Blank L., Tarquin A. Engineering Economy (McGraw-Hill Series in Industrial Engineering and Management)
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CONTENTS
Preface
xv
Chapter
1
THIS
IS
HOW
IT ALL
STARTS
Foundations
of
Engineering Economy 4
1.1 Why Engineering Economy Is Important to Engineers (and Other Professionals) 6
1.2
Role
of
Engineering Economy
in
Decision Making
1.3
Performing an Engineering Economy Study
1.4 Interest Rate and Rate
of
Return
1.5
Equivalence
1.6 Simple and Compound Interest
1.7 Terminology and Symbols
1.8 Introduction to Solution by Computer
1.9 Minimum Attractive Rate
of
Return
1.
10
Cash Flows: Their Estimation and Diagramming
1.
ll
Rule
of
72: Estimating Doubling Time and Interest Rate
1.12 Spreadsheet
Application-Simple
and Compound Interest, and
7
9
l2
l5
17
23
26
28
30
35
Changing Cash Flow Estimates 36
Additional Examples 39
Chapter Summary
41
Problems 42
FE Review
Problems 45
Extended
Exercise-Effects
of
Compound Interest 45
Case
St
ud
y-Descri
bing Alternatives for Producing R
ef
rigerator Shells 46
Chapter
2 Factors:
How
Time
and Interest
Affect
Money
48
50
2.1
Single-Payment Factors
(F
/ P and P / F)
2.2 Uniform-Series Present Worth Factor and Capital Recovery
Factor
(P/ A
andA/P)
56
2.3
2.4
2.5
2.6
2.7
2.8
2.9
Sinking Fund Factor and Uniform-Series Compound Amount
Factor
(A/
F and F /
A)
Interpolation
in
Interest Tables
Arithmetic Gradient Factors
(P
/G
and
A/G)
Geometric Gradient Series Factors
Determination
of
an Unknown Interest Rate
Determination
of
Unknown Number
of
Years
Spreadsheet
Application-Basic
Sensitivity Analysis
Additional Example
60
63
65
71
74
77
78
80
Chapter Summary
81
Problems
81
FE Review Problems 88
Case S
tud
y-What
a Difference the Years and
Com
pound Interest
Ca
n Make
90
viii
Chapter
3
CONTENTS
Combining
Factors
3.1
Calculations for
Unifonn
Series
That
Are Shifted
3.2 Calculations Involving Uniform-Series and Randomly
Placed Single Amounts
3.3 Calculations for Shifted Gradients
3.4
3.5
Shifted Decreasing Arithmetic Gradients
Spreadsheet
Application-Using
Different Functions
Additional Example
Chapter Summary
Problems
FE Review Problems
Extended
Exercise-Preserving
Land for Public
Use
92
94
98
103
108
110
114
115
lIS
121
123
Chapter
4
Nominal
and Effective Interest Rates
124
126
130
136
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
Nominal and Effective Interest Rate Statements
Effective Annual Interest Rates
Effective Interest Rates for Any Time
Period
Equivalence Relations: Comparing Payment Period and Compounding
Period Lengths (PP versus CP)
Equivalence Relations: Single Amounts with
PP
~
CP
Equivalence Relations: Series with
PP
~
CP
Equivalence Relations: Single Amounts and Series with
PP
<
CP
Effective Interest Rate for Continuous Compounding
Interest Rates
That
Vary over Time
Chapter Summary
Problems
FE Review Problems
Case
S
tud
y-Financing
a House
TOOLS FOR EVALUATING ALTERNATIVES
Chapter
5 Present
Wort
h Analysis
5.1
Formulating Mutually Exclusive Alternatives
5.2
Present Worth Analysis
of
Equal-Life Alternatives
5.3
5.4
5.5
5.6
5.7
5.8
5.9
Present Worth Analysis
of
Different-Life Alternatives
Future Worth Analysis
Capitalized Cost Calculation and Analysis
Payback
Period Analysis
Life-Cycle Cost
Present Worth
of
Bonds
Spreadsheet
Applications-PW
Analysis and Payback Period
Chapter Summary
138
139
142
147
149
151
153
154
159
162
168
170
172
174
177
179
185
190
194
197
202
Problems 202
FE Review Problems 210
Extended
Exercise-Evaluation
of
Social Security Retirement Estimates 212
Case S
tud
y-Paybac
k Eva
lu
ation
of
Ultralow-Flush Toilet Program 213
CONTENTS
Chapter 6 Annual
Worth
Analysis
6.l
Advantages and Uses of Annual Worth Analysis
6.2
6.3
6.4
Calculation
of
Capital Recovery and
AW
Values
Evaluating Alternatives by Annual Worth Analysis
AW
of
a Permanent Investment
Chapter
Summary
Problems
FE
Review
Problems
Ca
se
Stud
y-
The Changing Scene of
an
Annual Worth Analysis
Chapter 7 Rate
of
Return Analysis: Single Alternative
7.1
Interpretation of a Rate of Return Value
7.2 Rate
of
Return Calculation Using a PW or
AW
Equation
7.3
7.4
7.5
7.6
Cautions When Using the ROR Method
Multiple Rate
of
Return Values
Composite Rate
of
Return: Removing Multiple
i*
Values
Rate
of
Return
of
a Bond Investment
Chapter
Summary
Problems
FE
Review
Problems
Extended
Exercise
I-The
Cost
of
a Poor Credit Rating
Extended
Exercise
2-When
Is It Best to Sell a Business?
Case
Stu
d
y-B
ob Learns About Multiple Rates of Retu
rn
Chapter
8 Rate
of
Retu
rn
Analysis:
Mu
ltiple Alternatives
8.1
Why Incremental Analysis
is
Necessary
8.2
8.3
8.4
8.5
8.6
8.7
Calculation
of
Incremental Cash Flows for ROR Analysis
Interpretation
of
Rate
of
Return
on
the Extra Investment
Rate
of
Return Evaluation Using
PW:
Incremental and Breakeven
Rate
of
Return Evaluation Using
AW
Incremental ROR Analysis
of
Multipl
e,
Mutually Exclusi
ve
Alternatives
Spreadsheet
Application-PW,
AW,
and ROR Analyses All
in
One
Chapter
Summary
Problems
FE
Review
Problems
Extended
Exercise-Incremental
ROR Analysis When Estimated
ix
216
218
220
223
228
231
232
235
236
238
240
242
248
249
255
261
263
264
270
272
272
273
276
278
279
282
283
291
292
297
300
300
306
Alternative Lives are Uncertain 308
Ca
se
Stud
y I- So Many Option
s.
Can a New Engineering Gra
du
ate
He
lp
Hi
s Fa
th
er? 309
Case
Stu
dy 2- PW Analysis When Multiple
In
terest Rates Are Present 310
Chapter 9 Benefit/Cost Analysis and Public Sector Economics
9.1
Public Sector Projects
9.2 Benefit/Cost Analysis
of
a Single Project
31
2
314
319
x
CONTENTS
9.3
9.4
Alternative Selection
Using Incremental
B/C
Analysis
Incremental
B/C
Analysis
of
Multiple, Mutually Exclusive Alternatives
Chapter Summary
Problems
FE Review Problems
Extended
Exercise-Costs
to Provide Ladder Truck Service
fo
r Fire Protectionn
Case
St
u
dy-Freeway
Lighting
Chapter
10
Making Choices: The
Method,
MARR,
and Multiple Attributes
324
327
333
333
341
342
343
346
10
.1
Comparing Mutually Exclusive Alternatives
by
Different Eva
lu
ation Methods 348
10.2 MARR Relative to the Cost
of
Capital
351
10.3
Debt-Equity Mix and Weighted Average Cost
of
Capital 354
10.4 Determination
of
the Cost
of
Debt Capital 357
10.5 Determination
of
the Cost
of
Equity Capital and the MARR 359
10.
6 Effect
of
Debt-Equity Mix
on
Investment Ri
sk
362
10.7 Multiple Attribute Analysis: Identification and Importance
of
Each Attribute 364
10.8
Evaluat
ion
Measure for Multiple Attributes 369
Chapter Summary
371
Problems
Extended
Exercise-Emphasizing
the Right Things
Case
St
ud
y-W
h
ic
h Way to
Go-Debt
or Equity Financing?
MAKING
DECISIONS
ON
REAL-WORLD PROJECTS
Chapter
11
Replacement and Retention Decisions
11.1
Basics
of
the Replacement Study
11.2
Economic Service Life
11.3
Performing a Replacement Study
11.4
Additional Considerations
in
a Replacement Study
11
.5
Replacement Study over a Specified Study Period
Chapter Summary
372
38 1
382
386
388
391
397
403
404
410
Problems 410
FE Review Problems 418
Extended
Exercise-Economic
Service Life Under Varying Conditions 419
Case S
tud
y-Rep
lacement Analysis for Quarry Equipment 420
Chapter
12
Selection from Independent Projects
Under Budget Limitation
12.1
An
Overview
of
Capital Rationing Among Projects
12.2
Capi
tal
Rationing Using PW Analysis
of
Equal-Life Projects
422
424
426
CONTENTS
12.3
Capital Rationing Using PW Analysis of Unequal-Life Projects
12.4
Capital Budgeting Problem Formulation Using Linear Programming
Chapter Summary
xi
428
432
436
Problems 437
Case
St
udy-
Lif
elong Enginee
rin
g Education
in
a Web Environment 440
Chapter
13
Breakeven Analysis
13.1
Breakeven Analysis for a Single Project
13.2 Breakeven Analysis Between Two Alternatives
13.3
Spreadsheet
Application-Using
Excel's SOLVER for Breakeven
Analysis
Chapter Summary
Problems
Case
Stud
y-
Water Treatme
nt
Pla
nt
Process C
os
ts
ROUNDING
OUT
THE STUDY
Chapter 14 Effects
of
Inflation
14.1
Understanding the Impact
of
Inflation
14.2
Present Worth Calculations Adjusted for Inflation
14.3
Future Worth Calculations Adjusted for Inflation
14.4 Capital Recovery Calculations Adjusted for Inflation
Chapter Summary
Problems
FE Review Problems
Extended
Exercise-Fixed-Income
Investments versus the Forces
of
Inflationn
Chapter
15
Cost Estimation and Indirect Cost Allocation
15.1
Understanding How Cost Estimation Is Accomplished
15.2 Cost Indexes
15.3
Cost Estimating Relationships: Cost-Capacity Equations
15.4 Cost Estimating Relationships: Factor Method
15
.5 Traditional Indirect Cost Rates and Allocation
15.6 Activity-Based Costing (ABC) for Indirect Costs
442
444
451
455
459
459
464
470
472
474
480
485
486
487
491
492
494
496
499
503
505
508
5J2
Chapter Summary 5 J 6
Problems 5 J 7
FE Review Problems 525
Case Study
-To
tal C
os
t
Es
tim
ates for Optimizing Coag
ul
ant D
os
age 5
25
Case
Stud
y-
Indi rect Cost Co
mp
aris
on
of
Medical Equipment
Steriliza
ti
on U
ni
t 528
xii
CONTENTS
Chapter
16
Depreciation Methods
16.1
Depreciation Terminology
16
.2 Straight Line (SL) Depreciation
530
532
535
16.3
Declining Balance (DB) and Double Declining Balance (DDB) Depreciation 536
16.4 Modified Accelerated Cost Recovery
System (MACRS)
541
16.5
Determining the MACRS Recovery Period 545
16.6 Depletion Methods 545
Chapter Summary 548
Problems
FE Review Problems
16A.1
Sum-of-Year Digits (SYD) Depreciation
16A.2 Switching Between Depreciation Methods
16A.3 Determination
of
MACRS Rates
Appendix Problems
550
554
555
557
562
566
Chapter 17
After
-
Ta
x
Eco
nomic Analysis
568
1
7.1
Income Tax Terminology and Relations for Corporations (and Individual
s)
570
17.2 Before-Tax and After-Tax Cash Flow 574
17.3
Effect
on
Taxes
of
Different Depreciation Methods and Recovery Periods 578
17.4 Depreciation Recapture and Capital Gains (Losses): for Corporations
581
17.5
After-Tax
PW,
AW,
and ROR Evaluation 586
17.6
Spreadsheet Applications-After-Tax Incremental ROR Analysis 592
17
.7
After-Tax Replacement Study 595
17.8 After-Tax Value-Added Analysis 599
17
.9 After-Tax Analysis for International Projects 603
Chapter Summary 605
Problems
Case
St
ud
y- After-
Tax
Evaluat
ion
of
Debt and Equity Financing
606
617
Chapter 18 Formalized Sensitivity Anal
ysis
and Expected Value Decisi
ons
620
18.1
Determining Sensitivity
to
Parameter Variation 622
18.2 Formalized Sensitivity Analysis Using Three Estimates 629
18.3
Economic Variability and the Expected
Va
l
ue
18.4 Expected Value Computations for Alternatives
18.5
Staged Evaluation
of
Alternatives Using a Decision Tree
Chapter Summary
Problems
Extended
Exercise--Looking at Alternatives from Different Angles
Case
St
udy- Sensitivity Analysis
of
Public Sector
Pr
oj
ects-
Wa
ter Supply Plans
Chapter
19
More
on
Variation and Decision Making Under
Ri
sk
19
.1 Interpretation
of
Certainty, Risk, and Uncertainty
19
.2 Elements Important
to
Decision Making Under Risk
632
633
635
640
641
649
649
6
54
656
660
Appendix
A
Appendix
B
CONTENTS
19.3 Random Samples
19.4 Expected Value and Standard Deviation
19.5 Monte Carlo Sampling and Simulation Analysis
Additional Examples
Chapter Summary
Problems
Extended
Exercise-Using
Simulation and the Excel RNG for
Sensitivity Analysis
Using Spreadsheets and Microsoft Excel©
A.1
Introduction to Using Excel
A.2 Organization (Layout)
of
the Spreadsheet
A.3 Excel Functions Important to Engineering Economy (alphabetical order)
A.4
SOLVER-An
Excel Tool for Breakeven and
''W
hat If?" Analysis
A.5 List
of
Excel Financial Functions
A.6 Error Messages
Basics
of
Accounting Reports and Business Ratios
B.l The Balance Sheet
B.2 Income Statement and Cost
of
Goods Sold Statement
B.3 Business Ratios
Problems
Reference Materials 725
Factor Tables 727
Index 757
.
xiii
666
671
677
686
691
691
696
697
697
701
703
712
713
715
716
716
718
719
723
The primary purpose
of
this text
is
to present the principles and applications
of
economic analysis
in
a clearly written fashion, supported by a large number and
wide range
of
engineering-oriented examples, end-of-chapter exercises, and
electronic-based learning options. Through all editions
of
the book, our objective
has been
to
present the material
in
the clearest, most concise fashion possible
without sacrificing coverage or true understanding on the part
of
the learner. The
sequence
of
topics and flexibility
of
chapter selection used
to
accommodate dif-
ferent course objectives are described later
in
the preface.
EDUCATION LEVEL AND USE OF TEXT
This text
is
best used
in
learning and teaching at the university level, and
as
a ref-
erence book for the basic computations
of
engineering economic analysis. It is
well suited for a one-semester or one-quarter undergraduate course in engineer-
ing economic analysis, project analysis, or engineering cost analysis. Addition-
ally, because
of
its behavioral-based structure, it is perfect for individuals who
wish
to
learn the material for the first time completely on their own, and for in-
dividuals who simply want to review. Students should be at least at the sopho-
more level, and preferably
of
junior standing, so that they can better appreciate
the engineering context
of
the problems. A background in calculus
is
not neces-
sary
to
understand the calculations, but a basic familiarization with engineering
terminology makes the material more meaningful and therefore easier and more
enjoyable
to
learn. Nevertheless, the building-block approach used in the text's
design allows a practitioner unacquainted with economics and engineering prin-
ciples
to
use the text
to
learn, understand, and correctly apply the principles and
techniques for effective decision making.
NEW TO THIS EDITION
The basic design and structure
of
previous editions have been retained for the
sixth edition. However, considerable changes have been made. The most signif-
icant changes include:
• More than 80%
of
the end-of-chapter problems are new or revised for this edition.
• Time-based materials such
as
tax rates and cost indexes have been updated.
• The international dimension
of
the book
is
more apparent.
• Many
of
the Fundamentals
of
Engineering (FE) Review Problems are new
to
this edition.
STRUCTURE OF TEXT AND OPTIONS FOR PROGRESSION
THROUGH
THE CHAPTERS
The text
is
written
in
a modular form, providing for topic integration
in
a variety
of
ways that serve different course purposes, structures, and time limitations.
xvi
PREFACE
There are a total
of
19
chapters in four levels. As indicated in the flowchart
on
the
next page, some
of
the chapters have
to
be covered
in
sequential order; however,
the modular design allows for great flexibiljty
in
the selection and sequencing
of
topics. The chapter progression graphic (which follows the flowchart) shows
some
of
the options for introducing chapters earlier than their numerical order.
For example, if the course is designed to emphasize after-tax analysis early
in
the
semester or quarter, Chapter 16 and the injtial sections
of
Chapter
17
may be in-
troduced at any point after Chapter 6 without loss
of
foundation preparation.
There are clear primary and alternate entry points for the major categories
of
in-
flation, estimation, taxes, and risk. Alternative entries are indicated by a dashed
arrow on the graphic.
The material
in
Level One emphasizes basic computational skills, so these
chapters are prerequisites for all the others in the book. The chapters in Level
Two are primarily devoted to the most common analytical techniques for com-
paring alternatives. While it is advisable
to
cover all the chapters
in
this level,
only the first two (Chapters 5 and 6) are widely used throughout the remain-
der
of
the text. The three chapters
of
Level Three show how any
of
the
techniques
in
Level Two can be used
to
evaluate presently owned
as
sets or in-
dependent alternatives,
while the chapters in Level Four emphasize the tax
consequences
of
decision making and some additional concepts
in
cost esti-
mation, activity-based costing, sensitivity analysis, and risk,
as
treated using
Monte Carlo simulation.
Organization
oj
Chapters and End-oj-Chapter Exercises Each chapter con-
tains a purpose and a series
of
progressive learning objectives, followed by the
study material. Section headings correspond
to
each learning objective; for
example, Section
5.1
contains the material pertaining
to
the first objective
of
the
chapter. Each section contains one or more illustrative examples solved
by
hand,
or
by
both hand and computer methods. Examples are separated from the textual
material and include comments about the solution and pertinent connections to
other topics in the book. The crisp end-of-chapter summaries neatly tie together
the concepts and major topics covered to reinforce the learner's understanding
prior
to
engaging
in
the end-
of
chapter exercises.
The end-of-chapter unsolved problems are grouped and labeled
in
the same
general order
as
the sections
in
the chapter. This approach provides an opportu-
nity
to
apply material on a section-by-section basis or to schedule problem solv-
ing when the chapter is completed.
Appendices A and B contain supplementary information: a basic introduction
to
the use
of
spreadsheets (Microsoft Excel) for readers unfamiliar with them
and the basics
of
accounting and business reports. Interest factor tables are lo-
cated at the end
of
the text for easy access. Finally, the inside front covers offer
a quick reference to factor notation, formulas, and cash flow diagrams, plus a
guide to the format for commonly used spreadsheet functions. A glossary
of
common terms and symbols used
in
engineering economy appears inside the
back cover.
LEVEL
ONE
LEVEL
TWO
LEVEL {
THREE
LEVEL
FOUR
PREFACE
xvii
Composition
by
level
Chapter I
Foundations
of
Engineering Economy
Chapter
2
Factors: How Time and
Interest Affect Money
Chapter
3
Combining Factors
Chapter
4
Nominal and Effective
Interest Rates
I
I
Chapter 7
Rate of Return
Analysis: Single
Chapter
5
Chapter 6
Alternative
Chapter 9
Present Worth Annual Worth
Benefit/Cost Analysis
Analysis
Analysis
Chapter 8
a
nd
Public Sector
Rate
of
Return
Economics
Analysi
s:
Multiple
Alternatives
I
I
Chapter
10
Making Choices: The
Method, MARR, and
Multiple Attributes
I
I
I
I
Chapter
11
Chapter
12
Chapter
13
Selection from
Replacement a
nd
Independent Projects
Breakeven
Retention Decisions
Under Budget Limitation
Analysis
I
I
Chapter
14
Chapter
15
Chapter
16
Chapter
18
Effects
of
Cost Estimation and Depreciation Formalized Sensitivity
Inflation Indirect Cost Allocation Methods Analysis and Expected
I
Value Decisions
Chapter
17
Chapter
19
After-Tax Economic
More on Variation
Analysis and Decision Making
Under Risk