A Concise Introduction to Engineering Economics

P. Cassimatis

• Editore: Routledge
• Anno: 2013
• ISBN:
  9781135831127
• Edizione: 1
• Argomento: Arquitectura
• Categoria: Métodos y materiales arquitectónicos

This comprehensive yet accessible text emphasizes problem solving, evaluation of projects, capital budgeting and resource allocation under risk and uncertainty. Current theory of economics and finance is also discussed andthe text is complemented by a full set of problems, exercises and case studies.

PART I

The scope of engineering economics

1 Engineering and investment decisions

Engineering economics is concerned with problems encountered in making economic decisions for business firms. The increase in complexity of private and public enterprises in recent years requires a systematic evaluation of investment alternatives before a decision is made regarding such problems as the introduction of a new product, the expansion of productive facilities, changes in the product mix, or the adoption of new technology. Engineering economics seeks to provide the analytical framework for decision making from an economic viewpoint, and to advance the engineer's role in the decision process.

1.1 Long-range planning in business

The most important aspect of management is long-range planning. The need for long-range planning is dictated by the increasing number of economic, social, and technological factors which affect the performance of all enterprises. Long-range planning involves three managerial functions: identifying and forecasting a set of objectives, developing a formal plan, and committing the required resources to achieve the plan's objectives. The concept of long-range planning is also consistent with the changing role of governments and corporations in our economy. By adopting long-range planning in its decision making, management recognizes that there is a need for a systematic approach to a whole range of desired goals for economic and social progress.

Undoubtedly profit maximization is a major objective of the firm, and it is so assumed in most corporate plans. However, maximum market share, maximum rate of growth, and other optimal goals are concepts which can be analyzed within the framework of long-range planning. The basic approach is systematic analysis and evaluation of economic alternatives confronting the firm for managerial decision making.

1.2 The investment decision

In the long run, growth and profitability of the firm depend on its ability to increase its productive efficiency and expand its capacity and product lines. New facilities, new products, and new technology require new capital. Since most firms have limited resources, investment decisions require capital budgeting, i.e. the evaluation and selection of the best investment alternatives. The process involves the determination of the firm's cost of capital and the use of certain criteria of profitability. The investment decision usually focuses on the principle that in selecting a capital project, its expected returns must justify the funds expended by the firm in the light of alternative investment opportunities. Capital investment decisions and the sophisticated techniques required for the optimum allocation of the firm's capital expenditures are, in fact, the central focus of engineering economics.

1.3 The scope of engineering economics

Traditional economic theory is concerned with the optimum allocation of resources in our society. Engineering economics deals with the optimum allocation of the enterprise's capital. To this end, engineering economics employs economic theory, mathematical programming, and statistical analysis to formulate and solve problems concerning the evaluation and selection of capital projects.

A basic concept of engineering economics is the time value of money and the techniques associated with it: compounding, discounting, and economic equivalence, which have wide applications in capital expenditure analysis, as well as in financial analysis.

Because capital investments are made in anticipation of returns, their proper evaluation and measurement must be made in concert with their timing and the anticipated economic conditions. This requires a variety of methods for evaluating investments, such as net present value and the internal rate of return, that allow the decision maker to compare alternative projects in order to select the one that is best for the firm's objectives.

Engineering economics is also concerned with the impact of economic and institutional factors on capital investment decisions such as taxes, methods of depreciation, interest rates, and the availability of funds. Capital budgeting decisions are in fact largely determined by engineering economy studies. Also, the evaluation of public projects requires similar analysis in deriving benefit-cost criteria for the optimum allocation of public funds. Capital investments, however, involve a great deal of risk, and risk analysis and its methods are part of engineering economics.

From a managerial point of view, engineering economics contributes to better cost analysis of operations and capacity expansion and profitability analysis. Because capital investments can only be justified on the basis of their future returns, forecasting their cash flows over a time horizon is another essential part of economic analysis.

Finally, engineering economics provides managers with the economic concepts and analytical methods required for the preparation of economic feasibility studies. After all, making sound capital investment decisions is essential for maximizing the value of the firm, and this task is best accomplished by economic feasibility studies which provide a systematic process of selection of the best available capital investment projects.

2 Compounding, discounting, and economic equivalence

The primary goal of management is to maximize profitability for the firm and its shareholders, or to maximize cost-effectiveness in a public enterprise. Achievement of that goal depends in part on the type and timing of capital investments. Engineering economy focuses on the evaluation of capital investment alternatives by analyzing the amount and timing of each project's expected cash flows and expenditures. Central to this analysis is the concept of the time value of money and the techniques based upon it, compounding, discounting, and economic equivalence, which are presented in this...