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Engineering Economy

Applying Theory to Practice

Third Edition

Ted Eschenbach

Publication Date - August 2010

ISBN: 9780199772766

672 pages
7-1/2 x 9-1/4 inches

Retail Price to Students: $214.99


Now in its third edition, Ted G. Eschenbach's Engineering Economy: Applying Theory to Practice continues to solidify its reputation as one of the most innovative, authoritative, and reliable texts in Engineering Economics. It provides the tools and concepts--including cost estimating, sensitivity analysis, probability, and multiple objectives--that are necessary to successfully apply engineering economy in industry practice outside of the classroom.

Designed to emphasize the strengths of traditional factors and of spreadsheet coverage, Engineering Economy: Applying Theory to Practice, Third Edition, is an ideal text for undergraduate and beginning graduate-level Engineering Economy courses.

New to this Edition

  • A complete casebook on the in-text CD. Cases in Engineering Economy, Second Edition, by William Peterson and Ted G. Eschenbach (with contributed cases from 13 other professors of engineering economics) provides 54 robust, real-world cases. Each chapter is keyed to the cases--making it quick and easy to integrate them into courses--and complete solutions are available to instructors upon adoption.
  • A new appendix on using financial calculators. Appendix B demonstrates how using financial calculators, while requiring the same conceptual understanding as tables, can be a great time saver.
  • Further spreadsheet integration into topical coverage throughout the book. Chapter 10 now includes a spreadsheet approach that greatly simplifies the task of finding the optimal economic life.
  • Expanded ethics coverage added to the decision-making discussion in Chapter 1.
  • Topical coverage throughout updated and refined. Chapter 12 now includes the 50% initial "bonus" depreciation that has been used to stimulate economic activity; Chapter 18 now overviews real options; and Chapter 5 now includes simple formulae for perpetual economic gradient, perpetual arithmetic gradient, and perpetual annual series.
  • A set of FE exam practice problems in the new Appendix D.


  • Conceptual linking of theory and practice
  • An emphasis on mutually exclusive alternatives while maintaining the discussion of constrained project selection
  • Pedagogical support for students
  • A thorough integration of modern computational tools

About the Author(s)

Ted G. Eschenbach, P.E., is a consultant and Professor Emeritus of Engineering Management at the University of Alaska Anchorage. He received his Ph.D. in industrial engineering from Stanford University and his M.C.E. degree from the University of Alaska Anchorage.

Previous Publication Date(s)

April 2003
December 2001

Table of Contents

    Part One: Basic Concepts and Tools
    Chapter 1. Making Economic Decisions
    1.1 What Is Engineering Economy?
    1.2 Principles for Decision Making
    Common Measure
    Include All Consequences
    Only Differences Matter
    Make Separable Decisions Separately
    Adopt a Systems Viewpoint
    Use a Common Planning Horizon
    Address Uncertainty
    1.3 The Decision-Making Process
    1. Define Problem
    2. Choose Objective(s)
    3. Identify Alternatives
    4. Evaluate Consequences
    5. Select
    6. Implement
    7. Audit
    Summary of the Decision Process
    1.4 The Environment for Decisions
    Nonlinear Process
    Iterative Modeling and Spreadsheets
    One Decision in a Continuing Stream
    Importance of Communication Skills
    Analysis vs. Action
    Private and Public Politics
    1.5 Ethics and Decision Making
    Gaining Knowledge and Building Trust vs. Favors for Influence
    Cost, Quality, and Functionality
    The Environment We Live In
    Safety and Cost
    Emerging Issues and "Solutions"
    Importance of Ethics in Engineering and Engineering Economy
    1.6 The Role of Engineering Economy
    Problem too Small to Merit Engineering Economy
    Time Period too Short to Merit Engineering Economy
    Engineering Economy Dominates Decision Making
    Engineering Economy Is One Factor in Decision Making
    1.6 Operational Economics
    1.7 Summary
    Chapter 2. The Time Value of Money
    2.1 What Is Interest?
    Interest Rates Vary
    2.2 Simple vs. Compound Interest
    Simple Interest
    Compound Interest
    2.3 Cash Flow Diagrams
    Categories of Cash Flow
    Timing of Cash Flows
    It Is Better Not to Simplify the Cash Flow Diagrams
    Drawing Cash Flow Diagrams with a Spreadsheet
    2.4 Equivalence for Four Loans
    Equivalence Defined
    Calculating the Interest for Each Year
    Finding an Equivalent Present Worth
    2.5 Limits on Equivalence
    Equivalence Depends on the Interest Rate
    Equivalence with Respect to Time Value of Money Only
    2.6 Compounding Periods Shorter than a Year
    Compounding Periods Are M per Year
    Nominal vs. Effective Interest
    Continuous Compounding
    2.7 Summary
    Chapter 3. Equivalence Ä a Factor Approach
    3.1 Definitions and Assumptions
    Reality and the Assumed Uniformity of A and G
    3.2 Tables of Engineering Economy Factors
    Factor Notation
    Expanded Factors as Calculator Functions
    Names of the Engineering Economy Factors
    Format for the Interest Rate
    Formulas vs. Factors
    3.3 Single Payment Factors (Ps and Fs)
    Formula Development
    Tabulated Factors
    (P/F) and (F/P) as a Function of i and N
    3.4 Uniform Flows
    Formula Development
    Tabulated Factors
    Calculating an Interest Rate
    (A/P), (A/F), (P/A), and (F/A) vs. i and N
    3.5 Combining Factors
    Deferred Annuities
    Annuities Due for Prepaid Expenses and Other Beginning-of-Year Cash Flows
    Constructing Formulas from Cash Flow Diagrams
    Deriving One Factor's Formula From Another's
    3.6 Arithmetic Gradients
    Using the Arithmetic Gradient Factors
    Arithmetic Gradient Formulas
    3.7 Geometric Gradients
    Geometric Gradients Change at a Constant Rate
    The Basic Geometric Formula
    The Four Geometric Rates
    Mathematical Model for PW
    Present Worth Formula for a Single Geometric Gradient
    Using Equivalent Discount Rates for Geometric Gradients
    3.8 Summary
    Chapter 4. Spreadsheets and Economic Analysis
    4.1 Using Spreadsheets for Economic Analysis
    Why Use Spreadsheets
    Reality and the Flexibility of Spreadsheet Models
    The Elements of a Spreadsheet
    Relative and Absolute Addresses
    4.2 Spreadsheet Modeling
    Using a Data Block
    Defining Variables in a Spreadsheet
    Use Relative and Absolute Addresses in Your Formulas
    Explaining and Labeling Your Formulas
    Formatting Your Spreadsheets
    4.3 Financial Functions in Spreadsheets
    Spreadsheet Annuity Functions
    Spreadsheet Block Functions
    4.4 Examples Show Spreadsheet Models Can Be More Realistic
    4.5 Using Spreadsheets to Get a Project Funded
    Sensitivity Analysis
    Creating Graphs
    Documenting Data Sources
    4.6 Summary
    Part Two: Analyzing a Project
    Chapter 5. Present Worth

    5.1 The Present Worth Measure
    Is PW > 0?
    Standard Assumptions
    5.2 Examples of When to Use Present Worth
    5.3 Rolling Back Irregular Cash Flows for PW Calculations
    5.4 Salvage Values
    5.5 Capitalized Cost and Perpetual Life
    5.6 Staged Projects
    5.7 Cost of Underutilized Capacity
    5.8 Spreadsheets and Shorter Periods
    5.9 Spreadsheets and More Exact Models
    5.10 Summary
    Chapter 6. Equivalent Annual Worth
    6.1 The Equivalent Annual Worth Measure
    6.2 Assumptions and Sign Conventions
    6.3 Examples of Annual Evaluations
    6.4 Finding the EAC of "Irregular" Cash Flows
    EAC of a Single Interior Cash Flow
    Deferred Annuities to Regular Annuities
    6.5 EAC Formulas for Salvage Values and Working Capital
    Capital Recovery with Salvage Values
    Working Capital
    6.6 Perpetual Life
    Assumptions and Formulas
    N vs. Infinity
    Arithmetic Gradients and Perpetual Life
    6.7 Repeated Renewals
    Repetition for Every Subperiod
    Capitalized Costs
    Repeated Renewals with Neither an Initial nor a Final Cash Flow
    6.8 Spreadsheets and Analyzing Loan Repayments
    Finding the Balance Due
    Shortening the Time to Payoff by Increasing Payments
    How Much Goes to Interest? How Much Goes to Principal?
    6.9 Summary
    Chapter 7. Rate of Return
    7.1 The Internal Rate of Return
    7.2 Assumptions
    Multiple Sign Changes
    Reinvestment Assumption
    Applying the IRR Measure
    7.3 Finding the IRR
    Hints and Shortcuts for Finding the IRR
    7.4 Loans and Leases
    7.5 Spreadsheets and the IRR
    RATE Investment Function
    IRR Block Function
    7.6 Multiple Sign Changes
    Mineral Extraction
    Environmental Restoration
    Staged Construction or Expansion
    Summary of Multiple Sign Change Consequences
    7.7 Project Balances over Time
    7.8 Modified Internal Rate of Return (MIRR)
    7.9 Summary
    Chapter 8. Benefit/cost Ratios and Other Measures
    8.1 Measures of Economic Attractiveness
    Conceptual Definitions
    Frequency and Patterns of Use
    8.2 Benefit/Cost Ratio
    8.3 Present Worth Indexes
    Mathematical Definition of PW Indexes
    8.4 Future Worth
    8.5 Payback Period
    Difficulties with Payback Period
    When Can Payback Be Used?
    8.6 Discounted Payback
    Why to Use or Not Use
    Examples of Use
    8.7 Breakeven Volume
    8.8 Summary
    Part Three: Comparing Alternatives and Projects
    Introduction to mutually exclusive and constrained budget problems.
    Chapter 9. Mutually Exclusive Alternatives
    9.1 Applying Engineering Economy to Engineering Design
    9.2 Key Assumption Is the Interest Rate or Minimum Attractive Rate of Return
    Common Assumptions
    9.3 Comparing Alternatives with Lives of the Same Length
    9.4 PWs and Explicitly Comparing Different-Length Lives
    Approaches For Defining a Problem Horizon
    Choosing the Best Horizon
    Mutually Exclusive Alternatives without a Common Horizon
    9.5 EAWs and EACs and Implicitly Comparing Different-Length Lives
    9.6 Using EAC for Different-Length Lives Is a Robust Approach
    Robustness Due to Discounting
    Robustness Due to Estimated Lives
    9.7 Benefit/Cost and IRR Comparisons of Mutually Exclusive Alternatives Require Incremental Analysis
    9.8 Defender/Challenger Analysis
    9.9 PW, EAW, and IRR Have the Same Interest Rate Assumption
    9.10 Using Spreadsheet GOAL SEEK Tool to Calculate Incremental IRRs
    9.11 Summary
    Chapter 10. Replacement Analysis
    10.1 Why Is Equipment Replaced, Retired, or Augmented?
    Reduced Performance
    Altered Requirements
    Risk of Catastrophic Failure or Unplanned Replacement
    Lease or Rental vs. Ownership
    Summary of Reasons for Replacement
    10.2 Old and New Are Mutually Exclusive
    Different-Length Lives
    Economic Life
    10.3 Sunk Costs, Risks, and Short-Term Cost Savings
    Sunk Costs
    Risks of the New often Far Exceed Those of Extending the Old
    Short-term Cost Savings Are Not Enough to Compare Repair vs. Replace
    10.4 Optimal Challengers
    Challenger's Optimal or Economic Life
    Cost Curve for the Challenger's Economic Life
    Spreadsheets for Challenger's Economic Life
    10.5 Optimal Defenders
    Typical Defender's Economic Life
    Incorrect Assumptions for Minimizing the Defender's EAC
    When to Calculate the Defender=s Best EAC
    Flowchart to Summarize the Decision Rules
    10.6 Optimal Capacity Problems
    10.7 Estimating Future Challengers
    A Simple Rule of Thumb
    10.8 Replacement and Repair Models
    Classifying Replacement Models
    Block Replacement
    10.9 Summary and Conclusions
    Chapter 11. Constrained Project Selection
    11.1 The Constrained Project Selection Problem
    Mutually Exclusive Choices vs. Constrained Project Selection
    Budgets and Project Selection
    Problem Size
    Budget Flexibility and Contingency Allowances
    11.2 Ranking Projects
    Investment Opportunity Schedule
    Ranking by PW or EAW Does Not Work
    Strengths and Weaknesses of IRR
    11.3 Determining the Minimum Attractive Rate of Return Using the Opportunity Cost of Capital
    Minimum Attractive Rate of Return (MARR)
    11.4 A Theoretically Optimal Approach for Determining the Capital Budget
    11.5 Capital Limits in the Real World
    Why Capital Are Imposed
    Budget Limits and the Cost of Capital
    11.6 Matching Assumptions to the Real World
    Assumption of Indivisible Projects and Increments of Financing
    Assumption of Project Independence
    Assumption of Simultaneous Evaluation
    Stability and Reinvestment Assumptions
    11.7 Present Worth Indexes and Benefit/Cost Ratios
    11.8 Using the SORT Spreadsheet Tool
    Using Spreadsheet Investment and Block Functions
    Using the SORT Tool
    11.9 Summary
    Appendix 11A Mathematical Programming and Spreadsheets
    Using Spreadsheets to Solve Linear Programs
    Disadvantages of Mathematical Programming Models
    Part Four: Enhancements for the Real World
    Chapter 12. Depreciation

    12.1 Introduction
    12.2 Basic Depreciation Methods
    Straight-Line Method
    Declining Balance Method
    SOYD Method
    Units-of-Production Method
    12.3 Modified Accelerated Cost Recovery System (MACRS)
    Based on Accelerated Cost Recovery System (ACRS)
    Alternate MACRS
    12.4 Gains and Losses on Sales and Recaptured Depreciation
    12.5 Optimal Depreciation Strategies
    12.6 PW of a Depreciation Schedule
    Straight-Line Method
    Declining Balance Method
    SOYD Method
    12.7 Depletion of Resources
    Cost Depletion
    Percentage Depletion
    12.8 Section 179 Deduction and Bonus Depreciation
    Section 179
    Recapture for Section 179 Assets
    Bonus Depreciation
    12.9 Spreadsheet Functions for Depreciation
    Using VDB for MACRS
    12.10 Summary
    Chapter 13. Income Taxes
    13.1 Principles of Income Taxes
    Income, Property, Sales, and Value Added Taxes
    Point of View
    Principles of Calculation
    13.2 Progressive Marginal Tax Rates
    Effective Tax Rate for State, Local, and Federal Taxes
    13.3 Finding Taxable Income When Depreciation Is Included
    Categorizing Before-Tax Cash Flows
    13.4 Calculating After-Tax Cash Flows and EACs Using Tables or Spreadsheets
    Selecting an After-Tax Interest Rate
    13.5 Calculating After-Tax Cash Flows and EACs using Formulas
    Straight-Line Depreciation
    MACRS Depreciation
    Sum-of-the-Years'-digits (SOYD) Depreciation
    13.6 Investment Tax Credits (ITC) and Capital Gains
    History of ITC
    Computing and using an ITC
    Capital Gains
    13.7 Interest Deductions and an After-Tax IRR
    13.8 Summary
    Appendix 13A: Personal Income Taxes
    Chapter 14. Public Sector Engineering Economy
    14.1 Defining Benefits, Disbenefits, and Costs
    Agencies t)That Do Not Serve the Public Directly
    Benefits to Whomsoever They Accrue
    14.2 Why Are Public-Sector Problems Difficult?
    Quantifying and Valuing Benefits
    Long Problem Horizons
    Probabilities of Rare Events
    Multiple Objectives That May Conflict
    Interest Groups with Differing Perspectives
    Selecting an Interest Rate
    14.3 Correct Methods and Interest Rates
    Evaluating a Single Project
    Criteria for Mutually Exclusive Alternatives
    Criteria for Constrained Project Selection
    Deferred Maintenance
    14.4 Whose Point of View?
    What Is Internal? What Is External?
    Federal Subsidies
    Consumers' Surplus
    14.5 Allocating Costs to Benefit Recipients
    14.6 Valuing the Benefits of Public Projects
    A Life's Present Value
    Standards of Federal Agencies
    Risk and Valuing Public Benefits
    14.7 Cost Effectiveness
    14.8 Summary
    Chapter 15. Inflation
    15.1 Defining and Measuring Inflation and Deflation
    The Consumer Price Index (CPI)
    Annual Inflation Rate
    Producer Price Indexes
    15.2 Consistent Assumptions for Interest Rates and Cash Flow Estimates
    Inflation Terminology
    Matching Interest Rates to Inflation Assumptions
    Differential Inflation
    Estimating Differential Inflation
    Accuracy of Inflation Estimates
    15.3 Solving for PW or EAC When Inflation Is Included
    15.4 Inflation Examples with Multiple Inflation Rates
    15.5 Leases and Other Prepaid Expenses
    15.6 Depreciation and Loan Payments
    15.7 Inflation and Other Geometric Gradients
    The Four Geometric Gradients
    Formulas Based on the Equivalent Discount Rate
    15.8 Summary
    Part Five: Decision Making Tools
    Chapter 16. Estimating Cash Flows

    16.1 Introduction
    Importance of Cost Estimating
    The Impact of Early Project Decisions
    16.2 Cash Flow Estimating and Life-Cycle Stages
    Hidden Costs
    Costs during the Project Life Cycle
    16.3 Cash Flow Estimating Standards
    Stages of Cash Flow Estimating
    Conceptual Design
    Preliminary Systems Design
    Final Systems Design
    Cost Estimate Definitions and Accuracy
    16.4 Design Criteria and Specifications
    Design Criteria
    Specifying Performance
    16.5 Modeling the Base Case
    16.6 Using Indexes for an Order-of-Magnitude Estimate
    16.7 Using Capacity Functions for Order-of-Magnitude Estimates
    16.8 Using Growth Curves
    16.9 Using Learning Curves
    16.10 Using Factor Estimates
    16.11 Summary
    Chapter 17. Sensitivity Analysis
    17.1 What Is Sensitivity Analysis?
    Sources of Uncertainty
    Breakeven Charts
    Why Do Sensitivity Analysis?
    17.2 Uncertain Data and Its Impact
    Defining the Limits of Uncertain Data
    Estimating Sensitivities
    17.3 Techniques for Sensitivity Analysis
    The Relative Sensitivity of the Economic Criteria to Different Variables
    Tabulating Relative Sensitivity Analysis
    Tornado Diagram
    More Advanced Techniques
    17.4 Spiderplots
    Defining Spiderplots
    Interpreting a Spiderplot
    17.5 Constructing a Spiderplot
    By Hand
    Using a Spreadsheet
    Choosing a y-axis
    17.6 Constructing Tornado Diagrams
    Tornado Diagrams with Positive Values Only
    Tornado Diagrams with Positive and Negative Values
    Using the Tornado Diagram Template
    17.7 Multiple Alternatives
    17.8 Sensitivity Analysis with Multiple Variables
    17.9 Summary
    Chapter 18. Uncertainty and Probability
    18.1 Probabilities
    18.2 Computing Expected Values
    18.3 Choosing Alternatives Using Expected Values
    18.4 Economic Decision Trees
    Sequential Decisions
    Cash Flows That Occur over Time
    18.5 Risk
    18.6 Risk/Return Tradeoffs
    Buying Insurance
    Balancing Risks and Returns
    Efficient Frontier for Risk/Return Trade-offs
    Approaches to Risk/Return Tradeoffs
    18.7 Real Options
    18.8 Probability Distributions for Economic Outcomes
    Probability Distributions with Multiple Independent Variables
    N and i Need Complete Distributions for Exact Answers
    Continuous and Discrete Probability Distributions
    18.9 Summary
    Chapter 19. Multiple Objectives
    19.1 Multiple Attributes
    Definitions and Trade-offs
    Attribute Categories
    Selecting Multiple Objectives
    19.2 The Process of Evaluating Multiple Objectives
    Eliminating Dominated and Unsatisfactory Alternatives
    Decision Rules for Choosing the Best Alternative
    19.3 Identifying the Attributes
    19.4 Evaluating the Alternatives
    19.5 Graphical Techniques
    Shaded Circles and Squares
    Polar Graph
    19.6 Numerical Scales for Evaluation
    Numerical Variables
    Choosing the Best and the Worst Case
    Verbal Variables
    Missing Values
    19.7 Additive Models
    Direct Assignment of Weights
    Subjective Assignment of Importance Ratings
    Tabular Additive Models
    Graphical Additive Models
    Closing Comment on Additive Models
    19.8 Hierarchical Attributes and Objectives
    19.9 Summary
    A. Accounting
    A.1 Role of Accounting
    A.2 General Accounting
    Business Transactions
    A.3 The Balance Sheet
    Financial Ratios Derived from Balance Sheet Data
    A.4 Income Statement
    Financial Ratios Derived from Income Statement Data
    Linking the Balance Sheet, Income Statement, and Capital Transactions
    A.5 Traditional Cost Accounting
    Direct and Indirect Costs
    Indirect Cost Allocation
    Problems with Traditional Cost Accounting
    A.6 Activity Based Costs (ABC)
    ABC Provides More Accurate Costs
    Using ABC
    Economic Justification Using ABC Data
    Timely and Accurate Data
    A.7 Summary
    B. Time Value of Money (TVM) and Calculators
    B.1 Advantages and Types of TVM Calculators
    B.2 Notation for TVM Calculators
    B.3 Examples with TVM Calculators & Tabulated Factors
    C. End-of-Period Compound Interest Tables
    D. Fundamentals of Engineering (FE) Exam Practice Problems

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