Eighth Edition ENGINEERING ECONOMY Leland Blank, P. E. Texas A & M University American University of Sharjah, United Arab Emirates Anthony Tarquin, P. E. University of Texas at El Paso Mc Graw Hill Education
CONTENTS Preface to Eighth Edition xiv THE FUNDAMENTALS Chapter 1 Foundations of Engineering Economy 2 1.1 Why Engineering Economy and the Time Value of Money are Important 3 1.2 Performing an Engineering Economy Study 5 1.3 Professional Ethics and Economic Decisions 7 1.4 Interest Rate and Rate of Return 10 1.5 Terminology and Symbols 14 1.6 Cash Flows: Estimation and Diagramming 15 1.7 Economic Equivalence 19 1.8 Simple and Compound Interest 22 1.9 Minimum Attractive Rate of Return 26 1.10 Introduction to Spreadsheet Use 27 31 31 Exercises for Spreadsheets 35 Additional and FE Exam Review Questions 36 Case Study Cost of Electricity with Renewable Sources Added 37 Chapter 2 Factors: How Time and Interest Affect Money 38 0 Progressive Example The Steel Plant Case 39 2.1 Single-Amount Factors (F/P and P/F) 39 2.2 Uniform Series Present Worth Factor and Capital Recovery Factor (P/A and A/P) 43 2.3 Sinking Fund Factor and Uniform Series Compound Amount Factor (A/F and F/A) 46 2.4 Factor Values for Untabulated i or n Values 48 2.5 Arithmetic Gradient Factors (P/G and A/G) 50 2.6 Geometrie Gradient Series Factors 58 2.7 Determining i or n for Known Cash Flow Values 61 64 64 Exercises for Spreadsheets 68 Additional and FE Exam Review Questions 69 Case Study The Amazing Impact of Compound Interest 71 Chapter 3 Combining Factors and Spreadsheet Functions 72 3.1 Calculations for Uniform Series That Are Shifted 73 3.2 Calculations Involving Uniform Series and Randomly Placed Single Amounts 76 3.3 Calculations for Shifted Gradients 80 86 86 Exercises for Spreadsheets 92 Additional and FE Exam Review Questions 93 Case Study Preserving Land for Public Use 94 Chapter 4 Nominal and Effective Interest Rates 96 (ß Progressive Example The Credit Card Offer Case 97 4.1 Nominal and Effective Interest Rate Statements 98
ix 4.2 Effective Annual Interest Rates 101 4.3 Effective Interest Rates for Any Time Period 107 4.4 Equivalence Relations: Payment Period and Compounding Period 108 4.5 Equivalence Relations: Single Amounts with PP > CP 109 4.6 Equivalence Relations: Series with PP > CP 111 4.7 Equivalence Relations: Single Amounts and Series with PP < CP 115 4.8 Effective Interest Rate for Continuous Compounding 116 4.9 Interest Rates That Vary Over Time 118 120 120 Exercises for Spreadsheets 125 Additional and FE Exam Review Questions 125 Case Study Is Owning a Home a Net Gain or Net Loss Over Time? 127 LEARN1NG STAGE 2 BASIC ANALYSIS TOOLS Chapter 5 Present Worth Analysis (ß Progressive Example Water for Semiconductor Manufacturing Case 5.1 Formulating Alternatives 5.2 Present Worth Analysis of Equal-Life Alternatives 5.3 Present Worth Analysis of DifFerent-Life Alternatives 5.4 Future Worth Analysis 5.5 Capitalized Cost Analysis Exercises for Spreadsheets Additional and FE Exam Review Questions Case Study Comparing Social Security Benefits 130 131 131 133 135 139 140 144 144 149 150 152 Chapter 6 Annual Worth Analysis 6.1 Advantages and Uses of Annual Worth Analysis 6.2 Calculation of Capital Recovery and AW Values 6.3 Evaluating Alternatives by Annual Worth Analysis 6.4 AW of a Permanent Investment 6.5 Life-Cycle Cost Analysis Exercises for Spreadsheets Additional and FE Exam Review Questions Case Study Annual Worth Analysis Then and Now 154 155 157 159 161 164 168 168 173 175 176 Chapter 7 Rate of Return Analysis: One Project 7.1 Interpretation of a Rate of Return Value 7.2 Rate of Return Calculation Using a PW or AW Relation 7.3 Special Considerations When Using the ROR Method 7.4 Multiple Rate of Return Values 7.5 Techniques to Remove Multiple Rates of Return 7.6 Rate of Return of a Bond Investment 178 179 181 185 186 191 197 200 200
Exercises for Spreadsheets 205 Additional and FE Exam Review Questions 207 Case Study Developing and Selling an Innovative Idea 209 Chapter 8 Rate of Return Analysis: Multiple Alternatives 210 8.1 Why Incremental Analysis Is Necessary 211 8.2 Calculation of Incremental Cash Flows for ROR Analysis 211 8.3 Interpretation of Rate of Return on the Extra Investment 214 8.4 Rate of Return Evaluation Using PW: Incremental and Breakeven (Two Alternatives) 215 8.5 Rate of Return Evaluation Using AW 221 8.6 Incremental ROR Analysis of Multiple (More than Two) Alternatives 222 8.7 All-in-One Spreadsheet Analysis 226 228 228 Exercises for Spreadsheets 233 Additional and FE Exam Review Questions 234 Case Study Peforming ROR Analysis for 3D Printer and IIoT Technology 235 Case Study How a New Engineering Graduate Can Help His Father 236 Chapter 9 Benefit/Cost Analysis and Public Sector Economics (ß Progressive Example Water Treatment Facility #3 Case 9.1 Public Sector Projects 9.2 Benefit/Cost Analysis of a Single Project 9.3 Incremental B/C Analysis (Two Alternatives) 9.4 Incremental B/C Analysis of Multiple (More than Two) Alternatives 9.5 Service Sector Projects and Cost-Effectiveness Analysis 9.6 Ethical Considerations in the Public Sector Exercises for Spreadsheets Additional and FE Exam Review Questions Case Study Highway Lighting Options to Reduce Traffic Accidents 238 239 240 245 248 252 256 260 261 262 269 270 272 LEARNING STAGE 2 EPILOGUE: SELECTING THE BASIC ANALYSIS TOOL LEARNING STAGE 3 MARING BETTER DECISIONS Chapter 10 Project Financing and Noneconomic Attributes 278 10.1 MARR Relation to the Cost of Capital 279 10.2 Debt-Equity Mix and Weighted Average Cost of Capital 281 10.3 Determination of the Cost of Debt Capital 283 10.4 Determination of the Cost of Equity Capital and the MARR 285 10.5 Effect of Debt-Equity Mix on Investment Risk 287 10.6 Multiple Attribute Analysis: An Introduction 290 10.7 Evaluation Measure for Multiple Attributes 294 295 296 Exercises for Spreadsheets 301 Additional and FE Exam Review Questions 302 Case Study Expanding a Business Debt vs. Equity Financing? 303
xi Chapter 11 Replacement and Retention Decisions 304 Progressive Example Keep or Replace the Kiln Case 305 11.1 Basics of a Replacement Study 306 11.2 Economic Service Life 308 11.3 Performing a Replacement Study 314 11.4 Additional Considerations in a Replacement Study 318 11.5 Replacement Study over a Specified Study Period 319 11.6 Replacement Value 324 324 325 Exercises for Spreadsheets 331 Additional and FE Exam Review Questions 331 Case Study A Pumper System with an ESL Problem 333 Chapter 12 Independent Projects with Budget Limitation 334 12.1 An Overview of Capital Rationing among Projects 335 12.2 Capital Rationing Using PW Analysis of Equal-Life Projects 337 12.3 Capital Rationing Using PW Analysis of Unequal-Life Projects 339 12.4 Capital Budgeting Problem Formulation Using Linear Programming 341 12.5 Additional Project Ranking Measures 344 346 346 Additional and FE Exam Review Questions 351 Chapter 13 Breakeven and Payback Analysis 354 13.1 Breakeven Analysis for a Single Project 355 13.2 Breakeven Analysis Between Two Alternatives 359 13.3 Payback Analysis 362 13.4 More Breakeven and Payback Analysis on Spreadsheets 366 369 369 Exercises for Spreadsheets 374 Additional and FE Exam Review Questions 375 Case Study Water Treatment Plant Process Costs 376 LEARNfNG STAGE 4 Chapter 14 ROUNDING OUT THE STUDY 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 Additional and FE Exam Review Questions Case Study Inflation Considerations for Stock and Bond Investments 380 381 383 388 391 392 392 398 399 Chapter 15 Cost Estimation and Indirect Cost Allocation 15.1 Understanding How Cost Estimation Is Accomplished 15.2 Unit Method 15.3 Cost Indexes 400 401 404 405
xii Contents 15.4 Cost-Estimating Relationships: Cost-Capacity Equations 408 15.5 Cost-Estimating Relationships: Factor Method 409 15.6 Indirect Cost Rates and Allocation: The Traditional Method 411 15.7 Activity-Based Costing (ABC) for Indirect Costs 415 15.8 Making Estimates and Maintaining Ethical Practices 417 418 418 Additional and FE Exam Review Questions 424 Case Study Indirect Cost Analysis of Medical Equipment Manufacturing Costs 425 Case Study Deceptive Acts Can Get You in Trouble 427 Chapter 16 Depreciation Methods 428 16.1 Depreciation Terminology 429 16.2 Straight Line (SL) Depreciation 432 16.3 Declining Balance (DB) and Double Declining Balance (DDB) Depreciation 433 16.4 Modified Accelerated Cost Recovery System (MACRS) 436 16.5 Determining the MACRS Recovery Period 440 16.6 Depletion Methods 441 443 Appendix 444 16A.1 Sum-of-Years-Digits (SYD) and Unit-of-Production (UOP) Depreciation 444 16A.2 Switching between Depreciation Methods 446 16A.3 Determination of MACRS Rates 449 452 Additional and FE Exam Review Questions 455 Appendix 456 Chapter 17 After-Tax Economic Analysis 458 17.1 Income Tax Terminology and Basic Relations 459 17.2 Calculation of Cash Flow after Taxes 462 17.3 Effect on Taxes of Different Depreciation Methods and Recovery Periods 464 17.4 Depreciation Recapture and Capital Gains (Losses) 467 17.5 After-Tax Economic Evaluation 470 17.6 After-Tax Replacement Study 476 17.7 After-Tax Value-Added Analysis 479 17.8 After-Tax Analysis for International Projects 482 17.9 Value-Added Tax 484 486 487 Additional and FE Exam Review Questions 496 Case Study After-Tax Analysis for Business Expansion 497 Chapter 18 Sensitivity Analysis and Staged Decisions 498 18.1 Determining Sensitivity to Parameter Variation 499 18.2 Sensitivity Analysis Using Three Estimates 504 18.3 Estimate Variability and the Expected Value 505 18.4 Expected Value Computations for Alternatives 506 18.5 Staged Evaluation of Alternatives Using a Decision Tree 508 18.6 Real Options in Engineering Economics 512 517 517 Additional and FE Exam Review Questions 524 Case Study Sensitivity to the Economic Environment 525 Case Study Sensitivity Analysis of Public Sector Projects Water Supply Plans 525
xiii Chapter 19 More on Variation and Decision Making under Risk 528 19.1 Interpretation of Certainty, Risk, and Uncertainty 529 19.2 Elements Important to Decision Making under Risk 532 19.3 Random Samples 537 19.4 Sample Estimates: Mean and Standard Deviation 540 19.5 Monte Carlo Sampling and Simulation Analysis 547 554 554 Additional and FE Exam Review Questions 558 Case Study Using Simulation and Three-Estimate Sensit!vity Analysis 559 Appendix A Using Spreadsheets and Microsoft Excel 561 A.l Introduction to Using Excel 561 A.2 Organization (Layout) of the Spreadsheet 563 A.3 Spreadsheet Functions Important to Engineering Economy (Alphabetical Order) 564 A.4 Goal Seek A Tool for Breakeven and Sensitivity Analysis 572 A.5 Solver An Optimizing Tool for Capital Budgeting, Breakeven, and Sensitivity Analysis 573 A.6 Error Messages 574 Appendix B Basics of Accounting Reports and Business Ratios 575 B.l The Balance Sheet 575 B.2 Income Statement and Cost of Goods Sold Statement 576 B.3 Business Ratios 577 Appendix C Code of Ethics for Engineers 580 Appendix D Alternate Methods for Equivalence Calculations 583 D.l Using Programmable Calculators 583 D.2 Using the Summation of a Geometrie Series 584 Appendix E Glossary of Concepts and Terms 587 E.l Important Concepts and Guidelines 587 E.2 Symbols and Terms 590 Reference Materials Factor Tables Index 624