Table Of ContentENGINEERING ECONOMY
APPLYING THEORY TO PRACTICE
THIRD EDITION
Ted G. Eschenbach
University of Alaska Anchorage
New York Oxford
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2011
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Copyright ©2011, 2003, 2002 by Oxford University Press, Inc.
First edition ©1995 by Richard D. Irwin/McGraw-Hill.
Published by Oxford University Press, Inc.
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without the prior permission of Oxford University Press.
Library of Congress Cataloging-in-Publication Data
Eschenbach, Ted.
Engineering economy : applying theory to practice / Ted G. Eschenbach. — 3rd ed.
p. cm.
ISBN 978-0-19-976697-0
1. Engineering economy. I. Title.
TA177.4.E833 2010
658.15—dc22
2010022161
Printing number: 9 8 7 6 5 4 3 2 1
Printed in the United States of America
on acid-free paper
C
ASES IN
nd
ENGINEERING ECONOMY 2
William R. Peterson
Minnesota State University, Mankato
Ted G. Eschenbach
University of Alaska Anchorage
With cases contributed by
Kate Abel Stevens Institute of Technology
E. R. “Bear” Baker, IV University of Alaska Anchorage
Michael Dunn Petrotechnical Resources of Alaska
California Polytechnic State University –
Daniel Franchi
San Luis Obispo
Joseph Hartman University of Florida
Paul Kauffmann East Carolina University
Neal Lewis University of Bridgeport
Donald Merino Stevens Institute of Technology
California Polytechnic State University –
Lee McFarland
San Luis Obispo
Karen Schmahl Miami University
Herb Schroeder University of Alaska Anchorage
Andrés Sousa-Poza Old Dominion University
William Truran Stevens Institute of Technology
Oxford University Press
New York Oxford
2009
Oxford University Press
Oxford New York
Auckland Bangkok Buenos Aires Cape Town Chennai
Dar es Salaam Delhi Hong Kong Istanbul Karachi Kolkata
Kuala Lumpur Madrid Melbourne Mexico City Mumbai
Nairobi São Paulo Shanghai Taipei Tokyo Toronto
Copyright © 2009, by Oxford University Press, Inc.
Published by Oxford University Press, Inc.
198 Madison Avenue, New York, New York, 10016
http://www.oup-usa.org
Oxford is a registered trademark of Oxford University Press
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior permission of Oxford University Press.
Library of Congress Cataloging-in-Publication Data
Eschenbach, Ted G.
Cases in engineering economy / William R. Peterson & Ted G. Eschenbach. – 2nd ed.
p. cm.
ISBN 9780195397833
1. Engineering economy — case studies. I. Title.
TA177.4.E83 2009 658.1'52—dc19 88-22764
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
Preface
This text introduces the basic theory and application of engineering economy. It is suitable
for a first course in engineering economy, for self-study by practicing engineers, and for
reference during the practice of engineering. This text includes enough material so that in-
structors have some choices for a first course at the undergraduate level. At the graduate
level, instructors might add supplementary material, such as the cases which are found on
the CD accompanying this text. Examples from all major engineering disciplines are in-
cluded, with both private- and public-sector applications.
HIGHLIGHTS OFTHIRD EDITION CHANGES
Users of the first two editions, reviewers specifically chosen for this revision, and col-
leagues and coauthors for other texts and articles in engineering economy have suggested
the following improvements.
• Cases in Engineering Economy 2nd by Peterson and Eschenbach, with contributed
cases from 13 others, is on the student CD that comes with this text. Specific cases
are suggested at the end of each chapter’s list of problems.
• Anew Appendix B supports the use of financial calculators. This coverage concep-
tually matches the use of the tabulated factors, but it allows students to focus more
on concepts by reducing the time needed for financial arithmetic.
• Ethics has been added to the material on decision-making in Chapter 1.
• The use of uniform flow and gradient assumptions in feasibility and preliminary
economic analysis has been emphasized in Chapter 3.
• The flexibility of spreadsheets to more accurately model reality is emphasized in
Chapter 4.
• Chapter 4 introduces breakeven and what-if analyses. (If instructors need to skip
parts of the book, this coverage makes it possible to skip Chapters 8 and 17 and to
still include basic sensitivity analysis.)
• Chapter 5 now includes a simple formula for a perpetual geometric gradient, as well
as the formulas for a perpetual arithmetic gradient and a perpetual annual series.
• Chapter 10 now includes a spreadsheet approach that greatly simplifies the task of
finding the optimal economic life.
• Chapter 11 now addresses one approach for including mutually exclusive alterna-
tives in the investment opportunity schedule by breaking them into incremental
investments.
xxi
xxii Preface
• Chapter 12 now includes the 50% initial “bonus” depreciation that has been used to
stimulate economic activity.
• Chapter 13 now includes a 1-period example that provides a clearer and simpler
introduction to leverage.
• Chapter 14 now opens with an exhibit that provides multiple examples of benefits
and disbenefits for public projects.
• Chapter 17 now includes a section on creating tornado diagrams, and the student
website includes the file TornadoTemplateEschenbach3rd.xls.
• Chapter 18 now includes a section that provides an overview of real options.
• Appendix Ahas completely revamped examples and problems that more realisti-
cally reflect typical firms.
• Appendix D has been added to provide a set of practice problems for the FE exam.
• The addition of more and more difficult problems within most problem sets.
• Numerous improvements in wording, in the numerical results of examples and prob-
lems, and in the exhibits used to illustrate concepts.
KEY FEATURES OFTHETEXT
The first edition was based on studying what other texts have done well, surveying nearly
250 teachers of engineering economy, and responding to the comments of four sets of
reviewers. Since then users and many reviewers have helped improve on the key features
from the first edition. The following points are still the text's foundation:
1. Conceptually linking theory and practice.
2. Breadth and depth of coverage matched to introductory courses.
3. Emphasis on mutually exclusive alternatives while maintaining the discussion
of constrained project selection.
4. Pedagogical support for the students.
5. Modern computational tools.
1. Conceptually Linking Theory and Practice. Often the realism of engineering
economy texts stops with the numbers plugged into examples and problems. This text presents
the theory, and then it examines common practical violations of theoretical assumptions.
For example, most texts define payback period and demonstrate its inferiority to time
value of money measures. This text also explains why payback continues to be used and why
its use does not lead to bankruptcy. Similarly, this text, like most, explains the assumptions of
repeated lives or salvage values that are needed for valid present worth comparisons. This text
adds a thorough discussion of the impact of failing to satisfy the assumption of identical cost
repetition while using equivalent annual techniques.
I believe that understanding how and why basic principles are applied is more important
and interesting than fine theoretical nuances. In practice and in this text, ranking on the inter-
nal rate of return is used for constrained project selection, and present worth and equivalent
annual cost are used for the selection of mutually exclusive alternatives. This text now includes
complete coverage of incremental internal rate of return and benefit/cost ratios for mutually
exclusive alternatives.
Because students learn best when theory is clearly linked to real-world applications, the ex-
amples and homework problems are specifically chosen to illustrate practical realities and to in-
clude situations in which students can apply engineering economy concepts in their own lives.
Preface xxiii
2. Coverage Matched to Introductory Engineering Economy Courses.
Engineering economy relies on concepts and tools that are developed in accounting,
finance, management science, probability, and statistics. Many topics have far more depth
than can be included in an introductory course, and many engineering economy courses
have no specific prerequisites. To best choose what to include here, I analyzed a list of
needs established by a survey of nearly 250 faculty members in engineering economy.
For example, depreciation methods, income taxes, the distinction between assets and
income, and use of cost accounting data are covered, but more advanced accounting topics
are not. Similarly, the weighted cost of capital is discussed, but finance models for risk and
stock prices are not. Basic models for multiple criteria are included, while utility theory is
not. The application of expected value and decision trees is included from probability, and
learning-curve models for cost estimation from statistics; however, general forecasting
models are omitted.
The survey led to a text that has more material than most instructors will cover in one
semester. Thus, instructors have choices in the topics they will cover. To support this flex-
ibility, topics that were found to be “elective” were presented as independently as possible.
For example, the text includes cost estimating, inflation, sensitivity analysis, multiple cri-
teria evaluation, and economic decision trees, but each presentation is completely inde-
pendent. Appendices of more advanced material are also included with several chapters.
3. Emphasis on Mutually Exclusive Alternatives while Maintaining Coverage
of Constrained Project Selection. Engineering students will first apply the tools of
engineering economy in engineering design. These problems require choices between mu-
tually exclusive alternatives. More design examples have been included in Chapters 1
through 8, mutually exclusive alternatives are the subject of Chapter 9, and the special case
of replacement analysis is the subject of Chapter 10.
The discussion of mutually exclusive alternatives still focuses on the use of present
worth and equivalent annual measures. However, incremental IRRs and B/C ratios are now
covered completely, even though they are not the technique of choice.
Constrained project selection is placed in Chapter 11, rather than the choice of many
authors who relegate capital budgeting to the back of engineering economy texts, where
the presentation focuses on theoretical models and advanced techniques that are rarely
used. However, the capital budgeting problem is often solved in the real world by ranking
on the internal rate of return. Discussing this constrained project selection problem in
Chapter 11 provides a solid, intuitive foundation for selecting the interest rate for the time
value of money. This is applied in the comparison of mutually exclusive alternatives.
4. Pedagogical Support. It is clear that students learn more when the presentation’s
structure and the expectations are clear. Chapter objectives, key words and concepts, and
lists of major points are used to facilitate student understanding.
Realistic examples can engage student interest, and problems drawn from student life
can motivate high performance. To support continuity of understanding and development
of realistic problems, some examples and homework problems are carried through a se-
quence of chapters.
Exhibits are used liberally. It is possible and sometimes desirable to combine tables
and graphics to form more powerful exhibits. Asingle numbering scheme for the exhibits
is used to make it easier to find a referenced exhibit, whether table or figure.
xxiv Preface
5. Modern Computational Tools. Spreadsheets enhance the student's analytical ca-
pabilities, allow the inclusion of more realistic problems, and better prepare students to use
engineering economy after graduation. For these reasons spreadsheets are used in the
examples, and they can be applied to the homework problems. The power of spreadsheets
allows students to learn more and to address problems in realistic detail. Real-world engi-
neering economy almost universally relies on spreadsheets as an analytical tool.
For simpler problems TVM calculators have been used for decades by engineering
economy professors, but not by a large fraction of their students. As detailed in Appendix
B, properly programmed scientific calculators can be used on the FE exam while classes
can permit use of financial calculators or smart phones with a downloaded financial calcu-
lator “app.” As shown in Appendix B, these TVM calculators require the same conceptual
understanding as the tables, but they allow students to spend much less time on arithmetic.
I believe that engineering economy students should understand and be able to use all
of these tools: tables, TVM calculators, and spreadsheets. Then the choice of the tool can
be matched to the situation, the instructor’s requirements, and the student’s preference.
This text is designed to support use of spreadsheets and TVM calculators as instructors
prefer. Spreadsheets and calculators can be (1) an integral part of the course, including in-
struction on their use; (2) required or encouraged for homework without use in class; or (3)
used by students on their own to do homework. Obviously each instructor will define what
is permitted on exams. The spreadsheet instruction sections are placed at the ends of chap-
ters, so that they may be skipped if desired.
ORGANIZATION OFTHETEXT
The overall flow of the material is shown in Exhibit P.1. The first three parts are included in
most courses, but the last chapters in each part (Chapters 4, 8, 10, and 11) can be skipped
without a loss of continuity. Of the chapters that can be skipped without a loss of continuity,
19 on multiple objectives is the most suitable for self-study. Chapters 10 on replacement
analysis, 13 on income taxes, and 17 on sensitivity analysis are the most difficult for self-
study.
Some chapters or sections are more important for specific groups of engineers, such as
Chapter 14 on public sector applications for civil engineers, Chapter 10 on replacement
analysis for industrial engineers, and Section 16.7 on capacity functions for chemical
engineers.
Part One presents concepts that form the fundamental basis for engineering economic
calculations. Part Two reinforces this material for increasingly complex cash flows. Part
Three compares alternatives—those that are mutually exclusive and those that are con-
strained by a limited budget. Part Four includes the effect of income taxes on the private
sector, special concerns of the public sector, and inflation. Part Five explains tools that are
needed to deal with the complexities of the real world.
ACKNOWLEDGMENTS
I have had an enormous amount of help in completing this text. The authors of the numer-
ous other texts that I have used have provided fine examples and shaped my understanding
of the subject. Similarly, students at the University of Alaska Anchorage, the University of
Missouri—Rolla, and Merrimack College have endured classroom testing of drafts and pa-
tiently pointed out where further work was needed.
Preface xxv
EXHIBIT P.1 Organization of the Text (Shaded material can be skipped)
Part One
Basic Concepts and Tools
1 Making Economic Decisions
2 The Time Value of Money
3 Equivalence—A Factor
Approach
Part Two
Analyzing a Project
4 Arithmetic and Geometric
5 Present Worth
Gradients and Spreadsheets
6 Equivalent Annual Worth
7 Rate of Return
Part Three
8 Benefit/Cost Ratios and Other Comparing Alternatives and
Measures Projects
9 Mutually Exclusive Choices
10 Replacement Analysis
11 Constrained Project Selection
Part Four Part Five Appendix
Enhancements for the Real Decision-Making Tools A Accounting Effects in
World 16 Estimating Cash Flows Engineering Economics
12 Depreciation 17 Sensitivity Analysis B Time Value of Money (TVM)
13 Income Taxes 18 Uncertainty and Probability and Calculators
14 Public Sector Engineering 19 Multiple Objectives D Fundamentals of Engineering
Economy (FE) Examination Problems
15 Inflation
Nearly 250 faculty responded to a six-page survey about their current texts, courses,
and desired material for an introductory text. Their responses directed me to the best and
worst aspects of existing texts and provided great insight into their courses. Their responses
specifically guided me in the addition and deletion of topics in my outline.
Other faculty members have provided material, reviewed the manuscript, or tested it
in class. They have provided many helpful comments and criticisms. I would like to thank
the following individuals in particular for their help with the first edition:
James A. Alloway, Jr., Syracuse University
Daniel L. Babcock, University of Missouri—Rolla
Susan Burgess, University of Missouri—Rolla
John R. Canada, North Carolina State University
Barry Clemson, Old Dominion University
William J. Foley, Rensselaer Polytechnic Institute
Timothy J. Gallagher, Colorado State University
Carol S. Gattis, University of Arkansas, Fayetteville
Jarad Golkar, Texas A&M University
Joseph E. Gust, Jr., Northern Arizona University
Kim Hazarvartian, Merrimack College
Donald P. Hendricks, Iowa State University
Ken Henkel, California State University, Chico
Leonard Hom, California State University, Sacramento
Robert G. Lundquist, Ohio State University
Richard W. Lyles, Michigan State University
W. J. Kennedy, Clemson University
xxvi Preface
Anthony K. Mason, California State Polytechnic University at San Luis Obispo
Paul R. McCright, University of South Florida
Nancy L. Mills, University of Southern Colorado
Murl Wayne Parker, Mississippi State University
Louis Plebani, Lehigh University
Jang W. Ra, University of Alaska Anchorage
James Rice, University of Illinois, Chicago
Herbert P. Schroeder, University of Alaska Anchorage
Jack W. Schwalbe, Florida Institute of Technology
Paul L. Shillings, Montana State University
Sanford Thayer, Colorado State University
David Veshosky, Lafayette College
Ed Wheeler, University of Tennessee, Martin
Bob White, Western Michigan University
Henry Wiebe, University of Missouri—Rolla
For the second edition, the following individuals as users or reviewers provided spe-
cific suggestions for improvement:
David G. Alciatore, Colorado State University
Richard Bernhard, North Carolina State University
Ed Dodson, University of California at Santa Barbara
William Girouard, California State Polytechnic University at Pomona
Unknown,University of Arizona
S. M. Gupta, Northeastern University
Dennis Kroll, Bradley University
Jerome Lavelle, North Carolina State University
Gene H. Lee, University of Central Florida
Robert G. Lundquist, Ohio State University
Paul R. Munger, University of Missouri—Rolla
Steven R. Maberry, University of New Mexico
Donald G. Newnan
David C. Slaughter, University of California at Davis
Richard Monroe, Old Dominion University
Bill Moor, Arizona State University
William Peterson, Old Dominion University
Karen Schmahl, Miami University
Maureen Sevigny, Oregon Institute of Technology
Alice Smith, Auburn University
John Whittaker, University of Alberta
Rochelle Young, University of Colorado at Boulder
The following individuals provided insights, reviews, and contributed problems that
have significantly improved this third edition:
