Advanced engineering economics

Table Of Contents:
PART ONE BASIC CONCEPTS AND TECHNIQUES IN ECONOMIC ANALYSIS

Accounting Income and Cash Flow 3(35)

What Is Investment? 3(1)

The Corporate Investment Framework 4(4)

The Objective of the Firm 4(1)

The Functions of the Firm 5(1)

The Analysis Framework 6(1)

Accounting Information 7(1)

The Balance Sheets 8(6)

Reporting Format 8(3)

Cash versus Other Assets 11(1)

Liabilities versus Stockholders' Equity 11(1)

Inventory Valuation 12(1)

Depreciation 13(1)

Working Capital 13(1)

The Income Statement 14(5)

Methods of Reporting Income 14(1)

Reporting Format 14(2)

Measurement of Revenue 16(1)

Measurement of Expenses 17(1)

Retained Earnings, Cash Dividends, and Earnings per Share 18(1)

The Funds Flow Statement 19(6)

The Cash Flow Cycle 20(1)

Basic Relationship 20(1)

Funds Statement on a Cash Basis 21(2)

Funds Statement as Working Capital 23(2)

Tax Accounting and Business Accounting 25(4)

Deferred Income Taxes 25(1)

Computing Deferred Income Taxes 25(2)

Estimating Cash Flows from Income Statement 27(1)

Use of Cash Flows in Evaluating Investments 28(1)

Investment Project and Its Cash Flows 29(4)

The Cash Flow Statement 29(3)

Cash Flows over the Project Life 32(1)

Summary 33(5)

Problems 33(5)

Interest and Equivalence 38(51)

Introduction 38(1)

Cash Flow Profile 38(1)

Time Preference and Interest 39(6)

Time Preference 39(1)

Types of Interest 39(2)

Nominal and Effective Interest Rates 41(4)

Discrete Compounding 45(14)

Comparable Payment and Compounding Periods 45(12)

Noncomparable Payment and Compounding Periods 57(2)

Continuous Compounding 59(6)

Discrete Payments 59(2)

Continuous Cash Flows 61(4)

Equivalence of Cash Flows 65(5)

Concept of Equivalence 65(2)

Equivalence Calculations with Several Interest Factors 67(3)

Effect of Inflation on Cash Flow Equivalence 70(13)

Measure of Inflation 70(2)

Explicit and Implicit Treatments of Inflation in Discounting 72(6)

Home Ownership Analysis during Inflation 78(5)

Summary 83(6)

Problems 83(6)

Transform Techniques in Cash Flow Modeling 89(40)

Introduction 89(1)

Z-Transforms and Discrete Cash Flows 89(19)

The Z-Transform and Present Value 89(2)

Properties of the Z-Transform 91(6)

Development of Present Value Models 97(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