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Useful Lives Equal the Analysis Period 155 Useful Lives Different from the Analysis Period Infinite Analysis Period: Capitalized Cost 161 Multiple Alternatives 165 Spreadsheets and Prese[r]

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ENGINEERING ECONOMIC ANALYSIS TENTH EDITION Donald G Newnan State University Jerome P Lavelle North Carolina State University Ted G Eschenbach University ofAlaska Anchorage New York Oxford OXFORD UNIVERSITY PRESS 2009 Contents PREFACE xxi MAKING ECONOMIC DECISIONS Alternative Fuel Vehicles A Sea of Problems Simple Problems Intermediate Problems Complex Problems The Role of Engineering Economic Analysis Examples of Engineering Economic Analysis The Decision-Making Process Rational Decision Making Ethics 15 Ethical Dimensions in Engineering Decision Making 15 Importance of Ethics in Engineering and Engineering Economy 18 , Engineering Decision Making for Current Costs Summary 21 Problems 23 18 CONTENTS ENGINEERING COSTS A N D COST ESTIMATING North Slope Natural Gas Pipeline 32 Engineering Costs 34 Fixed, Variable, Marginal, and Average Costs Sunk Costs 37 Opportunity Costs 38 Recurring and Nonrecurring Costs 40 Incremental Costs 40 Cash Costs Versus Book Costs 41 Life-Cycle Costs 41 Cost Estimating 43 Types of Estimate 44 Difficulties in Estimation 34 45 Estimating Models 46 Per-Unit Model 46 Segmenting Model 48 Cost Indexes 49 Power-Sizing Model 51 Triangulation 52 Improvement and the Learning Curve Estimating Benefits 52 56 Cash Flow Diagrams 56 Categories of Cash Flows 57 Drawing a Cash Flow Diagram 57 Drawing Cash Flow Diagrams with a Spreadsheet Summary 59 Problems 60 Trust Me, You'll Use This! 68 INTEREST A N D EQUIVALENCE Going Up in Smoke 70 Computing Cash Flows 72 58 CONTENTS Time Value of Money 73 Simple Interest 74 Compound Interest 75 Repaying a Debt 76 Equivalence 78 Difference in Repayment Plans 78 Equivalence is Dependent on Interest Rate 81 Application of Equivalence Calculations 82 Single Payment Compound Interest Formulas 83 Summary 90 Problems 91 MORE INTEREST FORMULAS Anne Scheiber's Bonanza 94 Uniform Series Compound Interest Formulas 96 Economic Equivalence Viewed as a Moment Diagram Relationships Between Compound Interest Factors Single Payment 109 Uniform Series 109 Arithmetic Gradient 108 110 Derivation of Arithmetic Gradient Factors Geometric Gradient 106 111 116 Nominal and Effective Interest , 120 Continuous Compounding 126 Single Payment Interest Factors: Continuous Compounding ' Uniform Payment Series: Continuous Compounding at Nominal Rate r per Period 129 Spreadsheets for Economic Analysis 131 Spreadsheet Annuity Functions 131 Spreadsheet Block Functions 132 Using Spreadsheets for Basic Graphing 133 126 xi xii CONTENTS Summary Problems 134 137 PRESENT WORTH ANALYSIS Boeing Versus Airbus 150 Assumptions in Solving Economic Analysis Problems End-of-Year Convention 152 Viewpoint of Economic Analysis Studies Sunk Costs 153 Borrowed Money Viewpoint 153 Effect of Inflation and Deflation 153 Income Taxes 153 Economic Criteria 152 154 Applying Present Worth Techniques 154 Useful Lives Equal the Analysis Period 155 Useful Lives Different from the Analysis Period Infinite Analysis Period: Capitalized Cost 161 Multiple Alternatives 165 Spreadsheets and Present Worth Summary Problems 152 158 169 171 172 ANNUAL CASH FLOW ANALYSIS Lowest Prices on the Net! Buy Now! 184 Annual Cash Flow Calculations 186 Resolving a Present Cost to an Annual Cost Treatment of Salvage Value 186 Annual Cash Flow Analysis Analysis Period 186 190 192 Analysis Period Equal to Alternative Lives 194 Analysis Period a Common Multiple of Alternative Lives 194 CONTENTS Analysis Period for a Continuing Requirement Infinite Analysis Period 195 Some Other Analysis Period 196 Using Spreadsheets to Analyze Loans 194 198 Building an Amortization Schedule 198 How Much to Interest? How Much to Principal? 199 Finding the Balance Due on a Loan 199 Pay Off Debt Sooner by Increasing Payments 200 Summary 201 Problems 202 RATE OF RETURN ANALYSIS Bar Codes Gives a Number; RFID Codes Tell a Story 210 Internal Rate of Return 212 Calculating Rate of Return 213 Plot of NPW Versus Interest Rate i 217 Interest Rates When There Are Fees or Discounts Loans and Investments Are Everywhere 220 222 Incremental Analysis 226 Present Worth Analysis 229 Analysis Period 231 Spreadsheets and Rate of Return Analysis 233 Summary 233 Problems 235 Appendix 7A Difficulties in Solving for an Interest Rate 244 Why Multiple Solutions Can Occur 245 Projects with Multiple Sign Changes 246 Evaluating How Many Roots There Are 248 Modified Internal Rate of Return (MIRR) 252 xiii xiv CONTENTS CHOOSING THE BEST ALTERNATIVE Tapping into Controversy Incremental Analysis Graphical Solutions 258 260 260 Elements in Comparing Mutually Exclusive Alternatives 269 Doing a Set of Incremental Challenger-Defender Comparisons Choosing an Analysis Method 270 272 Spreadsheets and GOAL SEEK 272 Summary 274 Problems 274 OTHER ANALYSIS TECHNIQUES Clean, Green, and Far Between 282 Future Worth Analysis 284 Benefit-Cost Ratio Analysis 286 Variations on the Theme of the Benefit-Cost Ratio Payback Period 291 294 Sensitivity and Breakeven Analysis 298 Graphing with Spreadsheets for Sensitivity and Breakeven Analysis Doing What-lf Analysis with Spreadsheets 307 Summary 308 Problems 309 10 UNCERTAINTY I N FUTURE EVENTS They Only Thought They Were Done 318 Estimates and Their Use in Economic Analysis A Range of Estimates 322 Probability 324 320 304 CONTENTS Joint Probability Distributions Expected Value 327 329 Economic Decision Trees 332 Risk 338 Risk Versus Return Simulation 342 Real Options Summary Problems 341 346 346 347 11 DEPRECIATION Depreciation and Competitiveness Basic Aspects of Depreciation 354 356 Deterioration and Obsolescence 356 Depreciation and Expenses 357 Types of Property 358 Depreciation Calculation Fundamentals Historical Depreciation Methods 358 359 Straight-Line Depreciation 360 Sum-of-Years'-Digits Depreciation 361 Declining Balance Depreciation 363 Modified Accelerated Cost Recovery System (MACRS) 365 Cost Basis and Placed-in-Service Date 365 Property Class and Recovery Period 366 Percentage Tables 367 Where MACRS Percentage Rates (rt) Come From 369 MACRS Method Examples 370 Comparing MACRS and Historical Methods 371 Depreciation and Asset Disposal 372 Unit-of-Production Depreciation 376 xv xvi CONTENTS Depletion 377 Cost Depletion 377 Percentage Depletion 378 Spreadsheets and Depreciation 379 Using VDB for MACRS 380 Summary 381 Problems 382 12 INCOME TAXES On with the Wind 388 A Partner in the Business 390 Calculation of Taxable Income 390 Taxable Income of Individuals 390 Classification of Business Expenditures 391 Taxable Income of Business Firms 392 Income Tax Rates 393 Individual Tax Rates 393 Corporate Tax Rates 395 Combined Federal and State Income Taxes 396 Selecting an Income Tax Rate for Economy Studies 397 Economic Analysis Taking Income Taxes into Account 397 Capital Gains and Losses for Nondepreciated Assets 401 Investment Tax Credit 401 Estimating the After-Tax Rate of Return 402 After-Tax Cash Flows and Spreadsheets Summary 403 Problems 405 403 CONTENTS 13 REPLACEMENT ANALYSIS The $2 Billion Upgrade 416 The Replacement Problem 418 Replacement Analysis Decision Map 419 Minimum Cost Life of a New Asset—the Challenger 420 Defender's Marginal Cost Data 422 Do We Have Marginal Cost Data for the Defender? Are These Marginal Costs Increasing? 424 424 Replacement Analysis Technique 1: Defender Marginal Costs Can Be Computed and Are Increasing 425 Replacement Repeatability Assumptions 426 Replacement Analysis Technique 2: Defender Marginal Costs Can Be Computed and Are Not Increasing 427 Replacement Analysis Technique 3: When Defender Marginal Cost Data Are Not Available 431 Complications in Replacement Analysis 432 Defining Defender and Challenger First Costs 432 Repeatability Assumptions Not Acceptable A Closer Look at Future Challengers After-Tax Replacement Analysis 435 436 Marginal Costs on an After-Tax Basis Minimum Cost Life Problems 438 Spreadsheets and Replacement Analysis Summary 441 Problems 442 434 436 439 xvii xviii CONTENTS 14 INFLATION AND PRICE CHANGE The Athabasca Oil Sands 450 Meaning and Effect of Inflation 452 How Does Inflation Happen? 452 Definitions for Considering Inflation in Engineering Economy Analysis in Constant Dollars Versus Then-Current Dollars 453 460 Price Change with Indexes 462 What Is a Price Index? 462 Composite Versus Commodity Indexes 464 How to Use Price Indexes in Engineering Economic Analysis 466 Cash Flows That Inflate at Different Rates 466 Different Inflation Rates per Period 468 Inflation Effect on After-Tax Calculations 469 Using Spreadsheets for Inflation Calculations 472 Summary 474 Problems 475 15 SELECTION OF A M I N I M U M ATTRACTIVE RATE OF RETURN BP Goes to Russia 482 Sources of Capital 484 Money Generated from the Firm's Operations External Sources of Money 484 Choice of Source of Funds 484 484 Cost of Funds 485 Cost of Borrowed Money 485 Cost of Capital 485 Inflation and the Cost of Borrowed Money Investment Opportunities Opportunity Cost 487 487 486 CONTENTS Selecting a Minimum Attractive Rate of Return 490 Adjusting MARR to Account for Risk and Uncertainty Representative Values of MARR Used in Industry Capital Budgeting or Selecting the Best Projects 492 493 Spreadsheets, Cumulative Investments, and the Opportunity Cost of Capital 495 Summary Problems 498 500 16 ECONOMIC ANALYSIS IN THE PUBLIC SECTOR From Waste to Power and Money Investment Objective Viewpoint for Analysis 506 508 510 Selecting an Interest Rate 511 No Time-Value-of-Money Concept Cost of Capital Concept 511 Opportunity Cost Concept 512 Recommended Concept 512 The Benefit-Cost Ratio 511 513 Incremental Benefit-Cost Analysis 515 Elements of the Incremental Benefit-Cost Ratio Method 516 Other Effects of Public Projects 520 Project Financing 521 Project Duration 521 Quantifying and Valuing Benefits and Disbenefits Project Politics 524 Summary Problems 526 526 523 490 xx CONTENTS 17 ACCOUNTING AND ENGINEERING ECONOMY The Two Faces of ABB 534 The Role of Accounting 536 Accounting for Business Transactions The Balance Sheet 536 537 Assets 537 Liabilities 538 Equity 539 Financial Ratios Derived from Balance Sheet Data The Income Statement 539 540 Financial Ratios Derived from Income Statement Data 542 Linking the Balance Sheet, Income Statement, and Capital Transactions Traditional Cost Accounting 543 Direct and Indirect Costs 544 Indirect Cost Allocation 544 Problems with Traditional Cost Accounting Other Problems to Watch For 546 Problems 545 547 APPENDIX A INTRODUCTION TO SPREADSHEETS 551 The Elements of a Spreadsheet 551 Defining Variables in a Data Block 552 Copy Command 552 APPENDIX B C O M P O U N D INTEREST TABLES APPENDIX C FUNDAMENTALS OF ENGINEERING (FE) EXAM PRACTICE PROBLEMS REFERENCES INDEX 606 603 587 555 542