exclusive Risky Alternatives 12.5 Risk Simulation 12.5.1 Computer Simulation 12.5.2 Model Building 12.5.3 Monte Carlo Sampling 12.5.4 Simulation Output Analysis 12.5.5 Risk Simulation with Oracle Crystal Ball 12.6 Decision Trees and Sequential Investment Decisions 12.6.1 Structuring a Decision-Tree Diagram 12.6.2 Worth of Obtaining Additional Information 12.6.3 Decision Making after Having Imperfect Information Summary Problems Short Case Studies Chapter 13 Real-Options Analysis 13.1 Risk Management: Financial Options 13.1.1 Features of Financial Options 13.1.2 Buy Call Options when You Expect the Price to Go Up 13.1.3 Buy Put Options when You Expect the Price to Go Down 13.2 Option Strategies 13.2.1 Buying Calls to Reduce Capital That Is at Risk 13.2.2 Protective Puts as a Hedge3 13.3 Option Pricing 13.3.1 Replicating-Portfolio Approach with a Call Option 13.3.2 Risk-Free Financing Approach 13.3.3 Risk-Neutral Probability Approach 13.3.4 Put-Option Valuation 13.3.5 Two-Period Binomial Lattice Option Valuation 13.3.6 Multiperiod Binomial Lattice Model 13.3.7 Black--Scholes Option Model 13.4 Real-Options Analysis 13.4.1 A Conceptual Framework for Real Options in Engineering Economics 13.4.2 Types of Real-Option Models 13.5 Compound Options 13.6 Estimating Volatility at the Project Level 13.6.1 Mathematical Relationship between and 13.6.2 Estimating distribution Summary Problems Short Case Studies PART 5 SPECIAL TOPICS IN ENGINEERING ECONOMICS Chapter 14 Replacement Decisions 14.1 Replacement Analysis Fundamentals 14.1.1 Basic Concepts and Terminology 14.1.2 Opportunity Cost Approach to Comparing Defender and Challenger 14.2 Economic Service Life VT 14.3 Replacement Analysis When the Required Service is Long 14.3.1 Required Assumptions and Decision Frameworks 14.3.2 Replacement Strategies under the Infinite Planning Horizon 14.3.3 Replacement Strategies under the Finite Planning Horizon 14.3.4 Consideration of Technological Change 14.4 Replacement Analysis With Tax Considerations Summary Problems Short Case Studies Chapter 15 Capital-Budgeting Decisions 15.1 Methods of Financing 15.1.1 Equity Financing 15.1.2 Debt Financing 15.1.3 Capital Structure 15.2 Cost of Capital 15.2.1 Cost of Equity 15.2.2 Cost of Debt 15.2.3 Calculating the Cost of Capital 15.3 Choice of Minimum Attractive Rate of Return 15.3.1 Choice of MARR when Project Financing Is Known 15.3.2 Choice of MARR when Project Financing is Unknown 15.3.3 Choice of MARR under Capital Rationing 15.4 Capital Budgeting 15.4.1 Evaluation of Multiple Investment Alternatives 15.4.2 Formulation of Mutually Exclusive Alternatives 15.4.3 Capital-Budgeting Decisions with Limited Budgets Summary Problems Short Case Studies Chapter 16 Economic Analysis in the Service Sector 16.1 What is the Service Sector? 16.1.1 Characteristics of the Service Sector 16.1.2 Diffculty of Pricing Service 16.2 Economic Analysis in Health-Care Service 16.2.1 Economic Evaluation Tools 16.2.2 Cost-Effectiveness Analysis 16.3 Economic Analysis in the Public Sector 16.3.1 What Is Benefit--Cost Analysis? 16.3.2 Framework of Benefit--Cost Analysis 16.3.3 Valuation of Benefits and Costs 16.3.4 Quantifying Benefits and Costs 16.3.5 Difficulties Inherent in Public Project Analysis 16.4 Benefit--Cost Ratios 16.4.1 Definition of Benefit--Cost Ratio 16.4.2 Relationship Among B/C Ratio, Profitability Index, and NPW 16.4.3 Comparing Mutually Exclusive Alternatives: Incremental Analysis 16.5 Analysis of Public Projects Based on Cost-Effectiveness 16.5.1 Cost-Effectiveness Studies in the Public Sector 16.5.2 A Cost-Effectiveness Case Study14
Dr. Chan S. Park is a Ginn Distinguished Professor of Engineering in the Department of Industrial & Systems Engineering at Auburn University.His teaching and research interests are in the area of engineering economic decisions and financial engineering. He received his PhD from Georgia Institute of Technology.