Engineering-Economics PDF

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Summary

List of Symbols (A/F,i,N ) sinking fund factor BVsl (n) book value at end of period n using straight-line (A/G,i,N ) arithmetic gradient method to annuity conversion factor C present worth of costs (A/P,i,N ) capital recovery factor CCA capital cost allowance (F/A,i,N ) uniform series compound CSF ...

Description

List of Symbols (A/F,i,N )

sinking fund factor

BVsl (n)

(A/G,i,N )

arithmetic gradient to annuity conversion factor

book value at end of period n using straight-line method

C

present worth of costs

(A/P,i,N )

capital recovery factor

CCA

capital cost allowance

(F/A,i,N )

uniform series compound amount factor

CSF

capital salvage factor

CTF

capital tax factor

(F/P,i,N )

compound amount factor

d

(P/A,g,i,N )

geometric gradient to present worth conversion factor

depreciation rate for declining-balance method

Ddb(n)

depreciation amount for period n using decliningbalance method

Dsl (n)

depreciation amount for period n using straight-line method

EAC

equivalent annual cost

ERR

external rate of return

E(X )

expected value of the random variable, X

base annuity for arithmetic gradient to annuity conversion factor

F

future value, future worth

f

inflation rate per year

AW

annual worth

FW

future worth

B

present worth of benefits

g

growth rate for geometric gradient

BCR

benefit–cost ratio

i

current interest rate

BCRM

modified benefit–cost ratio

I

interest amount

BVdb(n)

book value at end of period n using declining-balance method

iⴕ

real interest rate

Ic

compound interest amount

(P/A,i,N )

series present worth factor

(P/F,i,N )

present worth factor

A

annuity amount, equivalent annual cost

AC

current dollars in year N

A tot

total annuity for arithmetic gradient to annuity conversion factor

A⬘

ie

effective interest rate

is

interest rate per subperiod

Is

simple interest amount

i°

growth adjusted interest rate

IRR

internal rate of return

IRRC

current dollar IRR

IRRR

real dollar IRR

i*

internal rate of return

i*e

external rate of return

i*ea

approximate external rate of return

I0,N

N

number of periods, useful life of an asset

P

present value, present worth, purchase price, principal amount

PW

present worth

p(x)

probability distribution

Pr{X = xi}

alternative expression of probability distribution

r

nominal interest rate, rating for a decision matrix

R0,N

real dollar equivalent to AN relative to year 0, the base year

the value of a global price index at year N, relative to year 0

S

salvage value

t

tax rate

m

number of subperiods in a period

UCC

undepreciated capital cost

MARR

minimum acceptable rate of return

X

random variable

π01

Laspeyres price index

MARRC

current dollar MARR

MARRR

real dollar MARR

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Vice-President, Editorial Director: Gary Bennett Executive Acquisitions Editor: Cathleen Sullivan Senior Marketing Manager: Kim Ukrainec Supervising Developmental Editor: Suzanne Schaan Developmental Editor: Eleanor MacKay Project Manager: Ioana Gagea Manufacturing Manager: Susan Johnson Production Editor: Ridhi Mathur Copy Editor: Sally Glover Proofreader: Susan Bindernagel Technical Review: Claude Théoret Coldread: Karen Alliston Index: Belle Wong Compositor: Cenveo Publisher Services Photo and Permissions Researcher: Joanne Tang Art Director: Julia Hall Cover and Interior Designer: Anthony Leung Cover Image: Rudy Sulgan/Corbis The image on the cover features the newest edition to Vancouver’s transportation network: The Canada Line Rapid Transit. In 2011, Engineers Canada awarded the Canada Line Rapid Transit project the National Award for an Engineering Project. Credits and acknowledgments for material borrowed from other sources and reproduced, with permission, in this textbook appear on page 515. If you purchased this book outside the United States or Canada, you should be aware that it has been imported without the approval of the publisher or the author.

Copyright © 2013, 2009, 2006, 2000, 1997 Pearson Canada Inc. All rights reserved. Manufactured in the United States of America. This publication is protected by copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. To obtain permission(s) to use material from this work, please submit a written request to Pearson Canada Inc., Permissions Department, 26 Prince Andrew Place, Don Mills, Ontario, M3C 2T8, or fax your request to 416-447-3126, or submit a request to Permissions Requests at www.pearsoncanada.ca. 10 9 8 7 6 5 4 3 2 1 [EB] Library and Archives Canada Cataloguing in Publication Engineering economics : financial decision making for engineers / Niall M. Fraser, Elizabeth M. Jewkes.—5th ed. First-3rd eds. publ. under title: Engineering economics in Canada. 4th ed. publ. under title: Global engineering economics. Includes bibliographical reference and index. ISBN 978-0-13-237925-0 1. Engineering economy. I. Fraser, Niall M. (Niall Morris), 1952– II. Jewkes, Elizabeth M. (Elizabeth Marie), 1958TA177.4.F725 2012

658.15

C2011-906926-1

ISBN 978-0-13-237925-0

Brief Contents Preface

xiii

CHAPTER 1 CHAPTER 2 CHAPTER 3 Appendix 3A CHAPTER 4 Appendix 4A CHAPTER 5 CHAPTER 6 Appendix 6A CHAPTER 7 CHAPTER 8 Appendix 8A CHAPTER 9 Appendix 9A CHAPTER 10 CHAPTER 11 CHAPTER 12 Appendix 12A CHAPTER 13

Engineering Decision Making 1 Time Value of Money 18 Cash Flow Analysis 45 Derivation of Discrete Compound Interest Factors 81 Comparison Methods Part 1 85 The MARR and the Cost of Capital 122 Comparison Methods Part 2 125 Depreciation and Financial Accounting 163 Cost Estimation 207 Replacement Decisions 215 Taxes 263 Deriving the Capital Tax Factor 301 Inflation 304 Computing a Price Index 338 Public Sector Decision Making 342 Project Management 387 Dealing With Uncertainty and Risk 424 Decision Matrices 471 Qualitative Considerations and Multiple Criteria COMPANION WEBSITE

APPENDIX A

Compound Interest Factors for Discrete Compounding, Discrete Cash Flows 477 Answers to Selected Problems 501

APPENDIX B Glossary 507 Photo Credits 515

Index 517

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Contents Preface

xiii

CHAPTER 1

Engineering Decision Making

Engineering Economics in Action, Part 1A: Naomi Arrives

1.1 1.2 1.3

2

Engineering Decision Making 2 What Is Engineering Economics? 3 Making Decisions 4

Engineering Economics in Action, Part 1B: Naomi Settles In

1.4 1.5

Dealing With Abstractions 6 The Moral Question: Three True Stories Uncertainty and Sensitivity Analysis How This Book Is Organized 12

5

9

NET VALUE 1.1: PROFESSIONAL ENGINEERING ASSOCIATIONS

1.6 1.7

1

11

11

Engineering Economics in Action, Part 1C: A Taste of What Is to Come

Problems 14 Mini-Case 1.1: R. v. Syncrude Canada Ltd.

CHAPTER 2

Time Value of Money

16

18

Engineering Economics in Action, Part 2A: A Steal For Steel

2.1 2.2

Introduction 19 Interest and Interest Rates

NET VALUE 2.1: PRIME INTEREST RATES

2.3 2.4 2.5 2.6 2.7

13

19

19 20

Compound and Simple Interest 22 Effective and Nominal Interest Rates Continuous Compounding 28 Cash Flow Diagrams 29 Equivalence 32

25

2.7.1 2.7.2 2.7.3

Mathematical Equivalence 32 Decisional Equivalence 32 Market Equivalence 33 Review Problems 34 Summary 38 Engineering Economics in Action, Part 2B: You Just Have to Know When

Problems 39 Mini-Case 2.1: Student Credit Cards

44

38

viii

CONTENTS

CHAPTER 3

Cash Flow Analysis

45

Engineering Economics in Action, Part 3A: Apples and Oranges

3.1 3.2 3.3 3.4 3.5 3.6 3.7

46

Introduction 46 Timing of Cash Flows and Modelling 46 Compound Interest Factors for Discrete Compounding 47 Compound Interest Factors for Single Disbursements or Receipts Compound Interest Factors for Annuities 51 Conversion Factor for Arithmetic Gradient Series 58 Conversion Factor for Geometric Gradient Series 61

NET VALUE 3.1: ESTIMATING GROWTH RATES

48

62

3.8 Non-Standard Annuities and Gradients 65 3.9 Present Worth Computations When N →  67 Review Problems 68 Summary 71 Engineering Economics in Action, Part 3B: No Free Lunch

Problems 73 Mini-Case 3.1: The Canadian Oil Sands

Appendix 3A

CHAPTER 4

79

Derivation of Discrete Compound Interest Factors 81

Comparison Methods Part 1

Engineering Economics in Action, Part 4A: What’s Best?

4.1 4.2 4.3 4.4

72

85

86

Introduction 86 Relations Among Projects 88 Minimum Acceptable Rate of Return (MARR) 90 Present Worth (PW) and Annual Worth (AW) Comparisons

91 Present Worth Comparisons for Independent Projects 91 Present Worth Comparisons for Mutually Exclusive Projects 94 Annual Worth Comparisons 94

4.4.1 4.4.2 4.4.3

NET VALUE 4.1: CAR PAYMENT CALCULATORS

95

4.4.4

Comparison of Alternatives With Unequal Lives 4.5 Payback Period 101 Review Problems 105 Summary 109 Engineering Economics in Action, Part 4B: Doing It Right

Problems 110 Mini-Case 4.1: Rockwell International

Appendix 4A

CHAPTER 5

109

121

The MARR and the Cost of Capital 122

Comparison Methods Part 2

125

Engineering Economics in Action, Part 5A: What’s Best? Revisited

5.1 5.2 5.3

Introduction 126 The Internal Rate of Return 126 Internal Rate of Return Comparisons

129

126

97

CONTENTS

5.3.1 5.3.2 5.3.3

IRR for Independent Projects 129 IRR for Mutually Exclusive Projects 132 Multiple IRRs 136

NET VALUE 5.1: ADDITIONAL PROJECT COMPARISON RESOURCES

5.3.4 5.3.5

5.4

External Rate of Return Methods When to Use the ERR 142

139

140

Rate of Return and Present/Annual Worth Methods Compared

143 Equivalence of Rate of Return and Present/Annual Worth Methods Why Choose One Method Over the Other? 147 Review Problems 149 Summary 152 5.4.1 5.4.2

Engineering Economics in Action, Part 5B: The Invisible Hand

Problems 154 Mini-Case 5.1: The Galore Creek Project

CHAPTER 6

161

Depreciation and Financial Accounting

Engineering Economics in Action, Part 6A: The Pit Bull

6.1 6.2

153

164

Introduction 164 Depreciation and Depreciation Accounting

165

6.2.1 6.2.2 6.2.3 6.2.4

6.3

Reasons for Depreciation 165 Value of an Asset 165 Straight-Line Depreciation 166 Declining-Balance Depreciation 168 Elements of Financial Accounting 172 6.3.1 Measuring the Performance of a Firm 173 6.3.2 The Balance Sheet 173 6.3.3 The Income Statement 178 6.3.4 Estimated Values in Financial Statements 180 6.3.5 Financial Ratio Analysis 180

NET VALUE 6.1: SECURITIES REGULATORS

6.3.6

Financial Ratios 188

181

181

Review Problems Summary 192

Engineering Economics in Action, Part 6B: Usually the Truth

Problems 193 Mini-Case 6.1: Research In Motion

Appendix 6A

CHAPTER 7

193

205

Cost Estimation 207 Problems 212

Replacement Decisions

215

Engineering Economics in Action, Part 7A: You Need the Facts

7.1 7.2 7.3 7.4

Introduction 216 A Replacement Example 217 Reasons for Replacement or Retirement Capital Costs and Other Costs 221

220

216

163

143

ix

x

CONTENTS

NET VALUE 7.1: ESTIMATING SALVAGE VALUES AND SCRAP VALUES

7.5 7.6

222

Defender and Challenger Are Identical 222 Challenger Is Different From Defender; Challenger Repeats Indefinitely

227 Converting From Subcontracted to In-House Production 229 The Irrelevance of Sunk Costs 230 When Capital or Operating Costs Are Non-Monotonic 231 7.7 Challenger Is Different From Defender; Challenger Does Not Repeat 234 Review Problems 235 Summary 240 7.6.1 7.6.2 7.6.3

Engineering Economics in Action, Part 7B: Decision Time

Problems 242 Mini-Case 7.1: Lighting the Way

CHAPTER 8

Taxes

241

261

263

Engineering Economics in Action, Part 8A: It’s in the Details

8.1 8.2 8.3 8.4 8.5

264

Introduction 264 Personal Income Taxes and Corporate Income Taxes Compared Corporate Tax Rates 265 Before- and After-Tax MARR 268 The Effect of Taxation on Cash Flows 269

265

8.5.1 8.5.2 8.5.3

8.6 8.7

8.8

The Effect of Taxes on First Cost 269 The Effect of Taxes on Savings 271 The Effect of Taxes on Salvage or Scrap Value 272 Present Worth and Annual Worth Tax Calculations 273 IRR Tax Calculations 274 8.7.1 Accurate IRR Tax Calculations 274 8.7.2 Approximate After-Tax Rate-of-Return Calculations 275 Specific Tax Rules in Canada 276 8.8.1 The Capital Cost Allowance System 276

NET VALUE 8.1: CANADA REVENUE AGENCY WEBSITE

276

8.8.2 8.8.3 8.8.4

Undepreciated Capital Cost and the Half-Year Rule 280 The Capital Tax Factor and Capital Salvage Factor 283 Components of a Complete Tax Calculation 285 Review Problems 288 Summary 293 Engineering Economics in Action, Part 8B: The Work Report 294

Problems 294 Mini-Case 8.1: Flat Taxes

Appendix 8A

CHAPTER 9

300

Deriving the Capital Tax Factor 301

Inflation

304

Engineering Economics in Action, Part 9A: The Inflated Expert 305

9.1 9.2

Introduction 305 Measuring the Inflation Rate

NET VALUE 9.1: STATISTICS CANADA

9.3

306

306

Economic Evaluation With Inflation 9.3.1

308 Converting Between Real and Current Dollars

308

CONTENTS

9.4

The Effect of Correctly Anticipated Inflation

311 9.4.1 The Effect of Inflation on the MARR 312 9.4.2 The Effect of Inflation on the IRR 314 9.5 Project Evaluation Methods With Inflation 316 Review Problems 322 Summary 325 Engineering Economics in Action, Part 9B: Exploting Volatility

326

Problems 326 Mini-Case 9.1: Economic Comparison of High Pressure and Conventional Pipelines: Associated Engineering 337

Appendix 9A

Computing a Price Index 338

CHAPTER 10 Public Sector Decision Making

342

Engineering Economics in Action, Part 10A: New Challenges Down Under

343

10.1 Introduction 343 10.2 Market Failure 346 10.2.1 Market Failure Defined 346 10.2.2 Remedies for Market Failure 348 10.3 Decision Making in the Public Sector 349 10.3.1 The Point of View Used for Project Evaluation NET VALUE 10.1: CANADIAN BENEFIT–COST ANALYSIS GUIDES

350

352

10.3.2 10.3.3 10.3.4 10.3.5

Identifying and Measuring the Costs of Public Projects 352 Identifying and Measuring the Benefits of Public Projects 353 Benefit–Cost Ratios 356 The MARR in the Public Sector 362 Review Problems 363 Summary 368 Engineering Economics in Action, Part 10B: Look at It Broadly

Problems 369 Mini-Case 10.1: Emissions Trading

369

384

CHAPTER 11 Project Management

387

Engineering Economics in Action, Part 11A: Filling a Vacuum

11.1 Introduction 388 11.2 Project Management Lifecycle

388

389 Initiation 390 Planning 390 Execution 391 Monitoring and Controlling 391 Closure 392 11.3 Project Management Tools 392 11.3.1 Work Breakdown Structure 392 11.3.2 Gantt Charts 394 11.3.3 The Critical Path Method 396 11.3.3.1 Project Scheduling and the Critical Path Method 400 11.3.3.2 Project Crashing and Time–Cost Tradeoffs 403 11.2.1 11.2.2 11.2.3 11.2.4 11.2.5

xi

xii

CONTENTS

Review Problems Summary 412

408

Engineering Economics in Action, Part 11B: A Crash Course

Problems 413 Mini-Case 11.1: No Longer LEEDing

412

422

CHAPTER 12 Dealing With Uncertainty and Risk Engineering Economics in Action, Part 12A: Trees from Another Planet

424 425

12.1 Introduction 425 12.2 Sensitivity Graphs 426 12.3 Break-Even Analysis 429 12.3.1 Break-Even Analysis for a Single Project 430 12.3.2 Break-Even Analysis for Multiple Projects 432 12.4 Basic Concepts of Probability 436 12.5 Structuring Decisions With Decision Trees 442 NET VALUE 12.1: DECISION TREE SOFTWARE

Review Problems Summary 454

446

448

Engineering Economics in Action, Part 12B: Chances Are Good

Problems 455 Mini-Case 12.1: China Steel Australia Limited

454

469

Appendix 12A Decision Matrices 471 Problems 474 Engineering Economics in Action, Part 12C: Moving On

476

CHAPTER 13 Qualitative Considerations and Multiple Criteria

COMPANION WEBSITE

Engineering Economics in Action, Part 13A: Don’t Box Them In

13.1 13.2 13.3 13.4

Introduction Efficiency Decision Matrixes The Analytical Hierarchy Process

NET VALUE 13.1: AHP SOFTWARE

13.5 The Consistency Ratio for AHP Review Problems Summary Engineering Economics in Action, Part 13B: Moving On

Problems Mini-Case 13.1: Northwind Stoneware

Appendix A Appendix B

Compound Interest Factors for Discrete Compounding, Discrete Cash Flows Answers to Selected Problems 501

Glossary 507 Photo Credits 515

Index 517

477

Preface Cou...