Sixth Edition. Global Edition CONTEMPORARY ENGINEERING ECONOMICS. Chan S. Park Department of Industrial and Systems Engineering Auburn University

Transcription

1 Sixth Edition Global Edition CONTEMPORARY ENGINEERING ECONOMICS Chan S. Park Department of Industrial and Systems Engineering Auburn University PEARSON Boston Columbus Indianapolis New York San Francisco Hoboken Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Säo Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

2 CONTENTS Preface 2I PART I BASICS OF FINANCIAL DECISIONS 31 Chapter I Engineering Economic Decisions Role of Engineers in Business Types of Business Organization Engineering Economic Decisions Personal Economic Decisions Economic Decisions Versus Design Decisions What Makes the Engineering Economic Decision Difficult? Large-Scale Engineering Projects Are Tesla's Plans for a Giant Battery Factory Realistic? Impact of Engineering Projects on Financial Statements Common Types of Strategie Engineering Economic Decisions Equipment or Process Selection Equipment Replacement New Product or Product Expansion Cost Reduction Improvement in Service or Quality Fundamental Principles of Engineering Economics 42 Summary 45 Short Case Studies 45 Chapter 2 Accounting and Financial Decision Making Accounting: The Basis of Decision Making Financial Status for Businesses The Balance Sheet The Income Statement The Cash Flow Statement Using Ratios to Make Business Decisions Debt Management Analysis Liquidity Analysis Asset Management Analysis Profitability Analysis 70 9

3 10 Contents Market Value Analysis Liraitations of Financial Ratios in Business Decisions 73 Summary 76 Problems 76 Short Case Studies 83 Chapter 3 Interest Rate and Economic Equivalence Interest: The Cost of Money The Time Value of Money Elements of Transactions Involving Interest Methods of Calculating Interest Economic Equivalence Definition and Simple Calculations Equivalence Calculations: General Principles Development of Formulas for Equivalence Calculations The Five Types of Cash Flows Single-Cash-Flow Formulas Equal-Payment Series Linear-Gradient Series Geometrie Gradient Series Irregulär (Mixed) Payment Series Unconventional Equivalence Calculations Composite Cash Flows Determining an Interest Rate to Establish Economic Equivalence Unconventional Regularity in Cash Flow Pattern 149 Summary 150 Problems 151 Short Case Studies 160 Chapter 4 Understanding Money and Its Management Nominal and Effective Interest Rates Nominal Interest Rates Effective Annual Interest Rates Effective Interest Rates per Payment Period Continuous Compounding 169

4 Contents Equivalence Calculations with Effective Interest Rates When Payment Period is Equal to Compounding Period Compounding Occurs at a Different Rate than That at Which Payments are Made Compounding is Less Frequent than Payments Equivalence Calculations with Continuous Compounding Discrete-Payment Transactions with Continuous Compounding Continuous-Funds Flow with Continuous Compounding Changing Interest Rates Single Sums of Money Series of Cash Flows Debt Management Commercial Loans Loan versus Lease Financing Home Mortgage Investing in Financial Assets Investment Basics How to Determine Your Expected Return Investing in Bonds 212 Summary 220 Problems 221 Short Case Studies 230 PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS 233 Chapter 5 Present-Worth Analysis Describing Project Cash Flows Loan versus Project Cash Flows Independent versus Mutually Exclusive Investment Projects 5.2 Initial Project Screening Method Payback Period: The Time It Takes to Pay Back Benefits and Flaws of Payback Screening Discounted Payback Period Where Do We Go From Here?

5 IT" 12 Contents 5.3 Discounted Cash Flow Analysis Net-Present-Worth Criterion Meaning of Net Present Worth Basis for Selecting the MARR Variations of Present-Worth Analysis Future-Worth Analysis Capitalized Equivalent Method Comparing Mutually Exclusive Alternatives Meaning of Mutually Exclusive and "Do Nothing" Service Projects versus Revenue Projects Application of Investment Criteria Scale of Investment Analysis Period Analysis Period Matches Project Lives Analysis Period Differs from Project Lives Analysis Period is Not Specified 276 Summary 279 Problems 280 Short Case Studies 293 Chapter 6 Annual Equivalent-Worth Analysis Annual Equivalent-Worth Criterion Fundamental Decision Rule Annual-Worth Calculation with Repeating Cash Flow Cycles Comparing Mutually Exclusive Alternatives Capital Costs Versus Operating Costs Applying Annual-Worth Analysis Benefits of AE Analysis Unit Profit or Cost Calculation Make-or-Buy Decision Outsourcing Decisions Pricing the Use of an Asset Life-Cycle Cost Analysis Design Economics 320 Summary 331 Problems 331 Short Case Studies 342

6 Contents 13 Chapter 7 Rate-of-Return Analysis Rate of Return Return on Investment Return on Invested Capital 7.2 Methods for Finding the Rate of Return Simple versus Nonsimple Investments Predicting Multiple i*s Computational Methods 7.3 Internal-Rate-of-Return Criterion Relationship to PW Analysis Net-Investment Test: Pure versus Mixed Investments Decision Rule for Pure Investments Decision Rule for Mixed Investments Modified Internal Rate of Return (MIRR) 7.4 Mutually Exclusive Alternatives Flaws in Project Ranking by IRR Incremental Investment Analysis Handling Unequal Service Lives Summary Problems Short Case Studies PART 3 ANALYSIS OF PROJECT CASH FLOWS 409 Chapter 8 Cost Concepts Relevant to Decision Making General Cost Terms Manufacturing Costs Nonmanufacturing Costs Classifying Costs for Financial Statements Period Costs Product Costs Cost Classification for Predicting Cost Behavior Volume Index Cost Behaviors Cost-Volume-Profit Analysis 424

7 14 Contents 8.4 Future Costs for Business Decisions Differential Cost and Revenue Opportunity Cost Sunk Costs Marginal Cost Estimating Profit from Operation Calculation of Operating Income Annual Sales Budget for a Manufacturing Business Preparing the Annual Production Budget Preparing the Cost-of-Goods-Sold Budget Preparing the Nonmanufacturing Cost Budget Putting It All Together: The Budgeted Income Statement Looking Ahead 449 Summary 449 Problems 450 Short Case Studies 453 Chapter 9 Depreciation and Corporate Taxes Asset Depreciation Economic Depreciation Accounting Depreciation Factors Inherent in Asset Depreciation Depreciable Property Cost Basis Useful Life and Salvage Value Depreciation Methods: Book and Tax Depreciation Book Depreciation Methods Straight-Line Method Declining Balance Method Units-of-Production Method Tax Depreciation Methods MACRS Depreciation MACRS Depreciation Rules Depletion Cost Depletion Percentage Depletion Repairs or Improvements Made to Depreciable Assets Revision of Book Depreciation Revision of Tax Depreciation 485

8 Contents Corporate Taxes Income Taxes on Operating Income Tax Treatment of Gains or Losses on Depreciable Assets Disposal of a MACRS Property Calculations of Gains and Losses on MACRS Property Income Tax Rate to Be Used in Economic Analysis Incremental Income Tax Rate Consideration of State Income Taxes The Need For Cash Flow in Engineering Economic Analysis Net Income versus Net Cash Flow Treatment of Noncash Expenses 501 Summary 504 Problems 506 Short Case Studies 514 Chapter 10 Developing Project Cash Flows Cost-Benefit Estimation for Engineering Projects Simple Projects Complex Projects Incremental Cash Flows Elements of Cash Outflows Elements of Cash Inflows Classification of Cash Flow Elements Developing Cash Flow Statements When Projects Require Only Operating and Investing Activities When Projects Require Working-Capital Investments When Projects are Financed with Borrowed Funds When Projects Result in Negative Taxable Income When Projects Require Multiple Assets Generalized Cash-Flow Approach Setting up Net Cash-Flow Equations Presenting Cash Flows in Compact Tabular Formats Lease-or-Buy Decision 547 Summary 553 Problems 554 Short Case Studies 563

9 16 Contents PART 4 HANDLING RISK AND UNCERTAINTY 567 Chapter I I Inflation and Its Impact on Project Cash Flows Meaning and Measure of Inflation Measuring Inflation Actual versus Constant Dollars Equivalence Calculations Under Inflation Market and Inflation-Free Interest Rates Constant-Dollar Analysis Actual-Dollar Analysis Mixed-Dollar Analysis Effects of Inflation on Project Cash Flows Multiple Inflation Rates Effects of Borrowed Funds Under Inflation Rate-of-Return Analysis Under Inflation Effects of Inflation on Return on Investment Effects of Inflation on Working Capital 596 Summary 598 Problems 600 Short Case Studies 605 Chapter 12 Project Risk and Uncertainty Origins of Project Risk Methods of Describing Project Risk Sensitivity (What-if) Analysis Break-Even Analysis Scenario Analysis Probability Concepts for Investment Decisions Assessment of Probabilities Summary of Probabilistic Information Joint and Conditional Probabilities Covariance and Coefficient of Correlation Probability Distribution of NPW Procedure for Developing an NPW Distribution Aggregating Risk over Time Decision Rules for Comparing Mutually Exclusive Risky Alternatives 645

10 Contents Risk Simulation Computer Simulation Model Building Monte Carlo Sampling Simulation Output Analysis Risk Simulation with Oracle Crystal Ball Decision Trees and Sequential Investment Decisions Structuring a Decision-Tree Diagram Worth of Obtaining Additional Information Decision Making after Having Imperfect Information 673 Summary 678 Problems 679 Short Case Studies 689 Chapter 13 Real-Options Analysis Risk Management: Financial Options Features of Financial Options Buy Call Options When You Expect the Price to Go Up Buy Put Options When You Expect the Price to Go Down Option Strategies Buying Calls to Reduce Capital That is at Risk Protective Puts as a Hedge Option Pricing Replicating-Portfolio Approach with a Call Option Risk-Free Financing Approach Risk-Neutral Probability Approach Put-Option Valuation Two-Period Binomial Lattice Option Valuation Multiperiod Binomial Lattice Model Black-Scholes Option Model Real-Options Analysis How is Real Options Analysis Different? A Conceptual Framework for Real Options in Engineering Economics Simple Real-Option Models Option to Defer Investment Patent and License Valuation Growth Option Option to Expand 728

11 18 Contents Scale-Up Option Compound Options Estimating Volatility at the Project Level Mathematical Relationship between er and <r T Estimating V T Distribution 740 Summary 746 Problems 747 Short Case Studies 751 PART 5 SPECIAL TOPICS IN ENGINEERING ECONOMICS 755 Chapter 14 Replacement Decisions Replacement Analysis Fundamentals Basic Concepts and Terminology Opportunity Cost Approach to Comparing Defender and Challenger Economic Service Life Replacement Analysis when the Required Service is Long Required Assumptions and Decision Frameworks Replacement Strategies under the Infinite Flanning Horizon Replacement Strategies under the Finite Flanning Horizon Consideration of Technological Change Replacement Analysis with Tax Considerations 780 Summary 794 Problems 795 Short Case Studies 805 Chapter 15 Capital-Budgeting Decisions Methods of Financing Equity Financing Debt Financing Capital Structure Cost of Capital Cost of Equity Cost of Debt Calculating the Cost of Capital 827

12 Contents Choice of Minimum Attractive Rate of Return Choice of MARR when Project Financing is Known Choice of MARR when Project Financing is Unknown Choice of MARR under Capital Rationing Capital Budgeting Evaluation of Multiple Investment Alternatives Formulation of Mutually Exclusive Alternatives Capital-Budgeting Decisions with Limited Budgets 839 Summary 847 Problems 848 Short Case Studies 852 Chapter 16 Economic Analysis in the Service Sector What Is The Service Sector? Characteristics of the Service Sector Difficulty of Pricing Service Economic Analysis in The Public Sector What is Benefit-Cost Analysis? Framework of Benefit-Cost Analysis Valuation of Benefits and Costs Quantifying Benefits and Costs Difficulties Inherent in Public Project Analysis Benefit-Cost Ratios Definition of Benefit-Cost Ratio Profitability Index (Net BJC Ratio) Relationship Among B/C Ratio, Profitability Index, and NPW Comparing Mutually Exclusive Alternatives: Incremental Analysis Analysis of Public Projects Based on Cost-Effectiveness Cost-Effectiveness Studies in the Public Sector A Cost-Effectiveness Case Study Economic Analysis in Health-Care Service Economic Evaluation Tools Cost-Effectiveness Analysis in the Healthcare Sector Cost-Utility Analysis 896 Summary 899 Problems 900 Short Case Studies 904

13 Contents Appendix A Fundamentals of Engineering Review Questions Appendix B Interest Factors for Discrete Compound Appendix C Values of the Standard Normal Distribution Function Index