Engineering Economics Financial Decision Making for Engineers Seventh Edition Niall M. Fraser Open Options Corporation Elizabeth M. Jewkes University of Waterloo Mehrdad Pirnia University of Waterloo Ketra Schmitt Concordia University A01_FRAS8826_07_SE_FM.indd 1 01/10/20 12:01 PM Please contact https://support.pearson.com/getsupport/s/contactsupport with any queries on this content. Pearson Canada Inc., 26 Prince Andrew Place, North York, Ontario M3C 2H4 Copyright © 2022, 2017 Pearson Canada Inc. All rights reserved. Printed in the United States of America. This publication is protected by copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise. 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Description: Seventh edition. | Includes index. | Revision of: Fraser, Niall M. (Niall Morris), 1952–. Engineering economics in Canada. Identifiers: Canadiana 20200285947 | ISBN 9780135728826 (softcover) Subjects: LCSH: Engineering economy—Canada—Textbooks. | LCSH: Engineering economy—Canada— Decision making—Textbooks. | LCGFT: Textbooks. Classification: LCC TA177.4 .F725 2020 | DDC 658.15—dc23 A01_FRAS8826_07_SE_FM.indd 2 05/10/20 4:30 PM Brief Contents Preface ix 10 Public Sector Decision Making 316 Acknowledgments xiv 11 Project Management 356 1 Engineering Decision Making 1 12 Dealing with Uncertainty and Risk 389 2 Time Value of Money 18 Appendix 12A: Basic Concepts of 3 Cash Flow Analysis 48 Probability 428 Appendix 3A: Derivation of Discrete Compound Interest Factors 82 13 Qualitative Considerations and Multiple Criteria 434 4 Comparison Methods Part 1 85 Appendix 13A: Calculating the Appendix 4A: The MARR and the Consistency Ratio for AHP 459 Cost of Capital 121 5 Comparison Methods Part 2 124 Appendix A Compound Interest Factors for Discrete Compounding, Discrete 6 Financial Accounting and Cash Flows 465 Business Plans 161 Appendix B Answers to Selected Problems 488 Appendix 6A: Cost Estimation 198 Appendix C List of Symbols 492 Appendix D List of Formulas 494 7 Replacement Decisions 205 8 Taxes 248 Glossary 496 Appendix 8A: Deriving the Capital Index 502 Tax Factor 281 Credits 509 9 Inflation 283 Appendix 9A: Computing a Price Index 313 iii A01_FRAS8826_07_SE_FM.indd 3 05/10/20 2:27 PM A01_FRAS8826_07_SE_FM.indd 4 01/10/20 12:01 PM Contents Preface ix Review Problems 38 Acknowledgments xiv Study Exercises 41 Mini-Case 2.1 Student Credit Cards 47 1 Engineering Decision Making 1 Engage!, Part 1A Naomi Arrives 2 3 Cash Flow Analysis 48 1.1 Engineering Decision Making 2 Engage!, Part 3A Apples and Oranges 49 1.2 What Is Engineering Economics? 3 Introduction 49 1.3 Making Decisions 4 3.1 Timing of Cash Flows and Modelling 49 Engage!, Part 1B Naomi Settles In 5 3.2 Compound Interest Factors for Discrete Compounding 50 1.4 Dealing with Abstractions 6 3.3 Compound Interest Factors for Single 1.5 The Moral Question: Three True Stories 8 Disbursements or Receipts 51 Analysis of the Examples 10 3.4 Compound Interest Factors for Annuities 53 Close-Up 1.1 Professional Engineering Associations 10 Close-Up 3.1 Capital Recovery Formula 55 Case in Point 1.1 Loss of Life in Engineering Projects 11 Close-Up 3.2 Mortgages 57 1.6 Uncertainty and Sensitivity Analysis 11 Close-Up 3.3 Linear Interpolation 58 1.7 How This Book Is Organized 12 Close-Up 3.4 Bonds 59 Engage!, Part 1C A Taste of What Is to Come 13 3.5 Conversion Factor for Arithmetic Gradient Series 60 Study Exercises 14 Case in Point 3.1 The RIM Park Scandal 62 Mini-Case 1.1 R. v. Syncrude Canada Ltd. 16 3.6 Conversion Factor for Geometric Gradient Series 63 Close-Up 3.5 Estimating Growth Rates 66 2 Time Value of Money 18 3.7 Non-Standard Annuities and Gradients 66 Engage!, Part 2A A Steal for Steel 19 3.8 Present Worth Computations When N S ` 68 Introduction 19 Summary 69 2.1 Interest and Interest Rates 19 Engage!, Part 3B No Free Lunch 70 Review Problems 70 Close-Up 2.1 Financial Terminology 20 Study Exercises 73 Close-Up 2.2 Interest Periods 21 Mini-Case 3.1 The Canadian Oil Sands 80 2.2 Compound and Simple Interest 22 Compound Interest 22 Appendix 3A: Derivation of Discrete Simple Interest 23 Compound Interest Factors 82 2.3 Effective and Nominal Interest Rates 24 2.4 Continuous Compounding 26 4 Comparison Methods Part 1 85 2.5 Cash Flow Diagrams 27 Engage!, Part 4A What’s Best? 86 Close-Up 2.3 Beginning and Ending of Periods 28 Introduction 86 2.6 Depreciation 29 Close-Up 4.1 What Happens with All Those Tax Dollars? 88 Close-Up 2.4 Willingness to Pay 29 4.1 Relations Among Projects 88 Reasons for Depreciation 30 4.2 Minimum Acceptable Rate of Return (MARR) 91 Value of an Asset 30 Case in Point 4.1 Dirk’s New Venture 91 Close-Up 2.5 Depreciation Methods 31 4.3 Present Worth (PW) and Annual Worth (AW) Straight-Line Depreciation 31 Comparisons 92 Declining-Balance Depreciation 33 Close-Up 4.2 Present Cost and Annual Cost 92 Case in Point 2.1 Guilty Figures 35 Present Worth Comparisons for Independent Projects 93 2.7 Equivalence 36 Present Worth Comparisons for Mutually Summary 37 Exclusive Projects 94 Engage!, Part 2B You Just Have to Know When 37 Annual Worth Comparisons 95 v A01_FRAS8826_07_SE_FM.indd 5 01/10/20 12:01 PM vi Contents Close-Up 4.3 Car Payment Calculators 96 Close-Up 6.2 Earnings Before Interest and Income Close-Up 4.4 Future Worth 96 Tax (EBIT) 168 4.4 Comparison of Alternatives with Unequal Lives 97 Estimated Values in Financial Statements 169 4.5 Payback Period 101 Financial Ratio Analysis 170 Advantages and Disadvantages of the Close-Up 6.3 NAICS Codes 170 Payback Period Method 103 Financial Ratios 172 Close-Up 4.5 Discounted Payback Period 103 Close-Up 6.4 Extraordinary Items 173 Summary 104 6.2 Preparing a Business Plan 176 Engage!, Part 4B Doing It Right 105 Case in Point 6.1 Dirk’s Business Plan 177 Review Problems 106 Executive Summary 177 Study Exercises 109 Company Description 177 Mini-Case 4.1 Rockwell International 119 Case in Point 6.2 Dirk’s Business Plan: Company Appendix 4A: The MARR and the Description 178 Cost of Capital 121 Market Analysis/Future Outlook 178 Case in Point 6.3 Dirk’s Business Plan: Market Analysis 179 Management and Organization 179 5 Comparison Methods Part 2 124 Funding Requirements 179 Engage!, Part 5A What’s Best? Revisited 125 Case in Point 6.4 Dirk’s Business Plan: Management and Introduction 125 Funding Requirements 180 5.1 The Internal Rate of Return 125 Sales and Marketing 180 5.2 Internal Rate of Return Comparisons for Case in Point 6.5 Dirk’s Business Plan: Sales and Marketing 180 Independent Projects 128 Appendix 180 5.3 Internal Rate of Return Comparisons for Close-Up 6.5 Outstanding Business Plan 181 Mutually Exclusive Projects 130 Summary 181 Systematic Analysis of Mutually Exclusive Alternatives with the IRR Method 133 Engage!, Part 6B Finding Treasure 181 Case in Point 5.1 The Economics of Electric Vehicles 136 Review Problems 182 Study Exercises 185 5.4 Multiple IRRs 136 Mini-Case 6.1 BlackBerry 195 Close-Up 5.1 The Ethics of Profits 138 5.5 External Rate of Return Methods 138 Appendix 6A: Cost Estimation 198 When to Use the ERR 140 5.6 Equivalence of Rate of Return and Present/Annual Replacement Decisions 205 Worth Methods 141 7 5.7 Levelized Cost 145 Engage!, Part 7A You Need the Facts 206 5.8 Why Choose One Method over the Other? 146 Introduction 206 Close-Up 5.2 Examples of Assessing the Economic 7.1 A Replacement Example 207 Feasibility of Investments 147 7.2 Reasons for Replacement or Retirement 210 Summary 148 7.3 Capital Costs and Other Costs 210 Engage!, Part 5B The Invisible Hand 149 Close-Up 7.1 Estimating Salvage Values and Review Problems 149 Scrap Values 212 Study Exercises 153 7.4 Defender and Challenger Are Identical 212 Mini-Case 5.1 The Galore Creek Project 159 7.5 Challenger Is