2. bla76302_fm_i-xx.indd iibla76302_fm_i-xx.indd ii 1/14/11
8:28 PM1/14/11 8:28 PM
3. Seventh 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
Seventh Edition TM bla76302_fm_i-xx.indd iiibla76302_fm_i-xx.indd
iii 1/14/11 8:28 PM1/14/11 8:28 PM
4. ENGINEERING ECONOMY: SEVENTH EDITION Published by
McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc.,
1221 Avenue of the Americas, New York, NY 10020. Copyright 2012 by
The McGraw-Hill Companies, Inc. All rights reserved. Previous
editions 2005, 2002, and 1998. No part of this publication may be
reproduced or distributed in any form or by any means, or stored in
a database or retrieval system, without the prior written consent
of The McGraw-Hill Companies, Inc., including, but not limited to,
in any network or other electronic storage or transmission, or
broadcast for distance learning. Some ancillaries, including
electronic and print components, may not be available to customers
outside the United States. This book is printed on recycled,
acid-free paper containing 10% postconsumer waste. 1 2 3 4 5 6 7 8
9 0 QDB/QDB 1 0 9 8 7 6 5 4 3 2 1 ISBN 978-0-07-337630-1 MHID
0-07-337630-2 Vice President & Editor-in-Chief: Marty Lange
Vice President EDP/Central Publishing Services: Kimberly Meriwether
David Global Publisher: Raghothaman Srinivasan Sponsoring Editor:
Peter E. Massar Senior Marketing Manager: Curt Reynolds Development
Editor: Lorraine K. Buczek Senior Project Manager: Jane Mohr Design
Coordinator: Brenda A. Rolwes Cover Designer: Studio Montage, St.
Louis, Missouri Cover Image: Brand X Pictures/PunchStock RF Buyer:
Kara Kudronowicz Media Project Manager: Balaji Sundararaman
Compositor: MPS Limited, a Macmillan Company Typeface: 10/12 Times
Printer: Quad/Graphics-Dubuque All credits appearing on page or at
the end of the book are considered to be an extension of the
copyright page. Library of Congress Cataloging-in-Publication Data
Blank, Leland T. Engineering economy / Leland Blank, Anthony
Tarquin. 7th ed. p. cm. Includes bibliographical references and
index. ISBN-13: 978-0-07-337630-1 (alk. paper) ISBN-10:
0-07-337630-2 1. Engineering economy. I. Tarquin, Anthony J. II.
Title. TA177.4.B58 2012 658.15dc22 2010052297 www.mhhe.com TM
bla76302_fm_i-xx.indd ivbla76302_fm_i-xx.indd iv 1/14/11 8:28
PM1/14/11 8:28 PM
5. This book is dedicated to Dr. Frank W. Sheppard, Jr. His
lifelong commitment to education, fair nancial practices,
international outreach, and family values has been an inspiration
to manyone person at a time. bla76302_fm_i-xx.indd
vbla76302_fm_i-xx.indd v 1/14/11 8:28 PM1/14/11 8:28 PM
6. McGraw-Hill Create Craft your teaching resources to match
the way you teach! With McGraw-Hill Create, www
.mcgrawhillcreate.com, you can easily rearrange chapters, combine
material from other content sources, and quickly upload content you
have written like your course syllabus or teaching notes. Find the
content you need in Create by searching through thousands of
leading McGraw-Hill textbooks. Arrange your book to t your teaching
style. Create even allows you to personalize your books appearance
by selecting the cover and adding your name, school, and course
infor- mation. Order a Create book and youll receive a
complimentary print review copy in 35 busi- ness days or a
complimentary electronic review copy (eComp) via email in minutes.
Go to www. mcgrawhillcreate.com today and register to experience
how McGraw-Hill Create empowers you to teach your students your
way. McGraw-Hill Higher Education and Blackboard Have Teamed Up
Blackboard, the Web-based course-management system, has partnered
with McGraw-Hill to bet- ter allow students and faculty to use
online materials and activities to complement face-to-face
teaching. Blackboard features exciting social learning and teaching
tools that foster more logical, visually impactful and active
learning opportunities for students. Youll transform your closed-
door classrooms into communities where students remain connected to
their educational experi- ence 24 hours a day. This partnership
allows you and your students access to McGraw-Hills Create right
from within your Blackboard course all with one single sign-on.
McGraw-Hill and Blackboard can now offer you easy access to
industry leading technology and content, whether your campus hosts
it, or we do. Be sure to ask your local McGraw-Hill representative
for details. Electronic Textbook Options This text is offered
through CourseSmart for both instructors and students. CourseSmart
is an online resource where students can purchase the complete text
online at almost half the cost of a traditional text. Purchasing
the eTextbook allows students to take advantage of CourseSmarts web
tools for learning, which include full text search, notes and
highlighting, and email tools for sharing notes between classmates.
To learn more about CourseSmart options, contact your sales
representative or visit www.CourseSmart.com. MCGRAW-HILL DIGITAL
OFFERINGS bla76302_fm_i-xx.indd vibla76302_fm_i-xx.indd vi 1/14/11
8:28 PM1/14/11 8:28 PM
7. CONTENTS Preface to Seventh Edition xiii LEARNING STAGE 1
THE FUNDAMENTALS Chapter 1 Foundations of Engineering Economy 2 1.1
Engineering Economics: Description and Role in Decision Making 3
1.2 Performing an Engineering Economy Study 4 1.3 Professional
Ethics and Economic Decisions 7 1.4 Interest Rate and Rate of
Return 10 1.5 Terminology and Symbols 13 1.6 Cash Flows: Estimation
and Diagramming 15 1.7 Economic Equivalence 19 1.8 Simple and
Compound Interest 21 1.9 Minimum Attractive Rate of Return 25 1.10
Introduction to Spreadsheet Use 27 Chapter Summary 31 Problems 31
Additional Problems and FE Exam Review Questions 35 Case
StudyRenewable Energy Sources for Electricity Generation 36 Case
StudyRefrigerator Shells 37 Chapter 2 Factors: How Time and
Interest Affect Money 38 PE Progressive ExampleThe Cement Factory
Case 39 2.1 Single-Amount Factors (FP and PF) 39 2.2 Uniform Series
Present Worth Factor and Capital Recovery Factor (PA and AP) 43 2.3
Sinking Fund Factor and Uniform Series Compound Amount Factor (AF
and FA) 46 2.4 Factor Values for Untabulated i or n Values 48 2.5
Arithmetic Gradient Factors (PG and AG) 50 2.6 Geometric Gradient
Series Factors 58 2.7 Determining i or n for Known Cash Flow Values
61 Chapter Summary 64 Problems 64 Additional Problems and FE Exam
Review Questions 69 Case StudyTime Marches On; So Does the Interest
Rate 70 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 Chapter
Summary 86 Problems 86 Additional Problems and FE Exam Review
Questions 92 Case StudyPreserving Land for Public Use 93 Chapter 4
Nominal and Effective Interest Rates 94 PE Progressive ExampleThe
Credit Card Offer Case 95 4.1 Nominal and Effective Interest Rate
Statements 96 4.2 Effective Annual Interest Rates 99 4.3 Effective
Interest Rates for Any Time Period 105 4.4 Equivalence Relations:
Payment Period and Compounding Period 106 4.5 Equivalence
Relations: Single Amounts with PP CP 107 bla76302_fm_i-xx.indd
viibla76302_fm_i-xx.indd vii 1/14/11 8:28 PM1/14/11 8:28 PM
8. viii Contents 4.6 Equivalence Relations: Series with PP CP
109 4.7 Equivalence Relations: Single Amounts and Series with PP CP
112 4.8 Effective Interest Rate for Continuous Compounding 114 4.9
Interest Rates That Vary over Time 116 Chapter Summary 117 Problems
118 Additional Problems and FE Exam Review Questions 122 Case
StudyIs Owning a Home a Net Gain or Net Loss over Time? 124
LEARNING STAGE 2 BASIC ANALYSIS TOOLS Chapter 5 Present Worth
Analysis 128 PE Progressive ExampleWater for Semiconductor
Manufacturing Case 129 5.1 Formulating Alternatives 129 5.2 Present
Worth Analysis of Equal-Life Alternatives 131 5.3 Present Worth
Analysis of Different-Life Alternatives 133 5.4 Future Worth
Analysis 137 5.5 Capitalized Cost Analysis 138 Chapter Summary 142
Problems 142 Additional Problems and FE Exam Review Questions 147
Case StudyComparing Social Security Benets 149 Chapter 6 Annual
Worth Analysis 150 6.1 Advantages and Uses of Annual Worth Analysis
151 6.2 Calculation of Capital Recovery and AW Values 153 6.3
Evaluating Alternatives by Annual Worth Analysis 155 6.4 AW of a
Permanent Investment 157 6.5 Life-Cycle Cost Analysis 160 Chapter
Summary 164 Problems 164 Additional Problems and FE Exam Review
Questions 169 Case StudyThe Changing Scene of an Annual Worth
Analysis 171 Chapter 7 Rate of Return Analysis: One Project 172 7.1
Interpretation of a Rate of Return Value 173 7.2 Rate of Return
Calculation Using a PW or AW Relation 175 7.3 Special
Considerations When Using the ROR Method 179 7.4 Multiple Rate of
Return Values 180 7.5 Techniques to Remove Multiple Rates of Return
184 7.6 Rate of Return of a Bond Investment 190 Chapter Summary 193
Problems 193 Additional Problems and FE Exam Review Questions 198
Case StudyDeveloping and Selling an Innovative Idea 200 Chapter 8
Rate of Return Analysis: Multiple Alternatives 202 8.1 Why
Incremental Analysis Is Necessary 203 8.2 Calculation of
Incremental Cash Flows for ROR Analysis 203 8.3 Interpretation of
Rate of Return on the Extra Investment 206 8.4 Rate of Return
Evaluation Using PW: Incremental and Breakeven 207 8.5 Rate of
Return Evaluation Using AW 213 8.6 Incremental ROR Analysis of
Multiple Alternatives 214 bla76302_fm_i-xx.indd
viiibla76302_fm_i-xx.indd viii 1/14/11 8:28 PM1/14/11 8:28 PM
9. Contents ix 8.7 All-in-One Spreadsheet Analysis (Optional)
218 Chapter Summary 219 Problems 220 Additional Problems and FE
Exam Review Questions 225 Case StudyROR Analysis with Estimated
Lives That Vary 226 Case StudyHow a New Engineering Graduate Can
Help His Father 227 Chapter 9 Benet/Cost Analysis and Public Sector
Economics 228 PE Progressive ExampleWater Treatment Facility #3
Case 229 9.1 Public Sector Projects 230 9.2 Benet/Cost Analysis of
a Single Project 235 9.3 Alternative Selection Using Incremental
B/C Analysis 238 9.4 Incremental B/C Analysis of Multiple, Mutually
Exclusive Alternatives 242 9.5 Service Sector Projects and
Cost-Effectiveness Analysis 246 9.6 Ethical Considerations in the
Public Sector 250 Chapter Summary 251 Problems 252 Additional
Problems and FE Exam Review Questions 258 Case StudyComparing B/C
Analysis and CEA of Trafc Accident Reduction 259 LEARNING STAGE 2
EPILOGUE: SELECTING THE BASIC ANALYSIS TOOL LEARNING STAGE 3 MAKING
BETTER DECISIONS Chapter 10 Project Financing and Noneconomic
Attributes 266 10.1 MARR Relative to the Cost of Capital 267 10.2
Debt-Equity Mix and Weighted Average Cost of Capital 269 10.3
Determination of the Cost of Debt Capital 271 10.4 Determination of
the Cost of Equity Capital and the MARR 273 10.5 Effect of
Debt-Equity Mix on Investment Risk 275 10.6 Multiple Attribute
Analysis: Identication and Importance of Each Attribute 278 10.7
Evaluation Measure for Multiple Attributes 282 Chapter Summary 283
Problems 284 Additional Problems and FE Exam Review Questions 289
Case StudyWhich Is BetterDebt or Equity Financing? 290 Chapter 11
Replacement and Retention Decisions 292 PE Progressive ExampleKeep
or Replace the Kiln Case 293 11.1 Basics of a Replacement Study 294
11.2 Economic Service Life 296 11.3 Performing a Replacement Study
302 11.4 Additional Considerations in a Replacement Study 306 11.5
Replacement Study over a Specied Study Period 307 11.6 Replacement
Value 312 Chapter Summary 312 Problems 313 Additional Problems and
FE Exam Review Questions 319 Case StudyWill the Correct ESL Please
Stand? 321 bla76302_fm_i-xx.indd ixbla76302_fm_i-xx.indd ix 1/14/11
8:28 PM1/14/11 8:28 PM
10. x Contents Chapter 12 Independent Projects with Budget
Limitation 322 12.1 An Overview of Capital Rationing among Projects
323 12.2 Capital Rationing Using PW Analysis of Equal-Life Projects
325 12.3 Capital Rationing Using PW Analysis of Unequal-Life
Projects 327 12.4 Capital Budgeting Problem Formulation Using
Linear Programming 329 12.5 Additional Project Ranking Measures 332
Chapter Summary 334 Problems 334 Additional Problems and FE Exam
Review Questions 338 Chapter 13 Breakeven and Payback Analysis 340
13.1 Breakeven Analysis for a Single Project 341 13.2 Breakeven
Analysis Between Two Alternatives 345 13.3 Payback Analysis 348
13.4 More Breakeven and Payback Analysis on Spreadsheets 352
Chapter Summary 355 Problems 355 Additional Problems and FE Exam
Review Questions 361 Case StudyWater Treatment Plant Process Costs
363 LEARNING STAGE 4 ROUNDING OUT THE STUDY Chapter 14 Effects of
Ination 366 14.1 Understanding the Impact of Ination 367 14.2
Present Worth Calculations Adjusted for Ination 369 14.3 Future
Worth Calculations Adjusted for Ination 374 14.4 Capital Recovery
Calculations Adjusted for Ination 377 Chapter Summary 378 Problems
379 Additional Problems and FE Exam Review Questions 384 Case
StudyInation versus Stock and Bond Investments 385 Chapter 15 Cost
Estimation and Indirect Cost Allocation 386 15.1 Understanding How
Cost Estimation Is Accomplished 387 15.2 Unit Method 390 15.3 Cost
Indexes 391 15.4 Cost-Estimating Relationships: Cost-Capacity
Equations 394 15.5 Cost-Estimating Relationships: Factor Method 395
15.6 Traditional Indirect Cost Rates and Allocation 397 15.7
Activity-Based Costing (ABC) for Indirect Costs 401 15.8 Making
Estimates and Maintaining Ethical Practices 403 Chapter Summary 404
Problems 404 Additional Problems and FE Exam Review Questions 410
Case StudyIndirect Cost Analysis of Medical Equipment Manufacturing
Costs 411 Case StudyDeceptive Acts Can Get You in Trouble 412
Chapter 16 Depreciation Methods 414 16.1 Depreciation Terminology
415 16.2 Straight Line (SL) Depreciation 418 16.3 Declining Balance
(DB) and Double Declining Balance (DDB) Depreciation 419 16.4
Modied Accelerated Cost Recovery System (MACRS) 422 16.5
Determining the MACRS Recovery Period 426 bla76302_fm_i-xx.indd
xbla76302_fm_i-xx.indd x 1/14/11 8:28 PM1/14/11 8:28 PM
11. Contents xi 16.6 Depletion Methods 427 Chapter Summary 429
Appendix 430 16A.1 Sum-of-Years-Digits (SYD) and Unit-of-Production
(UOP) Depreciation 430 16A.2 Switching between Depreciation Methods
432 16A.3 Determination of MACRS Rates 435 Problems 438 Additional
Problems and FE Exam Review Questions 442 Appendix Problems 443
Chapter 17 After-Tax Economic Analysis 444 17.1 Income Tax
Terminology and Basic Relations 445 17.2 Calculation of Cash Flow
after Taxes 448 17.3 Effect on Taxes of Different Depreciation
Methods and Recovery Periods 450 17.4 Depreciation Recapture and
Capital Gains (Losses) 453 17.5 After-Tax Evaluation 456 17.6
After-Tax Replacement Study 462 17.7 After-Tax Value-Added Analysis
465 17.8 After-Tax Analysis for International Projects 468 17.9
Value-Added Tax 470 Chapter Summary 472 Problems 473 Additional
Problems and FE Exam Review Questions 481 Case StudyAfter-Tax
Analysis for Business Expansion 482 Chapter 18 Sensitivity Analysis
and Staged Decisions 484 18.1 Determining Sensitivity to Parameter
Variation 485 18.2 Sensitivity Analysis Using Three Estimates 490
18.3 Estimate Variability and the Expected Value 491 18.4 Expected
Value Computations for Alternatives 492 18.5 Staged Evaluation of
Alternatives Using a Decision Tree 494 18.6 Real Options in
Engineering Economics 498 Chapter Summary 503 Problems 503
Additional Problems and FE Exam Review Questions 509 Case
StudySensitivity to the Economic Environment 510 Case
StudySensitivity Analysis of Public Sector ProjectsWater Supply
Plans 511 Chapter 19 More on Variation and Decision Making under
Risk 514 19.1 Interpretation of Certainty, Risk, and Uncertainty
515 19.2 Elements Important to Decision Making under Risk 518 19.3
Random Samples 523 19.4 Expected Value and Standard Deviation 526
19.5 Monte Carlo Sampling and Simulation Analysis 533 Chapter
Summary 540 Problems 540 Additional Problems and FE Exam Review
Questions 543 Case StudyUsing Simulation and Three-Estimate
Sensitivity Analysis 544 Appendix A Using Spreadsheets and
Microsoft Excel 547 A.1 Introduction to Using Excel 547 A.2
Organization (Layout) of the Spreadsheet 549 A.3 Excel Functions
Important to Engineering Economy 550 A.4 Goal SeekA Tool for
Breakeven and Sensitivity Analysis 558 A.5 SolverAn Optimizing Tool
for Capital Budgeting, Breakeven, and Sensitivity Analysis 559 A.6
Error Messages 560 bla76302_fm_i-xx.indd xibla76302_fm_i-xx.indd xi
1/14/11 8:28 PM1/14/11 8:28 PM
12. xii Contents Appendix B Basics of Accounting Reports and
Business Ratios 561 B.1 The Balance Sheet 561 B.2 Income Statement
and Cost of Goods Sold Statement 562 B.3 Business Ratios 563
Appendix C Code of Ethics for Engineers 566 Appendix D Alternate
Methods for Equivalence Calculations 569 D.1 Using Programmable
Calculators 569 D.2 Using the Summation of a Geometric Series 570
Appendix E Glossary of Concepts and Terms 573 E.1 Important
Concepts and Guidelines 573 E.2 Symbols and Terms 576 Reference
Materials 579 Factor Tables 581 Photo Credits 610 Index 611
bla76302_fm_i-xx.indd xiibla76302_fm_i-xx.indd xii 1/14/11 8:28
PM1/14/11 8:28 PM
13. PREFACE TO SEVENTH EDITION This edition includes the
time-tested approach and topics of previous editions and introduces
signi- cantly new print and electronic features useful to learning
about and successfully applying the excit- ing eld of engineering
economics. Money makes a huge difference in the life of a
corporation, an individual, and a government. Learning to
understand, analyze, and manage the money side of any project is
vital to its success. To be professionally successful, every
engineer must be able to deal with the time value of money,
economic facts, ination, cost estimation, tax considerations, as
well as spreadsheet and calculator use. This book is a great help
to the learner and the instructor in accom- plishing these goals by
using easy-to-understand language, simple graphics, and online
features. What's New and What's Best This seventh edition is full
of new information and features. Plus the supporting online
materials are new and updated to enhance the teaching and learning
experience. New topics: Ethics and the economics of engineering
Service sector projects and their evaluation Real options
development and analysis Value-added taxes and how they work
Multiple rates of return and ways to eliminate them using
spreadsheets No tabulated factors needed for equivalence
computations (Appendix D) New features in print and online: Totally
new design to highlight important terms, concepts, and decision
guidelines Progressive examples that continue throughout a chapter
Downloadable online presentations featuring voice-over slides and
animation Vital concepts and guidelines identied in margins; brief
descriptions available (Appendix E) Fresh spreadsheet displays with
on-image comments and function details Case studies (21 of them)
ranging in topics from ethics to energy to simulation Retained
features: Many end-of-chapter problems (over 90% are new or
revised) Easy-to-read language to enhance understanding in a
variety of course environments Fundamentals of Engineering (FE)
Exam review questions that double as additional or review problems
for quizzes and tests Hand and spreadsheet solutions presented for
many examples Flexible chapter ordering after fundamental topics
are understood Complete solutions manual available online (with
access approval for instructors) How to Use This Text This textbook
is best suited for a one-semester or one-quarter undergraduate
course. Students should be at the sophomore level or above with a
basic understanding of engineering concepts and terminology. A
course in calculus is not necessary; however, knowledge of the
concepts in advanced mathematics and elementary probability will
make the topics more meaningful. Practitioners and professional
engineers who need a refresher in economic analysis and cost
estimation will nd this book very useful as a reference document as
well as a learning medium. Chapter Organization and Coverage
Options The textbook contains 19 chapters arranged into four
learning stages, as indicated in the owchart on the next page, and
ve appendices. Each chapter starts with a statement of purpose and
a spe- cic learning outcome (ABET style) for each section. Chapters
include a summary, numerous bla76302_fm_i-xx.indd
xiiibla76302_fm_i-xx.indd xiii 1/14/11 8:28 PM1/14/11 8:28 PM
14. end-of-chapter problems (essay and numerical),
multiple-choice problems useful for course re- view and FE Exam
preparation, and a case study. The appendices are important
elements of learning for this text: Appendix A Spreadsheet layout
and functions (Excel is featured) Appendix B Accounting reports and
business ratios Appendix C Code of Ethics for Engineers (from NSPE)
Appendix D Equivalence computations using calculators and geometric
series; no tables Appendix E Concepts, guidelines, terms, and
symbols for engineering economics There is considerable exibility
in the sequencing of topics and chapters once the rst six chapters
are covered, as shown in the progression graphic on the next page.
If the course is de- signed to emphasize sensitivity and risk
analysis, Chapters 18 and 19 can be covered immediately xiv Preface
to Seventh Edition Learning Stage 1: The Fundamentals Learning
Stage 2: Basic Analysis Tools Learning Stage 3: Making Better
Decisions Learning Stage 4: Rounding Out the Study Chapter 5
Present Worth Analysis Chapter 6 Annual Worth Analysis Chapter 7
Rate of Return Analysis: One Project Chapter 8 Rate of Return
Analysis: Multiple Alternatives Learning Stage 2 Epilogue Selecting
the Basic Analysis Tool Chapter 12 Independent Projects with Budget
Limitation Chapter 11 Replacement and Retention Decisions Chapter
10 Project Financing and Noneconomic Attributes Chapter 18
Sensitivity Analysis and Staged Decisions Chapter 19 More on
Variation and Decision Making under Risk Chapter 15 Cost Estimation
and Indirect Cost Allocation Chapter 17 After-Tax Economic Analysis
Chapter 14 Effects of Inflation Composition by level Chapter 13
Breakeven and Payback Analysis Chapter 4 Nominal and Effective
Interest Rates Chapter 1 Foundations of Engineering Economy Chapter
2 Factors: How Time and Interest Affect Money Chapter 3 Combining
Factors and Spreadsheet Functions Chapter 16 Depreciation Methods
Chapter 9 Benefit/Cost Analysis and Public Sector Economics
CHAPTERS IN EACH LEARNING STAGE bla76302_fm_i-xx.indd
xivbla76302_fm_i-xx.indd xiv 1/14/11 8:28 PM1/14/11 8:28 PM
15. Chapter Organization and Coverage Options xv after Learning
Stage 2 (Chapter 9) is completed. If depreciation and tax emphasis
are vitally important to the goals of the course, Chapters 16 and
17 can be covered once Chapter 6 (annual worth) is completed. The
progression graphic can help in the design of the course content
and topic ordering. Topics may be introduced at the point indicated
or any point thereafter (Alternative entry points are indicated by
) Numerical progression through chapters Foundations Factors More
Factors Effective i Present Worth Annual Worth Rate of Return More
ROR Benefit/Cost Financing and Noneconomic Attributes Replacement
Capital Budgeting Breakeven and Payback Inflation 1. 2. 3. 4. 5. 6.
7. 8. 9. 10. 11. 12. 13. 14. Inflation Cost Estimation 15.
Estimation Sensitivity, Staged Decisions, and Risk 18. Sensitivity,
Decision Trees, and Real Options 19. Risk and Simulation Taxes and
Depreciation 16. Depreciation 17. After-Tax CHAPTER AND TOPIC
PROGRESSION OPTIONS bla76302_fm_i-xx.indd xvbla76302_fm_i-xx.indd
xv 1/14/11 8:28 PM1/14/11 8:28 PM
16. LEARNING OUTCOMES Each chapter begins with a purpose, list
of topics, and learning outcomes (ABET style) for each
corresponding section. This behavioral-based approach sensitizes
the reader to what is ahead, leading to improved understanding and
learning. S E C T I O N T O P I C L E A R N I N G O U T C O M E 3.1
Shifted series Determine the P, F or A values of a series starting
at a time other than period 1. 3.2 Shifted series and single cash
ows Determine the P, F, or A values of a shifted series and
randomly placed single cash ows. 3.3 Shifted gradients Make
equivalence calculations for shifted arithmetic or geometric
gradient series that increase or decrease in size of cash ows.
Purpose: Use multiple factors and spreadsheet functions to nd
equivalent amounts for cash ows that have nonstan- dard placement.
L E A R N I N G O U T C O M E S CONCEPTS AND GUIDELINES To
highlight the fundamental building blocks of the course, a
checkmark and title in the margin call attention to particularly
important concepts and decision-making guidelines. Appendix E
includes a brief description of each fundamental concept.
IN-CHAPTER EXAMPLES Numerous in-chapter examples throughout the
book reinforce the basic concepts and make understanding easier.
Where appropriate, the example is solved using separately marked
hand and spreadsheet solutions. A dot-com company plans to place
money in a new venture capital fund that currently returns 18% per
year, compounded daily. What effective rate is this (a) yearly and
(b) semiannually? Solution (a) Use Equation [4.7], with r 0.18 and
m 365. Effective i% per year (1 0.18 365 ) 365 1 19.716% (b) Here r
0.09 per 6 months and m 182 days. Effective i% per 6 months (1 0.09
182 ) 182 1 9.415% EXAMPLE 4.6 bla76302_ch04_094-126.indd 106
12/22/10 8:24 PM It is a well-known fact that money makes money.
The time value of money explains the change in the amount of money
over time for funds that are owned (invested) or owed (borrowed).
This is the most important concept in engineering economy.Time
value of money Water for Semiconductor Manufactur- ing Case: The
worldwide contribution of semiconductor sales is about $250 billion
per year, or about 10% of the worlds GDP (gross domestic product).
This indus- try produces the microchips used in many of the
communication, entertainment, transportation, and computing devices
we use every day. Depending upon the type and size of fabrication
plant (fab), the need for ultrapure water (UPW) to manufacture
these tiny integrated circuits is high, ranging from 500 to 2000
gpm (gallons per minute). Ultrapure water is obtained by special
processes that com- monly include reverse osmosisdeionizing resin
bed technologies. Potable water obtained from purifying seawater or
brackish groundwater may cost from $2 to $3 per 1000 gallons, but
to obtain UPW on-site for semiconductor manufac- turing may cost an
additional $1 to $3 per 1000 gallons. A fab costs upward of $2.5
billion to construct, with approximately 1% of this total, or $25
million, required to provide the ultrapure water needed, including
the necessary wastewater and recycling equipment. A newcomer to the
industry, Angular Enterprises, has estimated the cost pro- les for
two options to supply its antici- pated fab with water. It is
fortunate to have the option of desalinated seawater or puried
groundwater sources in the location chosen for its new fab. The
ini- tial cost estimates for the UPW system are given below. Source
Seawater (S) Groundwater (G) Equipment rst cost, $M 20 22 AOC, $M
per year 0.5 0.3 Salvage value, % of rst cost 5 10 Cost of UPW, $
per 1000 gallons 4 5 Angular has made some initial estimates for
the UPW system. Life of UPW equipment 10 years UPW needs 1500 gpm
Operating time 16 hours per day for 250 days per year This case is
used in the following topics (Sections) and problems of this
chapter: PW analysis of equal-life alternatives (Section 5.2) PW
analysis of different-life alterna- tives (Section 5.3) Capitalized
cost analysis (Section 5.5) Problems 5.20 and 5.34 PE
bla76302_ch05_127-149.indd 129 12/22/10 11:06 PM PROGRESSIVE
EXAMPLES Several chapters include a progressive examplea more
detailed problem statement introduced at the beginning of the
chapter and expanded upon throughout the chapter in specially
marked examples. This approach illustrates different techniques and
some increasingly complex aspects of a real-world problem. SAMPLE
OF RESOURCES FOR bla76302_fm_i-xx.indd xvibla76302_fm_i-xx.indd xvi
1/14/11 8:28 PM1/14/11 8:28 PM
17. Contents xvii 3.1 Calculations for Uniform Series That Are
Shifted When a uniform series begins at a time other than at the
end of period 1, it is called a shifted series. In this case
several methods can be used to nd the equivalent present worth P.
For example, P of the uniform series shown in Figure 31 could be
determined by any of the following methods: Use the PF factor to nd
the present worth of each disbursement at year 0 and add them. Use
the FP factor to nd the future worth of each disbursement in year
13, add them, and then nd the present worth of the total, using P
F(PF,i,13). Use the FA factor to nd the future amount F A(FA,i,10),
and then compute the present worth, using P F(PF,i,13). Use the PA
factor to compute the present worth P3 A(PA,i,10) (which will be
located in year 3, not year 0), and then nd the present worth in
year 0 by using the (PF,i,3) factor. bla76302_ch03_072-093.indd 73
12/7/10 7:26 AM ONLINE PRESENTATIONS An icon in the margin
indicates the availability of an animated voice-over slide
presentation that summarizes the material in the section and
provides a brief example for learners who need a review or prefer
video- based materials. Presentations are keyed to the sections of
the text. SPREADSHEETS The text integrates spreadsheets to show how
easy they are to use in solving virtually any type of engineering
economic analysis problem. Cell tags or full cells detail built-in
functions and relations developed to solve a specic problem.
Breakeven Incremental ROR 17% Breakeven ROR 17% Filter 2 ROR 23%
MARR MARR Filter 1 ROR 25% Figure 86 PW versus i graph and PW
versus incremental i graph, Example 8.4.
bla76302_ch08_202-227.indd21212/11/106:52PM Chris and her father
just purchased a small ofce building for $160,000 that is in need
of a lot of repairs, but is located in a prime commercial area of
the city. The estimated costs each year for repairs, insurance,
etc. are $18,000 the rst year, increasing by $1000 per year
thereafter. At an expected 8% per year return, use spreadsheet
analysis to determine the payback period if the building is (a)
kept for 2 years and sold for $290,000 sometime beyond year 2 or
(b) kept for 3 years and sold for $370,000 sometime beyond 3 years.
Solution Figure 1311 shows the annual costs (column B) and the
sales prices if the building is kept 2 or 3 years (columns C and E,
respectively). The NPV function is applied (columns D and F) to
determine when the PW changes sign from plus to minus. These
results bracket the payback period for each retention period and
sales price. When PW 0, the 8% return is exceeded. (a) The 8%
return payback period is between 3 and 4 years (column D). If the
building is sold after exactly 3 years for $290,000, the payback
period was not exceeded; but after 4 years it is exceeded. (b) At a
sales price of $370,000, the 8% return payback period is between 5
and 6 years (col- umn F). If the building is sold after 4 or 5
years, the payback is not exceeded; however, a sale after 6 years
is beyond the 8%-return payback period. EXAMPLE 13.8 Figure 1311
Payback period analysis, Example 13.8 NPV(8%,$B$4:B7)+$B$3
PV(8%,A7,,290000) If kept 2 years and sold, payback is between 3
and 4 If kept 3 years and sold, payback is between 5 and 6
bla76302_ch13_340-364.indd 354 12/17/10 1:02 PM Figure 712
Spreadsheet application of ROIC method using Goal Seek, Example
7.6. bla76302_ch07_172-201.indd 189 12/11/10 4:32 PM INSTRUCTORS
AND STUDENTS FE EXAM AND COURSE REVIEWS Each chapter concludes with
several multiple-choice, FE Examstyle problems that provide a
simplied review of chapter material. Additionally, these problems
cover topics for test reviews and homework assignments. 8.38 When
conducting a rate of return (ROR) analysis involving multiple
mutually exclusive alterna- tives, the rst step is to: (a) Rank the
alternatives according to decreas- ing initial investment cost (b)
Rank the alternatives according to increasing initial investment
cost (c) Calculate the present worth of each alterna- tive using
the MARR (d) Find the LCM between all of the alternatives 8.39 In
comparing mutually exclusive alternatives by the ROR method, you
should: (a) Find the ROR of each alternative and pick the one with
the highest ROR (b) S l h l i h i l 8.43 For these alternatives,
the sum of the incremental cash ows is: Year A B 0 10,000 14,000 1
2,500 4,000 2 2,500 4,000 3 2,500 4,000 4 2,500 4,000 5 2,500 4,000
(a) $2500 (b) $3500 (c) $6000 (d) $8000 ADDITIONAL PROBLEMS AND FE
EXAM REVIEW QUESTIONS bla76302_fm_i-xx.indd
xviibla76302_fm_i-xx.indd xvii 1/14/11 8:28 PM1/14/11 8:28 PM
18. CASE STUDIES New and updated case studies at the end of
most chapters present real- world, in-depth treatments and
exercises in the engineering profession. Each case includes a
background, relevant information, and an exercise section.
Background Pedernales Electric Cooperative (PEC) is the largest
member-owned electric co-op in the United States with over 232,000
meters in 12 Central Texas counties. PEC has a ca- pacity of
approximately 1300 MW (megawatts) of power, of which 277 MW, or
about 21%, is from renewable sources. The latest addition is 60 MW
of power from a wind farm in south Texas close to the city of
Corpus Christi. A constant question is how much of PECs generation
capacity should be from renewable sources, especially given the
environmental issues with coal-generated electricity and the rising
costs of hydrocarbon fuels. Wind and nuclear sources are the
current consideration for the PEC leadership as Texas is increasing
its generation by nuclear power and the state is the national
leader in wind farmproduced electricity. Consider yourself a member
of the board of directors of PEC. You are an engineer who has been
newly elected by the PEC membership to serve a 3-year term as a
director-at-large. As such, you do not represent a specic district
within the entire service area; all other directors do represent a
specic district. You have many questions about the operations of
PEC, plus you are interested in the economic and societal benets of
pursuing more renewable source generation capacity. Information
Here are some data that you have obtained. The information is
sketchy, as this point, and the numbers are very approxi- mate.
Electricity generation cost estimates are national in scope, not
PEC-specic, and are provided in cents per kilowatt-hour (/kWh).
Generation Cost, /kWh Fuel Source Likely Range Reasonable Average
Coal 4 to 9 7.4 Natural gas 4 to 10.5 8.6 Wind 4.8 to 9.1 8.2 Solar
4.5 to 15.5 8.8 National average cost of electricity to residential
custom- ers: 11/kWh PEC average cost to residential customers:
10.27 /kWh (fromprimarysources)and10.92/kWh(renewablesources)
Expected life of a generation facility: 20 to 40 years (it is
likely closer to 20 than 40) Time to construct a facility: 2 to 5
years Capital cost to build a generation facility: $900 to $1500
per kW You have also learned that the PEC staff uses the well-
recognized levelized energy cost (LEC) method to determine the
price of electricity that must be charged to customers to break
even. The formula takes into account the capital cost of the
generation facilities, the cost of capital of borrowed money,
annual maintenance and operation (M&O) costs, and the expected
life of the facility. The LEC formula, expressed in dollars per kWh
for (t 1, 2, ... , n), is LEC t1 tn Pt At Ct (1 i)t t1 tn Et (1 i)t
where Pt capital investments made in year t At annual maintenance
and operating (M&O) costs for year t Ct fuel costs for year t
Et amount of electricity generated in year t n expected life of
facility i discount rate (cost of capital) Case Study Exercises 1.
If you wanted to know more about the new arrange- ment with the
wind farm in south Texas for the addi- tional 60 MW per year, what
types of questions would you ask of a staff member in your rst
meeting with him or her? 2. Much of the current generation capacity
of PEC facilities utilizes coal and natural gas as the primary fuel
source. What about the ethical aspects of the governments allow-
ance for these plants to continue polluting the atmosphere with the
emissions that may cause health problems for citizens and further
the effects of global warming? What types of regulations, if any,
should be developed for PEC (and other generators) to follow in the
future? CASE STUDY RENEWABLE ENERGY SOURCES FOR ELECTRICITY
GENERATION bla76302_fm_i-xx.indd xviiibla76302_fm_i-xx.indd xviii
1/14/11 8:28 PM1/14/11 8:28 PM
19. ACKNOWLEDGMENT OF CONTRIBUTORS It takes the input and
efforts of many individuals to make signicant improvements in a
textbook. We wish to give special thanks to the following persons
for their contributions to this edition. Paul Askenasy, Texas
Commission on Environmental Quality Jack Beltran, Bristol-Myers
Squibb Robert Lundquist, Ohio State University William Peet,
Infrastructure Coordination, Government of Niue Sallie Sheppard,
Texas A&M University We thank the following individuals for
their comments, feedback, and review of material to assist in
making this edition a real success. Ahmed Alim, University of
Houston Alan Atalah, Bowling Green State University Fola Michael
Ayokanmbi, Alabama A&M University William Brown, West Virginia
University at Parkersburg Hector Carrasco, Colorado State
UniversityPueblo Robert Chiang, California State University, Pomona
Ronald Cutwright, Florida State University John F. Dacquisto,
Gonzaga University Houshang Darabi, University of Illinois at
Chicago Freddie Davis, West Texas A&M University Edward Lester
Dollar, Southern Polytechnic State University Ted Eschenbach,
University of Alaska Clara Fang, University of Hartford Abel
Fernandez, University of the Pacic Daniel A. Franchi, California
Polytechnic State University, San Luis Obispo Mark Frascatore,
Clarkson University Benjamin M. Fries, University of Central
Florida Nathan Gartner, University of MassachusettsLowell Johnny R.
Graham, University of North CarolinaCharlotte Liling Huang,
Northern Virginia Community College David Jacobs, University of
Hartford Adam Jannik, Northwestern State University Peter E.
Johnson, Valparaiso University Justin W. Kile, University of
WisconsinPlatteville John Kushner, Lawrence Technological
University Clifford D. Madrid, New Mexico State University Saeed
Manafzadeh, University of Illinois at Chicago Quamrul Mazumder,
University of MichiganFlint Deb McAvoy, Ohio University Gene
McGinnis, Christian Brothers University Bruce V. Mutter, Blueeld
State College Hong Sioe Oey, University of Texas at El Paso Richard
Palmer, University of Massachusetts Michael J. Rider, Ohio Northern
University John Ristroph, University of Louisiana at Lafayette
Saeid L. Sadri, Georgia Institute of Technology Scott Schultz,
Mercer University Kyo D. Song, Norfolk State University James
Stevens, University of Colorado at Colorado Springs John A.
Stratton, Rochester Institute of Technology Mathias J. Sutton,
Purdue University Pete Weiss, Valparaiso University
bla76302_fm_i-xx.indd xixbla76302_fm_i-xx.indd xix 1/14/11 8:28
PM1/14/11 8:28 PM
20. xx Acknowledgment of Contributors Greg Wiles, Southern
Polytechnic State University Richard Youchak, University of
Pittsburgh at Johnstown William A. Young, II, Ohio University If
you discover errors that require correction in the next printing of
the textbook or in updates of the online resources, please contact
us. We hope you nd the contents of this edition helpful in your
academic and professional activities. Leland Blank
[email protected] Anthony Tarquin [email protected]
bla76302_fm_i-xx.indd xxbla76302_fm_i-xx.indd xx 1/14/11 8:28
PM1/14/11 8:28 PM
21. LEARNING STAGE 1 The Fundamentals CHAPTER 1 Foundations of
Engineering Economy CHAPTER 2 Factors: How Time and Interest Affect
Money CHAPTER 3 Combining Factors and Spreadsheet Functions CHAPTER
4 Nominal and Effective Interest Rates T he fundamentals of
engineering economy are introduced in these chapters. When you have
completed stage 1, you will be able to understand and work problems
that account for the time value of money, cash ows occurring at
different times with different amounts, and equivalence at
different interest rates. The techniques you master here form the
basis of how an engineer in any discipline can take economic value
into account in virtually any project environment. The factors
commonly used in all engineering economy computa- tions are
introduced and applied here. Combinations of these fac- tors assist
in moving monetary values forward and backward through time and at
different interest rates. Also, after these chapters, you should be
comfortable using many of the spreadsheet functions. Many of the
terms common to economic decision making are introduced in learning
stage 1 and used in later chapters. A check- mark icon in the
margin indicates that a new concept or guideline is introduced at
this point. L E A R N I N G S T A G E 1 The Fundamentals
bla76302_ch01_001-037.indd 1bla76302_ch01_001-037.indd 1 1/14/11
9:22 PM1/14/11 9:22 PM
22. Purpose: Understand and apply fundamental concepts and use
the terminology of engineering economics. CHAPTER1 Foundations of
Engineering Economy L E A R N I N G O U T C O M E S S E C T I O N T
O P I C L E A R N I N G O U T C O M E 1.1 Description and role Dene
engineering economics and describe its role in decision making. 1.2
Engineering economy study approach Understand and identify the
steps in an engineering economy study. 1.3 Ethics and economics
Identify areas in which economic decisions can present questionable
ethics. 1.4 Interest rate Perform calculations for interest rates
and rates of return. 1.5 Terms and symbols Identify and use
engineering economic terminology and symbols. 1.6 Cash ows
Understand cash ows and how to graphically represent them. 1.7
Economic equivalence Describe and calculate economic equivalence.
1.8 Simple and compound interest Calculate simple and compound
interest amounts for one or more time periods. 1.9 MARR and
opportunity cost State the meaning and role of Minimum Attractive
Rate of Return (MARR) and opportunity costs. 1.10 Spreadsheet
functions Identify and use some Excel functions commonly applied in
engineering economics. bla76302_ch01_001-037.indd
2bla76302_ch01_001-037.indd 2 1/14/11 9:22 PM1/14/11 9:22 PM
23. he need for engineering economy is primarily motivated by
the work that engineers do in performing analyses, synthesizing,
and coming to a conclusion as they work on projects of all sizes.
In other words, engineering economy is at the heart of making
decisions. These decisions involve the fundamental elements of cash
ows of money, time, and interest rates. This chapter introduces the
basic concepts and terminology necessary for an engineer to combine
these three essential elements in organized, mathematically correct
ways to solve problems that will lead to better decisions. 1.1
Engineering Economics: Description and Role in Decision Making
Decisions are made routinely to choose one alternative over another
by individuals in everyday life; by engineers on the job; by
managers who supervise the activities of others; by corporate
presidents who operate a business; and by government ofcials who
work for the public good. Most decisions involve money, called
capital or capital funds, which is usually limited in amount. The
decision of where and how to invest this limited capital is
motivated by a primary goal of adding value as future, anticipated
results of the selected alternative are realized. Engineers play a
vital role in capital investment decisions based upon their ability
and experience to design, analyze, and synthesize. The factors upon
which a decision is based are commonly a combination of economic
and noneconomic elements. Engineering economy deals with the
economic factors. By denition, Engineering economy involves
formulating, estimating, and evaluating the expected economic
outcomes of alternatives designed to accomplish a dened purpose.
Mathematical techniques simplify the economic evaluation of
alternatives. Because the formulas and techniques used in
engineering economics are applicable to all types of money matters,
they are equally useful in business and government, as well as for
individuals. Therefore, besides applications to projects in your
future jobs, what you learn from this book and in this course may
well offer you an economic analysis tool for making personal
decisions such as car purchases, house purchases, major purchases
on credit, e.g., furniture, appliances, and electronics. Other
terms that mean the same as engineering economy are engineering
economic analysis, capital allocation study, economic analysis, and
similar descriptors. People make decisions; computers, mathematics,
concepts, and guidelines assist people in their decision-making
process. Since most decisions affect what will be done, the time
frame of engineering economy is primarily the future. Therefore,
the numbers used in engineering econ- omy are best estimates of
what is expected to occur. The estimates and the decision usually
involve four essential elements: Cash ows Times of occurrence of
cash ows Interest rates for time value of money Measure of economic
worth for selecting an alternative Since the estimates of cash ow
amounts and timing are about the future, they will be some- what
different than what is actually observed, due to changing
circumstances and unplanned events. In short, the variation between
an amount or time estimated now and that observed in the future is
caused by the stochastic (random) nature of all economic events.
Sensitivity analysis is utilized to determine how a decision might
change according to varying esti- mates, especially those expected
to vary widely. Example 1.1 illustrates the fundamental nature of
variation in estimates and how this variation may be included in
the analysis at a very basic level. T EXAMPLE 1.1 An engineer is
performing an analysis of warranty costs for drive train repairs
within the rst year of ownership of luxury cars purchased in the
United States. He found the average cost (to the nearest dollar) to
be $570 per repair from data taken over a 5-year period.
bla76302_ch01_001-037.indd 3bla76302_ch01_001-037.indd 3 1/14/11
9:22 PM1/14/11 9:22 PM
24. 4 Chapter 1 Foundations of Engineering Economy Year 2006
2007 2008 2009 2010 Average Cost, $/repair 525 430 619 650 625 What
range of repair costs should the engineer use to ensure that the
analysis is sensitive to changing warranty costs? Solution At rst
glance the range should be approximately 25% to 15% of the $570
average cost to include the low of $430 and high of $650. However,
the last 3 years of costs are higher and more consistent with an
average of $631. The observed values are approximately 3% of this
more recent average. If the analysis is to use the most recent data
and trends, a range of, say, 5% of $630 is recom- mended. If,
however, the analysis is to be more inclusive of historical data
and trends, a range of, say, 20% or 25% of $570 is recommended. The
criterion used to select an alternative in engineering economy for
a specic set of estimates is called a measure of worth. The
measures developed and used in this text are Present worth (PW)
Future worth (FW) Annual worth (AW) Rate of return (ROR) Benet/cost
(B/C) Capitalized cost (CC) Payback period Economic value added
(EVA) Cost Effectiveness All these measures of worth account for
the fact that money makes money over time. This is the concept of
the time value of money. It is a well-known fact that money makes
money. The time value of money explains the change in the amount of
money over time for funds that are owned (invested) or owed
(borrowed). This is the most important concept in engineering
economy. The time value of money is very obvious in the world of
economics. If we decide to invest capital (money) in a project
today, we inherently expect to have more money in the future than
we invested. If we borrow money today, in one form or another, we
expect to return the original amount plus some additional amount of
money. Engineering economics is equally well suited for the future
and for the analysis of past cash ows in order to determine if a
specic criterion (measure of worth) was attained. For example,
assume you invested $4975 exactly 3 years ago in 53 shares of IBM
stock as traded on the New York Stock Exchange (NYSE) at $93.86 per
share. You expect to make 8% per year appreciation, not considering
any dividends that IBM may declare. A quick check of the share
value shows it is currently worth $127.25 per share for a total of
$6744.25. This increase in value represents a rate of return of
10.67% per year. (These type of calculations are explained later.)
This past investment has well exceeded the 8% per year criterion
over the last 3 years. 1.2 Performing an Engineering Economy Study
An engineering economy study involves many elements: problem
identication, denition of the objective, cash ow estimation,
nancial analysis, and decision making. Implementing a struc- tured
procedure is the best approach to select the best solution to the
problem. The steps in an engineering economy study are as follows:
1. Identify and understand the problem; identify the objective of
the project. 2. Collect relevant, available data and dene viable
solution alternatives. 3. Make realistic cash ow estimates. 4.
Identify an economic measure of worth criterion for decision
making. Time value of money bla76302_ch01_001-037.indd
4bla76302_ch01_001-037.indd 4 1/14/11 9:22 PM1/14/11 9:22 PM
25. 1.2 Performing an Engineering Economy Study 5 5. Evaluate
each alternative; consider noneconomic factors; use sensitivity
analysis as needed. 6. Select the best alternative. 7. Implement
the solution and monitor the results. Technically, the last step is
not part of the economy study, but it is, of course, a step needed
to meet the project objective. There may be occasions when the best
economic alternative requires more capital funds than are
available, or signicant noneconomic factors preclude the most
economic alternative from being chosen. Accordingly, steps 5 and 6
may result in selection of an alternative different from the
economically best one. Also, sometimes more than one proj- ect may
be selected and implemented. This occurs when projects are
independent of one another. In this case, steps 5 through 7 vary
from those above. Figure 11 illustrates the steps above for one
alternative. Descriptions of several of the elements in the steps
are important to understand. Problem Description and Objective
Statement A succinct statement of the problem and primary
objective(s) is very important to the formation of an alternative
solution. As an illustra- tion, assume the problem is that a
coal-fueled power plant must be shut down by 2015 due to the
production of excessive sulfur dioxide. The objectives may be to
generate the forecasted electricity Step in study 1 Expected life
Revenues Costs Taxes Project nancing PW, ROR, B/C, etc. New
engineering economy study begins 5 3 7 6 1 Time passes 2 4 Problem
description Objective statement Measure of worth criterion
Engineering economic analysis Best alternative selection
Implementation and monitoring New problem description Cash ows and
other estimates Available data Alternatives for solution One or
more approaches to meet objective Consider: Noneconomic factors
Sensitivity analysis Risk analysis Figure 11 Steps in an
engineering economy study. bla76302_ch01_001-037.indd
5bla76302_ch01_001-037.indd 5 1/14/11 9:22 PM1/14/11 9:22 PM
26. 6 Chapter 1 Foundations of Engineering Economy needed for
2015 and beyond, plus to not exceed all the projected emission
allowances in these future years. Alternatives These are
stand-alone descriptions of viable solutions to problems that can
meet the objectives. Words, pictures, graphs, equipment and service
descriptions, simulations, etc. dene each alternative. The best
estimates for parameters are also part of the alternative. Some
parameters include equipment rst cost, expected life, salvage value
(estimated trade-in, resale, or market value), and annual operating
cost (AOC), which can also be termed maintenance and operating
(M&O) cost, and subcontract cost for specic services. If
changes in income (revenue) may occur, this parameter must be
estimated. Detailing all viable alternatives at this stage is
crucial. For example, if two alternatives are described and
analyzed, one will likely be selected and implementation initiated.
If a third, more attractive method that was available is later
recognized, a wrong decision was made. Cash Flows All cash ows are
estimated for each alternative. Since these are future expendi-
tures and revenues, the results of step 3 usually prove to be
inaccurate when an alternative is actually in place and operating.
When cash ow estimates for specic parameters are expected to vary
signicantly from a point estimate made now, risk and sensitivity
analyses (step 5) are needed to improve the chances of selecting
the best alternative. Sizable variation is usually ex- pected in
estimates of revenues, AOC, salvage values, and subcontractor
costs. Estimation of costs is discussed in Chapter 15, and the
elements of variation (risk) and sensitivity analysis are included
throughout the text. Engineering Economy Analysis The techniques
and computations that you will learn and use throughout this text
utilize the cash ow estimates, time value of money, and a selected
measure of worth. The result of the analysis will be one or more
numerical values; this can be in one of several terms, such as
money, an interest rate, number of years, or a probability. In the
end, a selected measure of worth mentioned in the previous section
will be used to select the best alternative. Before an economic
analysis technique is applied to the cash ows, some decisions about
what to include in the analysis must be made. Two important
possibilities are taxes and ination. Federal, state or provincial,
county, and city taxes will impact the costs of every alternative.
An after-tax analysis includes some additional estimates and
methods compared to a before-tax analysis. If taxes and ination are
expected to impact all alternatives equally, they may be
disregarded in the analysis. However, if the size of these
projected costs is important, taxes and ination should be
considered. Also, if the impact of ination over time is important
to the decision, an additional set of computations must be added to
the analysis; Chapter 14 covers the details. Selection of the Best
Alternative The measure of worth is a primary basis for selecting
the best economic alternative. For example, if alternative A has a
rate of return (ROR) of 15.2% per year and alternative B will
result in an ROR of 16.9% per year, B is better eco- nomically.
However, there can always be noneconomic or intangible factors that
must be considered and that may alter the decision. There are many
possible noneconomic factors; some typical ones are Market
pressures, such as need for an increased international presence
Availability of certain resources, e.g., skilled labor force,
water, power, tax incentives Government laws that dictate safety,
environmental, legal, or other aspects Corporate managements or the
board of directors interest in a particular alternative Goodwill
offered by an alternative toward a group: employees, union, county,
etc. As indicated in Figure 11, once all the economic, noneconomic,
and risk factors have been evaluated, a nal decision of the best
alternative is made. At times, only one viable alternative is
identied. In this case, the do-nothing (DN) alterna- tive may be
chosen provided the measure of worth and other factors result in
the alternative being a poor choice. The do-nothing alternative
maintains the status quo. bla76302_ch01_001-037.indd
6bla76302_ch01_001-037.indd 6 1/14/11 9:22 PM1/14/11 9:22 PM
27. 1.3 Professional Ethics and Economic Decisions 7 Whether we
are aware of it or not, we use criteria every day to choose between
alternatives. For example, when you drive to campus, you decide to
take the best route. But how did you dene best? Was the best route
the safest, shortest, fastest, cheapest, most scenic, or what?
Obvi- ously, depending upon which criterion or combination of
criteria is used to identify the best, a different route might be
selected each time. In economic analysis, nancial units (dollars or
other currency) are generally used as the tangible basis for
evaluation. Thus, when there are several ways of accomplishing a
stated objective, the alternative with the lowest overall cost or
highest overall net income is selected. 1.3 Professional Ethics and
Economic Decisions Many of the fundamentals of engineering ethics
are intertwined with the roles of money and economics-based
decisions in the making of professionally ethical judgments. Some
of these integral connections are discussed here, plus sections in
later chapters discuss additional aspects of ethics and economics.
For example, Chapter 9, Benet/Cost Analysis and Public Sector Eco-
nomics, includes material on the ethics of public project contracts
and public policy. Although it is very limited in scope and space,
it is anticipated that this coverage of the important role of
economics in engineering ethics will prompt further interest on the
part of students and instruc- tors of engineering economy. The
terms morals and ethics are commonly used interchangeably, yet they
have slightly different interpretations. Morals usually relate to
the underlying tenets that form the character and conduct of a
person in judging right and wrong. Ethical practices can be
evaluated by using a code of morals or code of ethics that forms
the standards to guide decisions and actions of individuals and
organizations in a profession, for example, electrical, chemical,
mechanical, industrial, or civil engineering. There are several
different levels and types of morals and ethics. Universal or
common morals These are fundamental moral beliefs held by virtually
all peo- ple. Most people agree that to steal, murder, lie, or
physically harm someone is wrong. It is possible for actions and
intentions to come into conict concerning a common moral. Consider
the World Trade Center buildings in New York City. After their
collapse on September 11, 2001, it was apparent that the design was
not sufcient to withstand the heat generated by the restorm caused
by the impact of an aircraft. The structural engineers who worked
on the design surely did not have the intent to harm or kill
occupants in the buildings. However, their design actions did not
foresee this outcome as a measurable possibility. Did they violate
the common moral belief of not doing harm to others or murdering?
Individual or personal morals These are the moral beliefs that a
person has and maintains over time. These usually parallel the
common morals in that stealing, lying, murdering, etc. are immoral
acts. It is quite possible that an individual strongly supports the
common morals and has excellent personal morals, but these may
conict from time to time when decisions must be made. Con- sider
the engineering student who genuinely believes that cheating is
wrong. If he or she does not know how to work some test problems,
but must make a certain minimum grade on the nal exam to graduate,
the decision to cheat or not on the nal exam is an exercise in
following or violating a personal moral. Professional or
engineering ethics Professionals in a specic discipline are guided
in their decision making and performance of work activities by a
formal standard or code. The code states the commonly accepted
standards of honesty and integrity that each individual is expected
to demonstrate in her or his practice. There are codes of ethics
for medical doctors, attorneys, and, of course, engineers. Although
each engineering profession has its own code of ethics, the Code of
Ethics for Engineers published by the National Society of
Professional Engineers (NSPE) is very com- monly used and quoted.
This code, reprinted in its entirety in Appendix C, includes
numerous sections that have direct or indirect economic and nancial
impact upon the designs, actions, bla76302_ch01_001-037.indd
7bla76302_ch01_001-037.indd 7 1/14/11 9:22 PM1/14/11 9:22 PM
28. 8 Chapter 1 Foundations of Engineering Economy and
decisions that engineers make in their professional dealings. Here
are three examples from the Code: Engineers, in the fulllment of
their duties, shall hold paramount the safety, health, and wel-
fare of the public. (section I.1) Engineers shall not accept
nancial or other considerations, including free engineering de-
signs, from material or equipment suppliers for specifying their
product. (section III.5.a) Engineers using designs supplied by a
client recognize that the designs remain the property of the client
and may not be duplicated by the engineer for others without
express permission. (section III.9.b) As with common and personal
morals, conicts can easily rise in the mind of an engineer between
his or her own ethics and that of the employing corporation.
Consider a manufacturing engineer who has recently come to rmly
disagree morally with war and its negative effects on human beings.
Suppose the engineer has worked for years in a military defense
contractors facility and does the detailed cost estimations and
economic evaluations of producing ghter jets for the Air Force. The
Code of Ethics for Engineers is silent on the ethics of producing
and using war materiel. Although the employer and the engineer are
not violating any ethics code, the engineer, as an individual, is
stressed in this position. Like many people during a declining
national economy, retention of this job is of paramount importance
to the family and the engi- neer. Conicts such as this can place
individuals in real dilemmas with no or mostly unsatisfactory
alternatives. At rst thought, it may not be apparent how activities
related to engineering economics may present an ethical challenge
to an individual, a company, or a public servant in government ser-
vice. Many money-related situations, such as those that follow, can
have ethical dimensions. In the design stage: Safety factors are
compromised to ensure that a price bid comes in as low as possible.
Family or personal connections with individuals in a company offer
unfair or insider informa- tion that allows costs to be cut in
strategic areas of a project. A potential vendor offers
specications for company-specic equipment, and the design engi-
neer does not have sufcient time to determine if this equipment
will meet the needs of the project being designed and costed. While
the system is operating: Delayed or below-standard maintenance can
be performed to save money when cost overruns exist in other
segments of a project. Opportunities to purchase cheaper repair
parts can save money for a subcontractor working on a xed-price
contract. Safety margins are compromised because of cost, personal
inconvenience to workers, tight time schedules, etc. A good example
of the last itemsafety is compromised while operating the systemis
the situation that arose in 1984 in Bhopal, India (Martin and
Schinzinger 2005, pp. 2458). A Union Carbide plant manufacturing
the highly toxic pesticide chemical methyl isocyanate (MIC) expe-
rienced a large gas leak from high-pressure tanks. Some 500,000
persons were exposed to inhala- tion of this deadly gas that burns
moist parts of the body. There were 2500 to 3000 deaths within
days, and over the following 10-year period, some 12,000 death
claims and 870,000 personal injury claims were recorded. Although
Union Carbide owned the facility, the Indian government had only
Indian workers in the plant. Safety practices clearly eroded due to
cost-cutting mea- sures, insufcient repair parts, and reduction in
personnel to save salary money. However, one of the surprising
practices that caused unnecessary harm to workers was the fact that
masks, gloves, and other protective gear were not worn by workers
in close proximity to the tanks containing MIC. Why? Unlike in
plants in the United States and other countries, there was no air
condition- ing in the Indian plant, resulting in high ambient
temperatures in the facility. Many ethical questions arise when
corporations operate in international settings where the corporate
rules, worker incentives, cultural practices, and costs in the home
country differ from those in the host country. Often these ethical
dilemmas are fundamentally based in the economics that provide
cheaper labor, reduced raw material costs, less government
oversight, and a host of bla76302_ch01_001-037.indd
8bla76302_ch01_001-037.indd 8 1/14/11 9:22 PM1/14/11 9:22 PM
29. 1.3 Professional Ethics and Economic Decisions 9 other
cost-reducing factors. When an engineering economy study is
performed, it is important for the engineer performing the study to
consider all ethically related matters to ensure that the cost and
revenue estimates reect what is likely to happen once the project
or system is operating. It is important to understand that the
translation from universal morals to personal morals and
professional ethics does vary from one culture and country to
another. As an example, consider the common belief (universal
moral) that the awarding of contracts and nancial arrangements for
ser- vices to be performed (for government or business) should be
accomplished in a fair and transparent fashion. In some societies
and cultures, corruption in the process of contract making is
common and often overlooked by the local authorities, who may also
be involved in the affairs. Are these im- moral or unethical
practices? Most would say, Yes, this should not be allowed. Find
and punish the individuals involved. Yet, such practices do
continue, thus indicating the differences in interpreta- tion of
common morals as they are translated into the ethics of individuals
and professionals. EXAMPLE 1.2 Jamie is an engineer employed by
Burris, a United Statesbased company that develops sub- way and
surface transportation systems for medium-sized municipalities in
the United States and Canada. He has been a registered professional
engineer (PE) for the last 15 years. Last year, Carol, an engineer
friend from university days who works as an individual consultant,
asked Jamie to help her with some cost estimates on a metro train
job. Carol offered to pay for his time and talent, but Jamie saw no
reason to take money for helping with data commonly used by him in
performing his job at Burris. The estimates took one weekend to
complete, and once Jamie delivered them to Carol, he did not hear
from her again; nor did he learn the iden- tity of the company for
which Carol was preparing the estimates. Yesterday, Jamie was
called into his supervisors ofce and told that Burris had not
received the contract award in Sharpstown, where a metro system is
to be installed. The project esti- mates were prepared by Jamie and
others at Burris over the past several months. This job was greatly
needed by Burris, as the country and most municipalities were in a
real economic slump, so much so that Burris was considering
furloughing several engineers if the Sharpstown bid was not
accepted. Jamie was told he was to be laid off immediately, not
because the bid was rejected, but because he had been secretly
working without management approval for a prime consultant of
Burris main competitor. Jamie was astounded and angry. He knew he
had done nothing to warrant ring, but the evidence was clearly
there. The numbers used by the com- petitor to win the Sharpstown
award were the same numbers that Jamie had prepared for Burris on
this bid, and they closely matched the values that he gave Carol
when he helped her. Jamie was told he was fortunate, because
Burrispresident had decided to not legally charge Jamie with
unethical behavior and to not request that his PE license be
rescinded. As a result, Jamie was escorted out of his ofce and the
building within one hour and told to not ask anyone at Burris for a
reference letter if he attempted to get another engineering job.
Discuss the ethical dimensions of this situation for Jamie, Carol,
and Burris management. Refer to the NSPE Code of Ethics for
Engineers (Appendix C) for specic points of concern. Solution There
are several obvious errors and omissions present in the actions of
Jamie, Carol, and Burris management in this situation. Some of
these mistakes, oversights, and possible code violations are
summarized here. Jamie Did not learn identity of company Carol was
working for and whether the company was to be a bidder on the
Sharpstown project Helped a friend with condential data, probably
innocently, without the knowledge or ap- proval of his employer
Assisted a competitor, probably unknowingly, without the knowledge
or approval of his employer Likely violated, at least, Code of
Ethics for Engineers section II.1.c, which reads, Engi- neers shall
not reveal facts, data, or information without the prior consent of
the client or employer except as authorized or required by law or
this Code. bla76302_ch01_001-037.indd 9bla76302_ch01_001-037.indd 9
1/14/11 9:22 PM1/14/11 9:22 PM
30. 10 Chapter 1 Foundations of Engineering Economy 1.4
Interest Rate and Rate of Return Interest is the manifestation of
the time value of money. Computationally, interest is the
difference between an ending amount of money and the beginning
amount. If the difference is zero or nega- tive, there is no
interest. There are always two perspectives to an amount of
interestinterest paid and interest earned. These are illustrated in
Figure 12. Interest is paid when a person or organiza- tion
borrowed money (obtained a loan) and repays a larger amount over
time. Interest is earned when a person or organization saved,
invested, or lent money and obtains a return of a larger amount
over time. The numerical values and formulas used are the same for
both perspectives, but the interpretations are different. Interest
paid on borrowed funds (a loan) is determined using the original
amount, also called the principal, Interest amount owed now
principal [1.1] When interest paid over a specic time unit is
expressed as a percentage of the principal, the re- sult is called
the interest rate. Interest rate (%) interest accrued per time unit
principal 100% [1.2] The time unit of the rate is called the
interest period. By far the most common interest period used to
state an interest rate is 1 year. Shorter time periods can be used,
such as 1% per month. Thus, the interest period of the interest
rate should always be included. If only the rate is stated, for
example, 8.5%, a 1-year interest period is assumed. Carol Did not
share the intended use of Jamies work Did not seek information from
Jamie concerning his employers intention to bid on the same project
as her client Misled Jamie in that she did not seek approval from
Jamie to use and quote his information and assistance Did not
inform her client that portions of her work originated from a
source employed by a possible bid competitor Likely violated, at
least, Code of Ethics for Engineers section III.9.a, which reads,
Engi- neers shall, whenever possible, name the person or persons
who may be individually re- sponsible for designs, inventions,
writings, or other accomplishments. Burris management Acted too
fast in dismissing Jamie; they should have listened to Jamie and
conducted an investigation Did not put him on administrative leave
during a review Possibly did not take Jamies previous good work
record into account These are not all ethical considerations; some
are just plain good business practices for Jamie, Carol, and
Burris. (a) (b) Loan Repayment Bank interest Borrower Corporation
Investor Loan Repayment interest Figure 12 (a) Interest paid over
time to lender. (b) Interest earned over time by investor.
bla76302_ch01_001-037.indd 10bla76302_ch01_001-037.indd 10 1/14/11
9:22 PM1/14/11 9:22 PM
31. 1.4 Interest Rate and Rate of Return 11 EXAMPLE 1.3 An
employee at LaserKinetics.com borrows $10,000 on May 1 and must
repay a total of $10,700 exactly 1 year later. Determine the
interest amount and the interest rate paid. Solution The
perspective here is that of the borrower since $10,700 repays a
loan. Apply Equation [1.1] to determine the interest paid. Interest
paid $10,700 10,000 $700 Equation [1.2] determines the interest
rate paid for 1 year. Percent interest rate $700 $10,000 100% 7%
per year EXAMPLE 1.4 Stereophonics, Inc., plans to borrow $20,000
from a bank for 1 year at 9% interest for new recording equipment.
(a) Compute the interest and the total amount due after 1 year. (b)
Con- struct a column graph that shows the original loan amount and
total amount due after 1 year used to compute the loan interest
rate of 9% per year. Solution (a) Compute the total interest
accrued by solving Equation [1.2] for interest accrued. Interest
$20,000(0.09) $1800 The total amount due is the sum of principal
and interest. Total due $20,000 1800 $21,800 (b) Figure 13 shows
the values used in Equation [1.2]: $1800 interest, $20,000 original
loan principal, 1-year interest period. Figure 13 Values used to
compute an interest rate of 9% per year. Example 1.4. $ Now $20,000
Interest = $1800 Original loan amount $21,800 1 year later Interest
period is 1 year Interest rate $1800 $20,000 100% = 9% per year
Comment Note that in part (a), the total amount due may also be
computed as Total due principal(1 interest rate) $20,000(1.09)
$21,800 Later we will use this method to determine future amounts
for times longer than one interest period.
bla76302_ch01_001-037.indd 11bla76302_ch01_001-037.indd 11 1/14/11
9:22 PM1/14/11 9:22 PM
32. 12 Chapter 1 Foundations of Engineering Economy From the
perspective of a saver, a lender, or an investor, interest earned
(Figure 12b) is the nal amount minus the initial amount, or
principal. Interest earned total amount now principal [1.3]
Interest earned over a specic period of time is expressed as a
percentage of the original amount and is called rate of return
(ROR). Rate of return (%) interest accrued per time unit principal
100% [1.4] The time unit for rate of return is called the interest
period, just as for the borrowers perspec- tive. Again, the most
common period is 1 year. The term return on investment (ROI) is
used equivalently with ROR in different industries and settings,
especially where large capital funds are committed to
engineering-oriented programs. The numerical values in Equations
[1.2] and [1.4] are the same, but the term interest rate paid is
more appropriate for the borrowers perspective, while the rate of
return earned is better for the investors perspective. (a)
Calculate the amount deposited 1 year ago to have $1000 now at an
interest rate of 5% per year. (b) Calculate the amount of interest
earned during this time period. Solution (a) The total amount
accrued ($1000) is the sum of the original deposit and the earned
interest. If X is the original deposit, Total accrued deposit
deposit(interest rate) $1000 X X(0.05) X(1 0.05) 1.05X The original
deposit is X 1000 1.05 $952.38 (b) Apply Equation [1.3] to
determine the interest earned. Interest $1000 952.38 $47.62 EXAMPLE
1.5 In Examples 1.3 to 1.5 the interest period was 1 year, and the
interest amount was calculated at the end of one period. When more
than one interest period is involved, e.g., the amount of in-
terest after 3 years, it is necessary to state whether the interest
is accrued on a simple or compound basis from one period to the
next. This topic is covered later in this chapter. Since ination
can signicantly increase an interest rate, some comments about the
funda- mentals of ination are warranted at this early stage. By
denition, ination represents a decrease in the value of a given
currency. That is, $10 now will not purchase the same amount of
gasoline for your car (or most other things) as $10 did 10 years
ago. The changing value of the currency affects market interest
rates. In simple terms, interest rates reect two things: a
so-called real rate of return plus the expected ination rate. The
real rate of return allows the investor to purchase more than he or
she could have purchased before the investment, while ination
raises the real rate to the market rate that we use on a daily
basis. The safest investments (such as government bonds) typically
have a 3% to 4% real rate of return built into their overall
interest rates. Thus, a market interest rate of, say, 8% per year
on a bond means that investors expect the ination rate to be in the
range of 4% to 5% per year. Clearly, ination causes interest rates
to rise. From the borrowers perspective, the rate of ination is
another interest rate tacked on to the real interest rate. And from
the vantage point of the saver or investor in a xed-interest
account, Ination bla76302_ch01_001-037.indd
12bla76302_ch01_001-037.indd 12 1/14/11 9:22 PM1/14/11 9:22 PM
33. 1.5 Terminology and Symbols 13 ination reduces the real
rate of return on the investment. Ination means that cost and
revenue cash ow estimates increase over time. This increase is due
to the changing value of money that is forced upon a countrys
currency by ination, thus making a unit of currency (such as the
dol- lar) worth less relative to its value at a previous time. We
see the effect of ination in that money purchases less now than it
did at a previous time. Ination contributes to A reduction in
purchasing power of the currency An increase in the CPI (consumer
price index) An increase in the cost of equipment and its
maintenance An increase in the cost of salaried professionals and
hourly employees A reduction in the real rate of return on personal
savings and certain corporate investments In other words, ination
can materially contribute to changes in corporate and personal
economic analysis. Commonly, engineering economy studies assume
that ination affects all estimated values equally. Accordingly, an
interest rate or rate of return, such as 8% per year, is applied
throughout the analysis without accounting for an additional
ination rate. However, if ination were explic- itly taken into
account, and it was reducing the value of money at, say, an average
of 4% per year, then it would be necessary to perform the economic
analysis using an inated interest rate. (The rate is 12.32% per
year using the relations derived in Chapter 14.) 1.5 Terminology
and Symbols The equations and procedures of engineering economy
utilize the following terms and symbols. Sample units are
indicated. P value or amount of money at a time designated as the
present or time 0. Also P is referred to as present worth (PW),
present value (PV), net present value (NPV), dis- counted cash ow
(DCF), and capitalized cost (CC); monetary units, such as dollars F
value or amount of money at some future time. Also F is called
future worth (FW) and future value (FV); dollars A series of
consecutive, equal, end-of-period amounts of money. Also A is
called the annual worth (AW) and equivalent uniform annual worth
(EUAW); dollars per year, euros per month n number of interest
periods; years, months, days i interest rate per time period;
percent per year, percent per month t time, stated in periods;
years, months, days The symbols P and F represent one-time
occurrences: A occurs with the same value in each inter- est period
for a specied number of periods. It should be clear that a present
value P represents a single sum of money at some time prior to a
future value F or prior to the rst occurrence of an equivalent
series amount A. It is important to note that the symbol A always
represents a uniform amount (i.e., the same amount each period)
that extends through consecutive interest periods. Both conditions
must exist before the series can be represented by A. The interest
rate i is expressed in percent per interest period, for example,
12% per year. Un- less stated otherwise, assume that the rate
applies throughout the entire n years or interest peri- ods. The
decimal equivalent for i is always used in formulas and equations
in engineering econ- omy computations. All engineering economy
problems involve the element of time expressed as n and interest
rate i. In general, every problem will involve at least four of the
symbols P, F, A, n, and i, with at least three of them estimated or
known. Additional symbols used in engineering economy are dened in
Appendix E. EXAMPLE 1.6 Today, Julie borrowed $5000 to purchase
furniture for her new house. She can repay the loan in either of
the two ways described below. Determine the engineering economy
symbols and their value for each option. bla76302_ch01_001-037.indd
13bla76302_ch01_001-037.indd 13 1/14/11 9:22 PM1/14/11 9:22 PM
34. 14 Chapter 1 Foundations of Engineering Economy (a) Five
equal annual installments with interest based on 5% per year. (b)
One payment 3 years from now with interest based on 7% per year.
Solution (a) The repayment schedule requires an equivalent annual
amount A, which is unknown. P $5000 i 5% per year n 5 years A ? (b)
Repayment requires a single future amount F, which is unknown. P
$5000 i 7% per year n 3 years F ? EXAMPLE 1.7 You plan to make a
lump-sum deposit of $5000 now into an investment account that pays
6% per year, and you plan to withdraw an equal end-of-year amount
of $1000 for 5 years, starting next year. At the end of the sixth
year, you plan to close your account by withdrawing the re- maining
money. Dene the engineering economy symbols involved. Solution All
ve symbols are present, but the future value in year 6 is the
unknown. P $5000 A $1000 per year for 5 years F ? at end of year 6
i 6% per year n 5 years for the A series and 6 for the F value
EXAMPLE 1.8 Last year Janes grandmother offered to put enough money
into a savings account to generate $5000 in interest this year to
help pay Janes expenses at college. (a) Identify the symbols, and
(b) calculate the amount that had to be deposited exactly 1 year
ago to earn $5000 in interest now, if the rate of return is 6% per
year. Solution (a) Symbols P (last year is 1) and F (this year) are
needed. P ? i 6% per year n 1 year F P interest ? $5000 (b) Let F
total amount now and P original amount. We know that F P $5000 is
accrued interest. Now we can determine P. Refer to Equations [1.1]
through [1.4]. F P Pi The $5000 interest can be expressed as
Interest F P (P Pi) P Pi $5000 P(0.06) P $5000 0.06 $83,333.33
bla76302_ch01_001-037.indd 14bla76302_ch01_001-037.indd 14 1/14/11
9:22 PM1/14/11 9:22 PM
35. 1.6 Cash Flows: Estimation and Diagramming 15 1.6 Cash
Flows: Estimation and Diagramming As mentioned in earlier sections,
cash ows are the amounts of money estimated for future projects or
observed for project events that have taken place. All cash ows
occur during specic time peri- ods, such as 1 month, every 6
months, or 1 year. Annual is the most common time period. For
example, a payment of $10,000 once every year in December for 5
years is a series of 5 outgoing cash ows.And an estimated receipt
of $500 every month for 2 years is a series of 24 incoming cash
ows. Engineering economy bases its computations on the timing,
size, and direction of cash ows. Cash inows are the receipts,
revenues, incomes, and savings generated by project and business
activity. A plus sign indicates a cash inow. Cash owCash outows are
costs, disbursements, expenses, and taxes caused by projects and
business activity. A negative or minus sign indicates a cash outow.
When a project involves only costs, the minus sign may be omitted
for some techniques, such as benet/cost analysis. Of all the steps
in Figure 11 that outline the engineering economy study, estimating
cash ows (step 3) is the most difcult, primarily because it is an
attempt to predict the future. Some ex- amples of cash ow estimates
are shown here. As you scan these, consider how the cash inow or
outow may be estimated most accurately. Cash Inow Estimates Income:
$150,000 per year from sales of solar-powered watches Savings:
$24,500 tax savings from capital loss on equipment salvage Receipt:
$750,000 received on large business loan plus accrued interest
Savings: $150,000 per year saved by installing more efcient air
conditioning Revenue: $50,000 to $75,000 per month in sales for
extended battery life iPhones Cash Outow Estimates Operating costs:
$230,000 per year annual operating costs for software services
First cost: $800,000 next year to purchase replacement earthmoving
equipment Expense: $20,000 per year for loan interest payment to
bank Initial cost: $1 to $1.2 million in capital expenditures for a
water recycling unit All of these are point estimates, that is,
single-value estimates for cash ow elements of an alternative,
except for the last revenue and cost estimates listed above.They
provide a range estimate, because the persons estimating the
revenue and cost do not have enough knowledge or experience with
the systems to be more accurate. For the initial chapters, we will
utilize point estimates. The use of risk and sensitivity analysis
for range estimates is covered in the later chapters of this book.
Once all cash inows and outows are estimated (or determined for a
completed project), the net cash ow for each time period is
calculated. Net cash ow cash inows cash outows [1.5] NCF R D [1.6]
where NCF is net cash ow, R is receipts, and D is disbursements. At
the beginning of this section, the timing, size, and direction of
cash ows were mentioned as important. Because cash ows may take
place at any time during an interest period, as a matter of
convention, all cash ows are assumed to occur at the end of an
interest period. The end-of-period convention means that all cash
inows and all cash outows are assumed to take place at the end of
the interest period in which they actually occur. When several
inows and outows occur within the same period, the net cash ow is
assumed to occur at the end of the period. End-of-period convention
bla76302_ch01_001-037.indd 15bla76302_ch01_001-037.indd 15 1/14/11
9:22 PM1/14/11 9:22 PM
36. 16 Chapter 1 Foundations of Engineering Economy In assuming
end-of-period cash ows, it is important to understand that future
(F) and uniform annual (A) amounts are located at the end of the
interest period, which is not necessarily December 31. If in
Example 1.7 the lump-sum deposit took place on July 1, 2011, the
withdraw- als will take place on July 1 of each succeeding year for
6 years. Remember, end of the period means end of interest period,
not end of calendar year. The cash ow diagram is a very important
tool in an economic analysis, especially when the cash ow series is
complex. It is a graphical representation of cash ows drawn on the
y axis with a time scale on the x axis. The diagram includes what
is known, what is estimated, and what is needed. That is, once the
cash ow diagram is complete, another person should be able to work
the problem by looking at the diagram. Cash ow diagram time t 0 is
the present, and t 1 is the end of time period 1. We assume that
the periods are in years for now. The time scale of Figure 14 is
set up for 5 years. Since the end-of-year convention places cash
ows at the ends of years, the 1 marks the end of year 1. While it
is not necessary to use an exact scale on the cash ow diagram, you
will probably avoid errors if you make a neat diagram to
approximate scale for both time and relative cash ow magnitudes.
The direction of the arrows on the diagram is important to
differentiate income from outgo. A vertical arrow pointing up
indicates a positive cash ow. Conversely, a down-pointing arrow in-
dicates a negative cash ow. We will use a bold, colored arrow to
indicate what is unknown and to be determined. For example, if a
future value F is to be determined in year 5, a wide, colored arrow
with F ? is shown in year 5. The interest rate is also indicated on
the diagram. Figure 15 illustrates a cash inow at the end of year
1, equal cash outows at the end of years 2 and 3, an interest rate
of 4% per year, and the unknown future value F after 5 years. The
arrow for the unknown value is generally drawn in the opposite
direction from the other cash ows; however, the engineering economy
computations will determine the actual sign on the F value. Before
the diagramming of cash ows, a perspective or vantage point must be
determined so that or signs can be assigned and the economic
analysis performed correctly. Assume you borrow $8500 from a bank
today to purchase an $8000 used car for cash next week, and you
plan to spend the remaining $500 on a new paint job for the car
two