Study Guide

Introduction

This study guide summarizes the key concepts, formulas, and applications from the 10-lecture course “Engineering Economic Analysis.” It is designed to help students achieve the course objectives and prepare for exams and real-world engineering decisions.

Course Objectives and Foundational Skills

Objective Supporting Concepts
Apply rational decision-making Nine steps, fixed input/output criteria
Distinguish cost concepts & estimates Sunk, opportunity, fixed, variable, marginal, average, life-cycle costs
Use time value of money Simple/compound interest, nominal/effective rates, cash flow factors
Compare investment alternatives PW, EUAW, ROR analysis
Incorporate uncertainty, inflation, taxes, replacement Depreciation, ATCF, Sensitivity, B/C Ratio, replacement analysis

Key Tools: - Spreadsheets: For cash flow tables, annuity/block functions, what-if analysis - Cash Flow Diagrams (CFD): Summarize size, sign, and timing of cash flows - Ethics: Consider trade-offs between cost, quality, and functionality

Detailed Lecture Breakdown

Lecture 1: Making Economic Decisions

  • Problem classification: Simple, Intermediate, Complex
  • Rational decision-making process: Nine steps
  • Economic criteria: Maximize profit, fixed input/output
  • Ethics: Issues at every stage

Lecture 2: Estimating Engineering Costs and Benefits

  • Cost concepts: Fixed, variable, marginal, average, sunk, opportunity, cash vs. book
  • Breakeven analysis
  • Life-cycle costs: Committed vs. spent
  • Estimate types: Rough, semidetailed, detailed
  • Estimating models: Per-unit, segmenting, cost indexes, power-sizing, triangulation, learning curve

Lecture 3: Interest and Equivalence

  • Simple vs. compound interest
  • Equivalence: Comparing cash flows at different times
  • Single-payment formulas: Future Worth (F/P), Present Worth (P/F)
  • Nominal vs. effective interest rates
  • Continuous compounding

Lecture 4: Equivalence for Repeated Cash Flows

  • Uniform series (annuity): F/A, A/F, P/A, A/P
  • Arithmetic and geometric gradient series
  • Spreadsheet functions: PMT, PV, FV, NPER, RATE, NPV, IRR

Lecture 5: Present Worth Analysis

  • PW criterion: Maximize NPW or minimize PWC
  • Assumptions: End-of-year cash flows, stable prices, before-tax
  • Comparison: Equal and unequal lives, LCM approach, study period, salvage value
  • Capitalized cost: Infinite time period, P = A/i

Lecture 6: Annual Cash Flow Analysis

  • EUAC, EUAB, EUAW definitions
  • Criteria: Maximize EUAW, minimize EUAC
  • Capital recovery cost
  • Irregular cash flows: Convert to PW, then annualize
  • Analysis period: EUAW for unequal lives
  • Spreadsheet application: Loan analysis, amortization, annuity due

Lecture 7: Rate of Return Analysis and Comparison Methods

  • ROR/IRR: Interest rate where NPW = 0
  • Calculation: Iterative, IRR function
  • Decision criterion: IRR ≥ MARR
  • Incremental analysis: Compare alternatives, calculate ΔIRR
  • Graphical methods: PW/EUAW vs. interest rate, changeover points

Lecture 8: Depreciation and Income Taxes

  • Depreciation: Book cost, reduces taxable income
  • Methods: SL, SOYD, DB, MACRS
  • Income taxes: ATCF calculation
  • Formulas:
    • ATCF = Before-Tax Cash Flow – Taxes
    • Taxes = (Taxable Income) Ă— (Tax Rate)
    • Taxable Income = Revenue – Expenses – Depreciation

Lecture 9: Uncertainty, Sensitivity, and Other Techniques

  • Future Worth (FW) analysis
  • Benefit–Cost Ratio (B/C): Accept if B/C ≥ 1.0, incremental B/C for exclusives
  • Payback period: Time to recover initial cost
  • Uncertainty & sensitivity: Range of estimates, sensitivity analysis, breakeven, what-if, expected value, decision trees

Lecture 10: Replacement and Public Sector Analysis

  • Replacement analysis: Defender vs. challenger
  • Minimum cost life: EUAC minimization
  • Defender marginal cost
  • Public sector analysis: General welfare, broad viewpoint, interest rate selection
  • Primary tool: B/C Ratio, incremental B/C for exclusives