Advanced Engineering Economics

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ISBN: 9780471799894 | 0471799890
Cover: Paperback
Copyright: 1/16/1991

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Describes important and useful project evaluation and selection concepts and techniques that have developed over the past twenty years. These concepts and techniques--essential in making individual, corporate and public investment decisions--are presented in an integrated framework based upon traditional engineering economics principles. Four main sections--Basic Concepts and Techniques in Economics Analysis, Deterministic Analysis, Stochastic Analysis, Special Topics--cover a wide variety of subjects, including: accounting income, interest, inflation, the use of tranforms in cash-flow modeling, depreciation and corporate taxation, investment worth, utility theory, decision tree analysis and much more. A number of analysis techniques for public investments are described and decision rules for selecting among multiple alternatives are given. Features numerous case studies, illustrative examples, tables and end-of-chapter questions.

PART ONE BASIC CONCEPTS AND TECHNIQUES IN ECONOMIC ANALYSIS

Accounting Income and Cash Flow

(35)

What Is Investment?

(1)

The Corporate Investment Framework

(4)

The Objective of the Firm

(1)

The Functions of the Firm

(1)

The Analysis Framework

(1)

Accounting Information

(1)

The Balance Sheets

(6)

Reporting Format

(3)

Cash versus Other Assets

(1)

Liabilities versus Stockholders' Equity

(1)

Inventory Valuation

(1)

Depreciation

(1)

Working Capital

(1)

The Income Statement

(5)

Methods of Reporting Income

(1)

Reporting Format

(2)

Measurement of Revenue

(1)

Measurement of Expenses

(1)

Retained Earnings, Cash Dividends, and Earnings per Share

(1)

The Funds Flow Statement

(6)

The Cash Flow Cycle

(1)

Basic Relationship

(1)

Funds Statement on a Cash Basis

(2)

Funds Statement as Working Capital

(2)

Tax Accounting and Business Accounting

(4)

Deferred Income Taxes

(1)

Computing Deferred Income Taxes

(2)

Estimating Cash Flows from Income Statement

(1)

Use of Cash Flows in Evaluating Investments

(1)

Investment Project and Its Cash Flows

(4)

The Cash Flow Statement

(3)

Cash Flows over the Project Life

(1)

Summary

(5)

Problems

(5)

Interest and Equivalence

(51)

Introduction

(1)

Cash Flow Profile

(1)

Time Preference and Interest

(6)

Time Preference

(1)

Types of Interest

(2)

Nominal and Effective Interest Rates

(4)

Discrete Compounding

(14)

Comparable Payment and Compounding Periods

(12)

Noncomparable Payment and Compounding Periods

(2)

Continuous Compounding

(6)

Discrete Payments

(2)

Continuous Cash Flows

(4)

Equivalence of Cash Flows

(5)

Concept of Equivalence

(2)

Equivalence Calculations with Several Interest Factors

(3)

Effect of Inflation on Cash Flow Equivalence

(13)

Measure of Inflation

(2)

Explicit and Implicit Treatments of Inflation in Discounting

(6)

Home Ownership Analysis during Inflation

(5)

Summary

(6)

Problems

(6)

Transform Techniques in Cash Flow Modeling

(40)

Introduction

(1)

Z-Transforms and Discrete Cash Flows

(19)

The Z-Transform and Present Value

(2)

Properties of the Z-Transform

(6)

Development of Present Value Models

(4)

Extension to Future and Annual Equivalent Models

101

(2)

Applications of Z-Transforms

103

(5)

Laplace Transforms and Continuous Cash Flows

108

(17)

Laplace Transform and Present Value

109

(3)

Properties of Laplace Transforms

112

(4)

Development of Continuous Present Value Models

116

(6)

Extension to Future and Annual Equivalent Models

122

(1)

Application of the Laplace Transform

122

(3)

Summary

125

(4)

Problems

126

(3)

Depreciation and Corporate Taxation

129

(38)

Introduction

129

(1)

Corporate Tax Rates

129

(5)

Tax Structure for Corporations

129

(2)

Depreciation and Its Relation to Income Taxes

131

(2)

Use of Effective and Marginal Income Tax Rates in Project Evaluations

133

(1)

Depreciation Methods and Regulations

134

(18)

Depreciation Regulations, Notation

134

(1)

Conventional Methods

135

(5)

Multiple-Asset Depreciation

140

(1)

1981 Accelerated Cost Recovery System (ACRS)

141

(3)

Tax Reform Act of 1986 (MACRS)

144

(4)

Adjustments to Income Taxes

148

(1)

Depreciation Strategies

149

(3)

After-Tax Cash Flow Analysis

152

(10)

Generalized Cash Flows

152

(3)

Effects of Depreciation Methods

155

(1)

Effects of Financing Costs

155

(3)

Effects of Inflation

158

(4)

Cash Flow Analysis for Tax-Exempt Corporations

162

(1)

Summary

162

(5)

Problems

163

(4)

Selecting a Minimum Attractive Rate of Return

167

(34)

Introduction

167

(1)

Investment and Borrowing Opportunities

167

(3)

Future Investment Opportunities

168

(1)

Financing Sources

168

(2)

Capital Rationing

170

(1)

Costs of Capital from Individual Sources

170

(11)

Debt Capital

171

(8)

Equity Capital

179

(2)

Use of a Weighted-Average Cost of Capital

181

(4)

Net Equity Flows

182

(2)

After-Tax Composite Flows

184

(1)

Specifying the Weighted-Average Cost of Capital

185

(10)

Basic Valuation Forms

186

(1)

Valuation with Debt and Taxes

187

(1)

The Firm's Capitalization Rate

188

(3)

Obtaining a Cutoff Rate

191

(2)

Other Issues

193

(1)

Effect of Inflation

194

(1)

Summary

195

(6)

Problems

196

(5)

PART TWO DETERMINISTIC ANALYSIS

Measures of Investment Worth-Single Project

201

(42)

Introduction

201

(1)

Initial Assumptions

201

(1)

Notation

202

(1)

The Net Present Value Criterion

202

(8)

Mathematical Definition

202

(5)

Economic Interpretation Through Project Balance

207

(3)

Internal Rate-of-Return Criterion

210

(16)

Definition of IRR

210

(3)

Classification of Investment Projects

213

(3)

IRR and Pure Investments

216

(2)

IRR and Mixed Investments

218

(4)

Modified Rate of Return

222

(4)

Benefit--Cost Ratios

226

(4)

Benefit--Cost Ratios Defined

227

(1)

Equivalence of B/C Ratios and PV

228

(2)

Payback Period

230

(1)

Payback Period Defined

230

(1)

Popularity of the Payback Period

231

(1)

Time-Dependent Measure of Investment Worth

231

(5)

Areas of Negative and Positive Balances

232

(1)

Investment Flexibility

233

(3)

Summary

236

(7)

Problems

238

(5)

Decision Rules for Selecting among Multiple Alternatives

243

(36)

Introduction

243

(1)

Formulating Mutually Exclusive Alternatives

243

(3)

Application of Investment Worth Criteria

246

(14)

Total Investment Approach

246

(5)

Incremental Analysis

251

(9)

Reinvestment Issues

260

(4)

Net Present Value

260

(2)

Internal Rate of Return

262

(2)

Benefit-Cost Ratio

264

(1)

Comparison of Projects with Unequal Lives

264

(9)

Common Service Period Approach

265

(3)

Estimating Salvage Value of Longer-Lived Projects

268

(4)

Reinvestment Issues When Revenues Are Unknown

272

(1)

Summary, Treatment of Unequal Lives

272

(1)

Decisions on the Timing of Investments

273

(1)

Summary

274

(5)

Problems

275

(4)

Deterministic Capital Budgeting Models

279

(74)

Introduction

279

(1)

The Use of Linear Programming Models

280

(7)

Criterion Function to Be Optimized

280

(2)

Multiple Budget Periods

282

(1)

Project Limits and Interdependencies

282

(1)

LP Formation of Lorie-Savage Problem

283

(1)

Duality Analysis

283

(4)

Pure Capital Rationing Models

287

(5)

Criticisms of the NPV Model

287

(2)

Consistent Discount Factors

289

(3)

Net Present Value Maximization with Lending and Borrowing

292

(2)

Inclusion of Lending Opportunities

292

(1)

Inclusion of Borrowing Opportunities

293

(1)

Weingartner's Horizon Model

294

(11)

Equal Lending and Borrowing Rates

294

(5)

Lending Rates Less Than Borrowing Rates

299

(2)

Inclusion of Borrowing Limits, Supply Schedule of Funds

301

(3)

Duality Analysis with Project Interdependencies

304

(1)

Bernhard's General Model

305

(5)

Model Formulation

305

(2)

Major Results

307

(3)

Discrete Capital Budgeting

310

(5)

Number of Fractional Projects in LP Solution

310

(1)

Branch-and-Bound Solution Procedure

311

(2)

Duality Analysis for Integer Solution

313

(2)

Capital Budgeting with Multiple Objectives

315

(4)

Goal programming

316

(2)

Interactive Multiple-Criteria Optimization

318

(1)

Summary

319

(34)

Problems

321

(8)

Appendix 8.A---A Dividend-Terminal-Wealth Capital Budgeting Model: A Case Study

329

(24)

PART THREE STOCHASTIC ANALYSIS

Utility Theory

353

(25)

Introduction

353

(4)

The Concept of Risk

353

(3)

Role of Utility Theory

356

(1)

Alternative Approaches to Decision Making

356

(1)

Preference and Ordering Rules

357

(3)

Bernoulli Hypothesis

357

(1)

Axioms of Utility Theory

358

(2)

Properties of Utility Functions

360

(5)

Risk Attitudes

360

(3)

Types of Utility Functions

363

(2)

Empirical Determination of Utility Functions

365

(4)

General Procedure

365

(2)

Sample Results

367

(2)

Mean--Variance Analysis

369

(5)

Indifference Curves

369

(1)

Coefficient of Risk Aversion

370

(2)

Justification of Certainty Equivalent Method

372

(2)

Summary

374

(4)

Problems

375

(3)

Measures of Investment Worth under Risk--Single Project

378

(66)

Introduction

378

(3)

The Common Measures of Project Risk

378

(1)

How Businesspeople Perceive Risk in Project Evaluation

379

(2)

Estimating Values in Probabilistic Terms

381

(18)

Statistical Moments of a Single Random Variable

381

(5)

Statistical Moments of Linear Combinations of Random Variables

386

(3)

Products of Random Variables

389

(3)

Quotients of Random Variables

392

(2)

Powers of Independent Random Variables

394

(4)

General Approximation Formulas

398

(1)

Statistical Moments of Discounted Cash Flows

399

(18)

Expected Net Present Value

399

(1)

Variance of Net Present Value

399

(4)

Mixed Net Cash Flows

403

(1)

Net Cash Flows Consisting of Several Components

404

(2)

Cash Flows with Uncertain Timing: Continuous Case

406

(8)

Cash Flows with Uncertain Timing: Discrete Case

414

(3)

Statistical Distributions of Net Present Value

417

(5)

Discrete Cash Flows Described by a Probability Tree

418

(1)

Use of the First Two Statistical Moments

418

(3)

Use of the First Four Statistical Moments

421

(1)

Estimating Risky Cash Flows

422

(9)

Beta-Function Estimators for Single Cash Flows

423

(5)

Hillier's Method for Correlated Cash Flows

428

(3)

Summary

431

(13)

Problems

433

(11)

Methods for Comparing Risky Projects

444

(53)

Introduction

444

(1)

Comparative Measures of Investment Worth

444

(6)

Mean--Variance, E--V

444

(3)

Mean--Semivariance, E--S

447

(2)

Safety First

449

(1)

Stochastic Dominance

450

(10)

First-Degree Stochastic Dominance

450

(3)

Second-Degree Stochastic Dominance

453

(4)

Third-Degree Stochastic Dominance

457

(2)

Relationship Between Dominance and Mean-Variance Criterion

459

(1)

Portfolio Theory

460

(10)

Efficiency Frontier

461

(2)

Diversification of Risk

463

(1)

Full Covariance Model

464

(1)

Index Model

465

(2)

Capital Market Theory

467

(3)

Discrete Capital-Rationing Models under Risk

470

(3)

Hillier's Method for Partially Correlated Projects

471

(1)

Stochastic Programming

472

(1)

Multiperiod Index Model for Project Portfolio

473

(5)

Model Structure and Assumptions

473

(2)

Procedure

475

(3)

Uncertainty Resolution

478

(2)

Summary

480

(17)

Problems

482

(8)

Appendix 11.A Example of Use of Multiperiod Index Model for Selecting Project Portfolio

490

(7)

Risk Simulation

497

(54)

Introduction

497

(1)

An Overview of the Logic of Simulation

497

(2)

Monte Carlo Sampling

497

(1)

Using the Simulation Output

498

(1)

Selecting Input Probability Distributions

499

(11)

Selecting a Distribution Based on Observed Data

500

(7)

Selecting a Distribution in the Absence of Data

507

(3)

Sampling Procedures for Independent Random Variables

510

(5)

Inverse Transformation Techniques

510

(3)

Other Frequently Used Random Deviates

513

(2)

Sampling Procedures for Dependent Random Variables

515

(17)

Assessment of Conditional Probabilities

515

(2)

Sampling a Pair of Dependent Random Samples

517

(3)

Sampling Based on Regression Equation

520

(4)

Conditional Sampling in the Absence of Data

524

(3)

Normal Transformation Method

527

(5)

Output Data Analysis

532

(5)

Replication and Precision of Results

532

(2)

Comparison of Two Projects

534

(3)

Programming Risk Simulation Model on Computers

537

(7)

Decision Problem

537

(2)

Description of the Simulation Model

539

(4)

Replication Results

543

(1)

Summary

544

(7)

Problems

548

(3)

Decision Tree Analysis

551

(34)

Introduction

551

(1)

Sequential Decision Process

551

(5)

Structuring the Decision Tree

552

(3)

Expected Value as a Decision Criterion

555

(1)

Obtaining Additional Information

556

(9)

The Value of Perfect Information

556

(3)

Determining Revised Probabilities

559

(5)

Expected Monetary Value after Receiving Sample Information

564

(1)

Value of the Market Survey

565

(1)

Decision Tree and Risk

565

(4)

Sensitivity Analysis

566

(1)

Decision Based on Certainty Equivalents

567

(2)

Investment Decisions with Replication Opportunities

569

(6)

The Opportunity To Replicate

569

(1)

Experiment Leading to Perfect Information

569

(5)

Sampling Leading to Imperfect Information

574

(1)

Summary

575

(10)

Problems

576

(9)

PART FOUR SPECIAL TOPICS IN ENGINEERING ECONOMIC ANALYSIS

Evaluation of Public Investments

585

(39)

Introduction

585

(1)

Benefit--Cost Analysis

585

(8)

The Nature of Public Activities

585

(1)

Why Benefit--Cost Analysis?

586

(1)

The Procedure of Benefit--Cost Analysis

586

(1)

Valuation of Benefits and Costs

587

(3)

Decision Criteria

590

(3)

The Benefit--Cost Concept Applied to a Mass Transit System

593

(14)

The Problem Statement

594

(2)

User's Benefits and Disbenefits

596

(7)

Sponsor's Costs

603

(2)

Benefit--Cost Ratio for Project

605

(2)

Risk and Uncertainty in Benefit--Cost Analysis

607

(11)

Exact Distribution of Benefit--Cost Ratio

607

(2)

Exact Distribution of Incremental Benefit--Cost Ratio

609

(9)

Summary

618

(6)

Problems

619

(5)

Economic Analysis in Public Utilities

624

(30)

Introduction

624

(1)

Capital Costs

625

(3)

Debt and Equity Financing for Public Utilities

625

(1)

Weighted After-Tax Cost of Capital

626

(1)

Capital Recovery Cost Based on Book Depreciation Schedule

627

(1)

The Revenue Requirement Method

628

(8)

Assumptions of the Revenue Requirement Method

629

(1)

Determination of Annual Revenue Requirements

630

(4)

Effect of Inflation in Revenue Requirements

634

(2)

Equivalence of the Present Value and Revenue Requirement Methods

636

(5)

The A/T Equity Cash Flows and Revenue Requirement Series

636

(2)

Important Results Regarding the Equivalence of the PV and RR Methods

638

(3)

Flow-Through and Normalization Accounting

641

(8)

Flow-Through Method

641

(3)

Normalizing Method

644

(5)

Summary

649

(5)

Problems

650

(4)

Procedures for Replacement Analysis

654

(45)

Introduction

654

(8)

Quantifying Obsolescence and Deterioration

654

(6)

Forecasting Future Data

660

(2)

Basic Concepts in Replacement Analysis

662

(11)

Sunk Costs

662

(1)

Outsider Point of View

663

(6)

Economic Life of an Asset

669

(4)

Infinite Planning Period Methods

673

(7)

No Technology or Cost Changes, AE Method

673

(3)

Geometric Changes in Purchasing Costs and O&M Costs, PV Method

676

(4)

Finite Planning Period Methods

680

(7)

Sensitivity Analysis of PV with Respect to Inflation

680

(2)

Dynamic Programming Method

682

(5)

Building a Data Base

687

(4)

Summary

691

(8)

Problems

693

(6)

APPENDIX A: Discrete Interest Compounding Tables

699

(28)

APPENDIX B: Statistical Tables

727

(5)

Table B.1 Cumulative Standard Normal Distribution

728

(2)

Table B.2 Percentage Points of the χ2 Distribution

730

(2)

Index

732

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Advanced Engineering Economics

Summary

Author Biography

Table of Contents

Supplemental Materials

FREE SHIPPING

Rent More, Save More! Use code: BBRENTAL

5% off 1 book, 7% off 2 books, 10% off 3+ books

Advanced Engineering Economics

Summary

Author Biography

Table of Contents

Supplemental Materials

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