,.........,..

CONTENTS

.,

Preface xix

PART 1 BASICS OF FINANCIAL DECISIONS 1

Chapter I Engineering Economic Decisions 2

1.1 Role of Engineers in Business 4 L 1.1 Types of Business Organization 5 1.1.2 Engineering Economic Decisions 6 1.1.3 Personal Economic Decisions 6

1.2 What Makes the Engineering Economic Decision Difficult? 7

1.3 Economic Decisions versus Design Decisions 8

1.4 Large-Scale Engineering Projects 9 1.4.1 How a Typical Project Idea Evolves 9 1.4.2 Impact of Engineering Projects on Financial Statements 12 1.4.3 A Look Back in 2005: Did Toyota Make the Right Decision? 13

1.5 Common Types of Strategic Engineering Economic Decisions 13

1.6 Fundamental Principles of Engineering Economics 15

Summary 17

Chapter 2 Understanding Financial Statements 18

2.1 Accounting: The Basis of Decision Making 21

2.2 Financial Status for Businesses 22 1 The Balance Sheet 24

2.2.2 The Income Statement 27 2.2.3 The Cash Flow Statement 30

2.3 U sing Ratios to Make Business Decisions 33 2.3.1 Debt Management Analysis 34 2.3.2 Liquidity Analysis 37 2.3.3 Asset Management Analysis 38 2.3.4 Profitability Analysis 39 2.3.5 Market Value Analysis 41 2.3.6 Limitations of Financial Ratios in Business Decisions 42 Summary 43 Prnhl..Tn<1 AA

viii CONTENTS

52Chapter 3 Interest Rate and Economic Equivalence

543.1 Interest: The Cost of Money 553.1.1 The Time Value of Money 563.1.2 Elements of Transactions Involving Interest 593. 1.3 Methods of Calculating Interest 623.1.4 Simple Interest versus Compound Interest 633.2 Economic Equivalence 633.2. 1 Definition and Simple Calculations 663.2.2 Equivalence Calculations: General Principles 713.2 .3 Looking Ahead 713.3 Development of Interest Formulas 723.3. 1 The Five Types of Cash Flows 733.3.2 SingIe-Cash-Flow Formulas 803.3.3 Uneven Payment Series 843.3.4 Equal Payment Series 963.3.5 Linear Gradient Series

1023.3.6 Geometric Gradient Series 1073.4 Unconventional Equivalence Calculations 1073.4. 1 Composite Cash Flows 1143.4.2 Determining an Interest Rate to Establish Economic Equivalence

119Summary 119Problems 129Short Case Studies

Chapter 4 Understanding Money and Its Management 134

1364.1 Nominal and Effective Interest Rates 1364.1.1 Nominal Interest Rates 1374.1.2 Effective Annual Interest Rates 1404.1.3 Effective Interest Rates per Payment Period 1414.1.4 Continuous Compounding 143

4.2 Equivalence Calculations with Effective Interest Rates 1444.2.1 When Payment Period Is Equal to Compounding Period

4.2.2 Compounding Occurs at a Different Rate than that at 145Which Payments Are Made 152Equivalence Calculations with Continuous Payments4.3 1524.3.1 Single-Payment Transactions 1524.3 .2 Continuous-Funds Flow

4.4 Changing Interest Rates

4.4.1 Single Sums of Money

4.4.2 Series of Cash Flows

4.5 Debt Management

4.5.1 Commercial Loans

4 .5.2 Loan versus Lease Financing

4.5.3 Home Mortgage

4.6 Investing in Financial Assets

4.6.1 Inves tment Basics

4.6.2 How to Determine Your Expected Return 4.6.3 Investing in Bonds

Summary

Problems

Short Case Studies

PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS 203

Chapter 5 Present-Worth Analysis 204

". 1 Describing Project Cash Flows

S. 1. 1 Loan versus Projec t Cash Flows

S. J.2 Independent versus Mutually Exclusive Investment Projects

.-.2 Initial Project Screening Method

5.2.1 Payback Period : The Time It Takes to Pay Back

5.2.2 Benefits and Flaws of Payback Screening

5.2.3 Discounted Payback Period

5.2.4 Where Do We Go from Here?

5.3 Discounted Cash Flow Analysis

5.3.1 Net-Present-Worth Criterion

5.3.2 Meaning of Net Present Worth

5.3.3 Basis for Selecting the MARR

SA Variations of Present-Worth Analysis

5.4. I Future-Worth Analysis

5.4.2 Capitalized Equivalent Method

5.5 Comparing Mutually Exclusive Alternatives

5.5.1 Meaning of Mutually Exclusive and "Do Nothing" 5.5.2 Analysis Period

st Kate and Economic Equivalence 52

st of Money 54

55Value of Money

56of Transactions Invo lving Interest

59f Calculating Interest

62terest versus Compound Interest

63alence

and Simple Calculations 63

66ce Calculations: Genera! Principles

71head

71Interest Formulas

ypes of Cash Flows 72 h-Flow Formulas 73

80yment Series

84ent Series

96dient Series

Gradient Series 102

107quivalence Calculations

107Cash Flows

g an Interes t Rate to Establish Economic Equivalence 114

119

119 ~s

129

;tanding Money and Its Management 134

:tive Interest Rates 136

~rest Rates 136

nual Interest Rates 137

140~rest Rates per Payment Period :ompounding

141

143ations with Effective Interest Rates

144nt Period Is Equal to Compounding Period

: Occurs at a Different Rate than that at nts Are Made

145 Itions with Continuous Payments 152 It Transactions

152'nds Flow

152

4.4 Changing Interest Rates 156

4.4.1 Single Sums of Money 156

4.4.2 Series of Cash Flows 158

4.5 Debt Management 159

4.5.1 Commercial Loans 159

4.5 .2 Loan versus Lease Financing 167

4.5.3 Home MOItgage 171

4.6 Investing in Financial Assets 175

4.6.1 Investment Basics 175 4.6.2 How to Determine Your Expected Retum 176

4.6.3 Investing in Bonds 179

Summary 187

Problems 188

Short Case Studies 199

PART 2 EVALUATION OF BUSINESS AND ENGINEERING ASSETS 203

Chapter 5 Present-Worth Analysis 204

5.1 Describing Project Cash Flows 207

5.l.! Loan versus Project Cash Flows 207

5.1.2 Independent versus Mutually Exclusive Investment Projects 209

5.2 Initial Project Screening Method 210

5.2. 1 Payback Period: The Time It Takes to Pay Back 210

5.2.2 Benefits and Flaws of Payback Screening 213

5.2.3 Discounted Payback Period 214

5.2.4 Where Do We Go from Here? 215

5.3 Discounted Cash Flow Analysis 215

5.3.1 Net-Present-Worth Criterion 216

5.3.2 Meaning of Net Present Worth 220 5.3.3 Basis for Selecting the MARR 222

5.4 Variations of Present-Worth Analysis 223

5.4 .! Future-Worth Analysi s 223

5.4.2 Capitalized Equivalent Method 227

5.5 Comparing Mutually Exclusive Alternatives 232

5.5.1 Meaning of Mutually Exclusive and "Do Nothing" 232

5.5.2 Analysis Period 235

).:"3 Analysis Period Equals Project Lives 5.5.4 Analysis Period Differs from Project Lives 5.5.5 Anal ys is Period Is Not Specified

Summary

Problems

Short Case Studies

Chapter 6 Annual Equivalent-Worth Analysis 268

6.1 Annual Equivalent-Worth Criterion

6.1. J Fundamental Decision Rule

6.1.2 Annual-Worth Calculation with Repeating Cash Flow Cycles

6.1.3 Comparing Mutually Exclusive Alternatives

6.2 Capital Costs versus Operating Costs

6.3 Applying Annual-Worth Analysis

6.3. J Benefits of AE Ana lysis

6.3.2 Unit Profit or Cost Calculation

6.3.3 Make-or-Buy Decision

6.3.4 Pricing the Use of an Asset

6.4 Life-Cycle Cost Analysis

6.5 Design Economics

Summary

Problems

Short Case Studies

Chapter 7 Rate-of-Return Analysis 322

7.1 Rate of Return

7.1. I Return on Investment

7.1.2 Return on Invested Capital

7.2 Methods for Finding the Rate of Return

7.2.1 Simple versus Nonsimple Investments

7.2.2 Predicting Multiple i*'s

7.2.3 Computational Methods

7.3 Internal-Rate-of-Return Criterion

7.3.1 Relationship to PW Analysis

7.3.2 Net-Investment Test: Pure versu s Mixed Investments

7.3.3 Decision Rule for Pure Investments

7.3.4 Decision Rule for Mixed Investments

236

238 246

249

249

265

270

270

273

275

277

280

281

28 1

283 286

287

294

303

304

318

324

324

326

327

327

329

331

338

338

339

341 344

7.4 Mutually eXclusIve f\.1 It: I lid 1I v t::"

7.4. J Flaws in Project Ranking by IRR

7.4.2 Incremental Investment Analysis

7.4.3 Handling Unequal Service Lives

Summary

Problems

Short Case Studies

A RT 3 ANALYSIS OF PROJECT CASH FL

lhapter 8 Cost Concepts Relevant to Decision

~.l General Cost Terms

8. I. I Manufacturing Costs

8. 1.2 Nonmanufacturing Costs

~.2 Classifying Costs for Financial Statements

8.2.1 Period Costs

8.2.2 Product Costs

lU Cost Classification for Predicting Cost Behavior

8.3 .1 Volume Index

8.3.2 Cost Behaviors

Future Costs for Business Decisions8.4 8.4. I Di1lerential Cost and Revenue

8.4.2 Opportunity Cost

8.4.3 Sunk Costs

8.4.4 Marginal Cost

8.5 Estimating Profit from Production

8.5 . I Calc ul at ion of Operat ing Income

8.5 .2 Sales Budget for a Manufacturing Business

8.5 .3 Preparing the Production Budget

8.5.4 Preparing the Cost-of-Goods-Sold Budget

8.5.S Preparing the Nonmanufacturing Cost Budget

8.5.6 Putting It All Together: The Budgeted Income State

8.5.7 Looking Ahead

Summary

Problems

Short Case Study

Contents xi

'eriod Equals Project Lives

'eriod Differs from Project Lives

'eriod Is Not Specified

ies

11 Equivalent-Worth Analysis 268

;!nt-Worth Criterion

Hal Decis ion Rule fort h Calculation with Repeating Cash Flow Cycles

g Mutually Exclusive Alternatives

~rsus Operating Costs

I-Worth Analysis

)f AE Analysis

it o r Cost Calculation

Buy Decision

e Use of an Asset

Analysis

ics

lies

of-Return Analysis 322

I Inves tment

I Invested Capital

[ding the Rate of Return

:rsus Nonsimple Investments

~ Multiple i*'s

ional Methods

f-Return Criterion

lip to PW Analysis tment Test: Pure versus Mixed Investments Rill!>. for Pllrp. Tnvestments

236 238 246

249

249

265

270 270

273 275

277

280

281 28 1 283 286

287

294

303

304

3 18

324 324 326

327 327 329 33 1

338 338 339 34 1

7.4 Mutually Exclusive Alternatives 352 7.4. 1 Flaws in Project Ranking by IRR 352 7.4.2 Inc remental Investment Analysis 353 7.4 .3 Handling Unequal Service Lives 360

Summary 363

Problems 364

Short Case Studies 381

PART 3 ANALYSIS OF PROJECT CASH FLOWS 385

Chapter 8 Cost Concepts Relevant to Decision Making 386

8.1 General Cost Terms 388 8. 1.1 Manufac turing Costs 388 8. 1.2 Nonmallufacturing Costs 390

8.2 Classifying Costs for Financial Statements 390 8.2. 1 Period Costs 39 1 8.2.2 Product Costs 391

8.3 Cost Classification for Predicting Cost Behavior 394 8.3 .1 Volume Index 394 8.3.2 Cost Behaviors 395

8.4 Future Costs for Business Decisions 400 8.4. 1 Differential Cost and Revenue 400 8.4.2 Opportunity Cost 404 8.4.3 Sunk Costs 406 8.4.4 Marg inal Cost 406

8.S Estimating Profit from Production 411 8.5.1 Calculation of Operating Income 412 8.5.2 Sales Budget for a Man ufact uring Business 412 8.5 .3 Preparing the Production Budget 413 8.5.4 Preparing the Cost-of-Goods-Sold Budge t 415 8.5.5 Preparing the Nonmanufact uring Cost Budget 416 8.5.6 Putting It All Together: The Budgeted Income Statement 418 8.5.7 Looking Ahead 419 Summary 420 Problems 421

Chapter 9 Depreciation and Corporate Taxes 428

9.1 Asset Depreciation 43 1

9 .1 . 1 Economic Depreciation 432 9. 1.2 Accounting Depreciation 432

9.2 Factors Inherent in Asset Depreciation 433

9.2. 1 Depreciable Property 433

9.2.2 Cost Basis 434

9.2 .3 Useful Life and Salvage Value 435

9.2 .4 Depreciation Methods: Book and Tax Deprec iation 436

9.3 Book Depreciation Methods 437

9.3. 1 Straight-Line Method 437

9. 3.2 Acce lerated Methods 439

9. 3.3 Units-of-Production Method 445

9.4 Tax Depreciation Methods 446

9.4.1 MACR S Deprec iation 446

9.4.2 MACRS Depreci ation Rules 447

9.5 Depletion 453

9.5.1 Cost Depletion 453

9 .5.2 Percentage Depletion 454

9.6 Repairs or Improvements Made to Depreciable Assets 456

9.6. 1 Revis ion of Book Deprec iati on 456

9.6.2 Revis ion of Tax Depreciation 457

9.7 Corporate Taxes 459

9.7.1 Income Taxes on Operating Income 459

9.8 Tax Treatment of G a ins or Losses on Depreciable Assets 462

9.S .1 Di sposa l of a M ACRS Prope rty 462

9.8.2 Calc ulatio ns of Gains and Losses on MACRS Property 464

9.9 Income Tax Rate to Be Used in Economic Analysis 467

9.9 .1 Incre menta l Income Tax Rate 467

9.9 .2 Consideration of State Income Taxes 470

9.10 The Need for Cash Flow in Engineering Economic Analysis 472

9. 10.1 Net Income versus Net Cash Flow 472

9.1 0 .2 Treatment of Noncash Expenses 473

Summary 476

Problems 478

Short Case Studies 487

Chapter 10 Developing Project Cash Flows 490

10.1 Cost-Benefit Estimation for Engineering Projects J0.1.1 Simple Projects

10.1.2 Complex Projec ts

t 0.2 Incremental Cash Flows

1 0.2. I Elements of Cash O utfl ows

10.2.2 Elements of Cash Jnflows

10.2.3 Classification of Cash Flow Elements

10.3 Developing Cash Flow Statements

10.3. 1 Whe n Projects Requi re Only Operating and Investing.

10.3.2 When Projects Require Working-Capital Investments

10.3.3 When Projects Are Financed with Borrowed Funds

10.3.4 When Projec ts Result in Negative Taxable Income

10.3.5 When Projects Require Multiple Asse ts

10.4 Generalized Cash Flow Approach

10.4. I Setting up Net Cash Flow Equations

[0.4.2 Presenting Cash Flows in Compac t Tabul ar Formats 10 .4.3 Lease-or-Bu y Decis ion

Summary

Problems

Short Case Studies

PART 4 HAND LING RISK AN D UN C ERTAI

Chapter II Inflation and Its Impact on Project Ca

11.1 Meaning and Measure ofInflation

11.1. [ Meas uring Infl at ion

J 1.1 .2 Actual versus Constant Dollars

11.2 EquivaJence Calculations under Inflation

11.2. I Market and Inflation-Free Interest Rates

11 .2.2 Constant-Dollar Analys is

1 1.2.3 Actu al-Dollar Analysis

J 1.2.4 Mi xed-Dollar Analysis

11.3 Effects of Inflation on Project Cash Flows

11.3.1 Multiple Inflation Rates

I I .3.2 Effec ts of Borrowed Funds under Inflation

Contents xiii

:iation and Corporate Taxes

lepreciation

Depreciation

n Asset Depreciation

Property

and Salvage Value

1 Methods: Book and Tax Depreciation

1 Methods

e Method

Methods

)duction Me thod

Methods

prec iation

preciation Rules

ion

)epletion

'ements Made to Depreciable Assets

Book Deprec iation

Tax De prec iation

S on Operating Income

Jains or Losses on Depreciable Assets

I MACRS Property

of Gains and Losses on MACRS Property

) Be Used in Economic Analysis

ncome Tax Rate

I of State Income Taxes

Flow in Engineering Economic Analysis

ersus Net Cash Flow

Noncash Expenses

428

431 432 432

433 433 434 435 436

437 437 439 445

446 446 447

453 453 454

456 456 457

459 459

462 462 464

467 467 470

472

472

473

476

478

487

Chapter 10 Developing Project Cash Flows 490

10.1 Cost-Benefit Estimation for Engineering Projects 492 10.1 .1 Simple Projects 493 10.1.2 Complex Projects 493

10.2 Incremental Cash Flows 494 10.2.1 Elements of Cash Outflows 494 10.2.2 Elements of Cash Inflows 495 10.2.3 Classification of Cash Flow Elements 497

10.3 Developing Cash Flow Statements 498 10.3. 1 When Projects Require Only Operating and Investing Activities 498 10.3.2 When Projects Require Working-Capilal Investments 502 10.3.3 Whe n Projects Are Financed with Borrowed Funds 507 10.3.4 When Projects Result in Negative Taxable Income 509 10.3.5 When Projects Require MUltiple Assels 513

10.4 Generalized Cash Flow Approach 516 10.4.1 Setting up Net Cash Flow Equations 517 10.4.2 Presenting Cash Flows in Compact Tabular Formats SIR 10.4.3 Lease-or-B uy Decision 520

Summary 524

Problems 525 Short Case Studies 537

PA RT 4 HAN DLING RI SK AND UN CE RTAINTY 541

Chapter II Inflation and Its Impact on Project Cash Flows 542

11.1 Meaning and Measure of Inflation 544 11.l.l Measuring Inflation 544 11 .1.2 Actual versus Constant Dollars 550

11.2 Equivalence Calculations under Inflation 553 11 .2. 1 Marke t and Inflation-Free Interest Rates 553 11.2.2 Constant-Dollar Analysis 553 11 .2.3 Actual-Dollar Analysis 554 11 .2.4 Mixed-Dollar Analysis 558

11.3 Effects of Inflation on Project Cash Flows 558 11 .3. 1 Multiple Inflation Rates 562 I 1.3.2 Effects of Borrowed Funds under Inflation 563

11.4. I Effects of Inflation on Return on Investment 566 11.4.2 Effects of Inflation on Working Capital 569

Summary 572

Problems 574

Short Case Studies 582

Chapter 12 Project Risk and Uncertainty 584

12.1 Origins of Project Risk 586

12.2 Methods of Describing Project Risk 587

12.2.1 Sensitivity Analysis 587

12.2.2 Break-Even Analysis 591

12.2.3 Scenario Analysis 594

12.3 Probability Concepts for Investment Decisions 596

12.3. 1 Assessment of Probabilities 596

12.3.2 Summary of Probabil istic Information 601

12.3.3 Joint and Conditional Probabilities 603

12.3 .4 Covariance and Coefficient of Correlation 60S

12.4 Probability Distribution of NPW 60S 12.4.1 Procedure for Developing an NPW Di stribution 605

12.4.2 Aggregating Risk over Time 611

12.4.3 Decision Rules for Comparing Mutually Exclusive Risk y Alternatives 616

12.5 Risk Simulation 618

12.5.1 Computer Simulation 619

12.5.2 Model Building 620

12.5.3 Monte Carlo Sampling 623

12.5.4 Simulation Output Analysis 628

12.5.5 Risk Simulation with @RISK 630

12.6 Decision Trees and Sequential Investment Decisions 633

12.6.1 Structuring a Decision-Tree Diagram 634

12.6.2 Worth of Obtaining Additional Information 639

12.6.3 Dec is ion Making after Having Imperfec t

Information 642

Summary 647

Problems 648

Short Case Studies 658

Lnaprer

Risk Management: Financial Options13.1 13.t. I Buy Call Options when You Expect the Price to C

13. 1.2 Bu y Put Options when You Expect the Price to G

Option Strategies13.2 13.2. 1 Bu ying Calls to Reduce Capital That Is at Risk

13.2.2 Protective Puts as a Hedge

13.3 O ption Pricing 13.3 1 Replicating-Portfolio Approach with a Call Optio

13.3.2 Risk-Free Financing Approach

13.3.3 Risk-Neutral Probab ility Approach

13.3 .4 Put-Option Valuation

13 .3.5 Two-Period Binom ial Lattice Option Valuation

J3.3.6 Multiperiod Binomial Lattice Model

13.:n Black-Scholes Option Model

13.4 Real-Options Analysis

13.4. 1 A Conceptual Framework for Real Options in Engineering Economics

13.4.2 Types of Real-Opti on Models

13.5 Estimating Volatility at the Project Level

13.5.1 Estimating a Project's Volatility through a Simple Defe rral Option

13.5.2 Use the Existing Mode l of a Financial Opti on to £

13.6 Compound Options

Summary

Problems

Short Case Studies

PART 5 SPECIAL TOPICS IN ENGlNEER ECONOMICS 715

Chapter 14 Replacement Decisions 716

14.1 Replacement Analysis Fundamentals

14. t . 1 Basic Concepts and Temlinology

14.1.2 Opportunity Cost Approach to Comparing

Defender and Challenger

l"'I.t::dl-'-JI-'I.IUII~ ,",llal, ~I~ ou'+I J

Contents xv

nalysis under Inflation

Inflation on Return on Investment

Inflation on Working Capital

ies

ct Risk and Uncertainty 584

:t Risk

ribing Project Risk

Analysis

,n Analysis

nalysis

.epts for Investment Decisions

t of Probabilities

of Probabilistic Information

""'onditional Probabilities

and Coefficient of Con-elation

'ibution of NPW

for Deve loping an NPW Distribution

19 Risk over Time

~ules for Comparing Mutually Exclusive rnatives

Simulation

Iding

10 Sampling

Output Analysis

lation with @RISK

Id Sequential Investment Decisions : a Decision-Tree Diagram

)btaining Additional Information

taking after Having ImpeIiect

~s

566 Chapter 13 Real-Options Analysis 664 566 569 13.1 Risk Management: Financial Options

572 13.1.1 Buy Call Options when You Expect the Price to Go Up

13.1.2 Buy Put Options when You Expect the Price to Go Down574 13.2 Option Strategies582

13.2.1 Buying Calls to Reduce Capital That Is at Risk

13.2.2 Protective Puts as a Hedge

13.3 Option Pricing

13.3.1 Replicating-Portfolio Approach with a Call Option 586 13 ,3.2 Risk-Free Financing Approach

587 13.3.3 Risk-Neutral Probability Approach

587 13.3.4 Put-Option Valuation

591 13.3.5 Two-Period Binomial Lattice Option Valuation

594 13.3.6 Multiperiod Binomial Lattice Model

596 13.3.7 Black-Scholes Option Model 596

13.4 Real-Options Analysis601

13.4.1 A Conceptual Framework for Real 0pLions 603

in Enginee ring Economics 605

13.4.2 Types of Real-Option Models 605

13.5 Estimating Volatility at the Project Level 605 13.5.1 Estimating a Project's Volatility through a 611 Simple Deferral Option

13.5.2 Use the Existing Model of a Financial Option to Estimate 0 2

616 13.6 Compound Options

618 Summary619

620 Problems

623 Short Case Studies 628 630

PART 5 SPECIAL TOPICS IN ENGINEERING 633 ECONOMlCS 715634 639

Chapter 14 Replacement Decisions 716

642 14.1 Replacement Analysis Fundamentals

647 14.1.1 Basic Concepts and Terminology

648 14.1.2 Opportunity Cost Approach to Comparing 658 Defender and Challenger

666

669

669

670

670

673

675 675

677 679

680 681 683 684

686

687 688

697

697 699

703

708

709

713

718 718

721

l

xiv CC'· tf

~

s

14.2 Econom ic Service Life 723

14.3 Replacement Analysis when the Required Service Is Long 728

14.3.1 Required Assumption s and Decision Frameworks 729

14.3.2 Replacement Strategies under the Infinite Planning Hori zon 730

14.3.3 Replacement Strategies under the Finite Planning Hori zon 73S 14.3.4 Consideration of Technological Change 738

14.4 Replacement Analysis with Tax Considerations 739

Summary 7SS Problems 7S6 Short Case Studies 768

Chapter 15 Capital-Budgeting Decisions 776

IS.1 Methods of Financing 778

IS. 1.1 Equity Financing 779

1S.I.2 Debt Financing 780

15.1 .3 Capital Structure 782

IS.2 Cost of Capital 787

IS.2.1 Cost of Equity 787

15.2.2 Cost of Debt 792

15.2.3 Calculating the Cost of Capital 794

IS.3 Choice of Minimum Attractive Rate of Return 795

15.3 . 1 Choice of MARR when Project Financing Is Known 795

15.3.2 Choice of MARR when Project Financing Is Unknown 797

15.3.3 Choice of MARR under Capital Rat ioning 799

IS.4 Capital Budgeting 803 15.4. 1 Evaluation of Multiple Investment A lternatives 803

15.4.2 Formu lation of Mutually Exclusive Alternatives 803

15.4.3 Capita l-Budgeting Decis ions with Limited Budgets 80S

Summary 809

Problems 810

Short Case Studies 816

Chapter 16 Economic Analysis in the Service Sector 822

16.1 What Is the Service Sector? 824

16. J . 1 Characteristics of the Service Sector 825

16.1.2 How to Price Service 825

)6.2 Economic Analysis in Health-Care Service

16.21 Economic Evaluation Tools

\6.2.2 Cost-Effectiveness Analysis

J6.2.3 How to Use a CEA

16.3 Economic Analysis in the Public Sector

\6.31 What Is Benefit-Cost Analysis?

16.3.2 Framework of Benefit-Cost Analysis

16.3.3 Valuation of Benefits and Costs

16.3.4 Quantifying Benefits and Costs

16.3 .5 Difficulties Inherent in Public-Project Analysis

1Ci.4 Benefit-Cost Ratios 16.4.1 Definition of Benefi t-Cost Ratio

16.4.2 Relationship between BIC Ratio and NPW

16.4.3 Comparing Mutu all y Exclusive Alternatives:

Incremental Analysis

l6.S Analysis of Public Projects Based on Cost-Effectivenl

16.5.1 Cost-Effectiveness Studies in the Public Sector

16.5.2 A Cost-Effecti veness Case Study

Summary

Problems

Short Case Studies

Appendix A Interest Factors for Discrete CO

Index 899

ice Life ~nalysis when the Required Service Is Long

j Assumptions and Decision Frameworks ment Strategies under the Infinite Planning Horizon

:ment Strategies under the Finite Planning Horizon

eration of TechnolOgical Change

Analysis with Tax Considerations

~tudies

776 apital-BUdgeting Decisions

f Financing

ity Financing

t Financing ital Structure

:apital st of Equity

st of Debt alculating the Cost of Capital

)f Minimum Attractive Rate of Return :hoice of MARR when Project Financing Is Known ~hoice of MARR when Project Financing Is Unknown

hoice of MARR under Capital Rationing

I BudgetingEvaluation of Multiple Investment Alternatives Formulation of Mutually Exclusive Alternatives

Capital-Budgeting Decisions with Limited Budgets

ary

ems

t Case Studies

EconomiC Analysis in the Service Sector \6

• T _ .h", ,prvice sector?

.,

723

728 729 730

735 738

739

755

756

768

778 779 780 782

787 787 792

794

795

795 797 799

803 803 803 805

809

8 10

816

822

824 825 Q') <;

16.2 Economic Ana lysis in Health-Care Service

16.2.1 Economic Evaluati on Too ls

16.2 .2 Cost-Effecti veness Analysis

16.2.3 How to Use a CEA

16.3 Economic Analysis in the Public Sector

\6.3.1 What [s Benefit-Cost Analysis?

16.3 .2 Framework of Benefi t-Cost Analys is

16.3.3 Valu at ion of Benefit s and Costs

16.3 .4 Quantifying Benefits and Costs

16.3.5 Difficulties Inherent in Public-Projec t Anal ysis

16.4 Benefit-Cost Ratios

\6.4.1 Definition of Benefit-Cost Ratio

16.4.2 Relationship between BIC Ratio and NPW

16.4.3 Comparing Mu[ually Exclusive Alternatives: Incremental Analysis

16.5 Analysis of Public Projects Based on Cost-Effectiveness

\6.5.1 Cost-Effectiveness Studies in the Public Sector

16.5.2 A Cost-Effecti veness Case Study

Summary

Problems

Short Case Studies

Appendix A Interest Factors for Discrete Compounding

Index 899

Contents xvii

826

827

828

829

832

833

833

834

836

840

840

840

843

843

846

847

847

856

857

862

869