Engineering Economics

Think like an Economist

 Every field of study has its own language and its own way of
thinking:
 Mathematicians talk about integrals, and vector spaces.
 Lawyers talk about the legal terms.
 Economics is no different. Supply, demand, elasticity,
comparative advantage, consumer surplus, deadweight loss—
these terms are part of the economist’s language.
Definition
What is Engineering Economy ?
 Is a subset of economy for application to engineering
projects

 Engineers seek solutions to problems, and the

economic viability of each potential alternative or
design is normally considered along with the technical
aspects

 Engineering economy involves the evaluation of the

costs and benefits of proposed projects
Typical work flow of Engineering economics
decisions
Why Engineering Economy is Important?

 ƒ There are lots of factors that are considered in

making Decisions, these factors are combinations of
economic and non economic ones. •
Engineers play a major role in investment by making
decisions based on economic analysis and design
considerations
Thus, decisions often reflect the engineer’s choice of
how to best invest funds by choosing the proper
alternative out of a set of alternatives
Role of Engineering Economy in Decision
Making
 Engineers make decisions but tools and computers do
not.
 Tools assist engineers in making decisions.
 Decisions affect what will happen in the future and

thus the time frame of engineering economy is the

future.
 So, engineering economy analysis presents the best

estimates of what is expected to occur.

Understand the Problem
Collect all relevant data/information
Evaluate each alternative
Select the “best” alternative
Implement and monitor
Role of Engineering Economy in Decision
Making

The economic evaluation of alternatives is based on the

so called “Measure of Worth” such as:

 Present worth: amount of money at the current time

 Future worth: amount of money at some future time
 Payback period: Number of years to recover the initial investment
and a stated rate of return.
 Rate of return: Compound interest rate on unpaid or unrecovered
balances.
 Benefit/cost ratio
There are other factors that affect
the decision making such as:
 Social
 Environmental
 Legal
 Political
 Personal
 What is Time Value?
 Time Value of Money (TVM) is an important
concept

 We say that money has a time value because

that money can be invested with the
expectation of earning a positive rate of return
 In other words, “a dollar received today is
worth more than a dollar to be received
tomorrow”

 That is because today’s dollar can be invested

so that we have more than one dollar
tomorrow

21
Time Value of Money;

 Calculation of Future Value

 Calculation of Current Value
 Simple interests and compound

interests
 Continuous compounding

23
Basics of Time Value of Money
Interest rate
 Reward for use of capital$
 Usually expressed in % per year

 Simple Interest
Only the principal earns interest
Interest amount =P • i • n
Future value = P + P • i • n = P (1 + i • n)

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 Basics of Time Value of Money

 Compound Interest
Interest on interest
dependant on compounding period
 (yearly, semi-annually, monthly)

For 2 years:

Future value = P ( 1+i) + i • P (1+i) = P (1+ i)2

For n years:
Future value = P (1+ i)n
 see column 2 of interest tables

25
Compound Interest
 The amount of interest earned each year is
increasing

Year 1: $10
Year 2: $11
Year 3: $12.10

26
 Interest Formulation F  Pe rt

Simple Interest
I (iP)N
F P  I P(1 iN)
Compound Interest
P(1  i)  i[P(1  i)]
P(1  i)(1  i)
P(1  i) 2
After N periods, the total accumulated value F will grow to

F P(1  i) N F
P
(1  i ) N
27
Continuous Compounding
 There is no reason why we need to stop increasing the
compounding frequency at daily

 We could compound every hour, minute, or second

 We can also compound every instant (i.e., continuously):
F  Pe rt

 Here, F is the future value, P is the present value, r is the

annual rate of interest, t is the total number of years, and e
is a constant

28
Ex;
 Invest your dollar for one year at a 6% annual interest
rate
 Accumulate $1.06 at the end of the year.

 So the future value of the dollar is $1.06 given a 6%

interest rate and a one-year period
 In a secure investment will increase in value
depending on the elapsed time and the interest rate.

 Interest rate used in calculation is the effective

interest rate.
 If compounding is once a year it is known as

effective annual interest rate

 Effective quarterly , monthly or daily interest rates

are also used.

Cash Flow & its’ Diagrams
Cash Flow- expenses and receipts
 Engineering projects generally have economic
consequences(Penalty) that occur over an extended period of
time

◦ Example;

◦ If an expensive piece of machinery is installed in a plant

were brought on credit, the simple process of paying for it
may take several years

 Each project is described as cash receipts or expenses at

different points in time

34
 Categories of Cash Flows
The expenses and receipts due to engineering projects usually fall into one
of the following categories:

 First cost: expense to build or to buy and install

 Operations and maintenance (O&M): annual expense, such as

electricity, labor, and minor repairs

 Salvage value: receipt at project termination for sale or transfer of the

equipment (can be a salvage cost)

 Revenues: annual receipts due to sale of products or services

 Overhaul: major capital expenditure that occurs during the asset’s life
35
Principal Uses of A Statement of Cash
Flows
 Evaluate a business’s ability to produce positive cash
flows in the future.
 Determine whether a company can satisfy its
financial obligations.
 Identify sources of differences between a business’s
net income and its related (net) cash flow from
revenue and expense transactions.
 Analyze the impact on a business’s financial
condition of its major investing and financing
transactions.

36
Examples of cash flows

 Deposits to a bank,
 dividend interest payments,
 loan payments,
 operating and maintenance costs,
 And trade-in salvage on equipment.

Whether the cash flow is considered to be a receipt or

disbursement depends on the project under consideration.
Examples of Cash Inflows & Outflows

 Receipts from customers--operating activity

 Loans made to other firms--investing activity

 Dividend payments--financing activity

 Payments to investing activity

 Payments of taxes--operating activity

Slide 14.8 38
Types of Cash Flows

 Single cash flow

 Uniform series

 Linear gradient series

 Geometric gradient series

 Irregular series

40
Cash flows handle by Engineering economic
analysis techniques

Standard cash flows :

1. Single payment cash flow

2. Uniform series cash flow
3. Gradient series cash low
Single payment cash flow

Can occur ;

 At the beginning of the time line (designated as t=0)

 At the end of the time line (designated as t=n) or,
 At any time in between
Cash Flow Diagrams
 The costs and benefits of engineering projects over time are
summarized on a cash flow diagram.

 Pictorial representation of engineering economic problem ;

incomes and expenditures
time period
interest rate

 Cash flow diagram illustrates the size, sign, and timing of individual
cash flows, and forms the basis for engineering economic analysis

 Tool! To show expenses and receipts

43
Cash flow diagrams ;

 A cash flow diagram is created by first drawing a segmented time-based

horizontal line, divided into appropriate time unit.

 Each time when there is a cash flow, a vertical arrow is added  pointing
down for costs and up for revenues or benefits. The cost flows are drawn
to relative scale

 It is customary to take cash flows during a year at the end of the year, or EOY (end-of-
year)

 There are certain cash flows to be handled differently.

Ex;
Rent, which is normally taken at the beginning of a cash period.

There are other pre-paid flows which are handled similarly.

Cash Flow Diagrams

P-Pattern “present”
1 2 3 n

F-Pattern “future”
1 2 3 n

A-Pattern “annual”
1 2 3 n

G-Pattern “gradient”
1 2 3 n

45
Cash Flow Diagrams

$15,000

Positive net Cash flow $2000

(receipts) $13,000 is net positive cash flow

1 2 3 4 5 Time (# of interest periods)

0

Negative net Cash Flow

(payments)

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Single Cash Flow

F
Compounding Process
P
Discounting Process

F
F P(1  i) N P
(1  i) N
P=Present equivalent value A=Annual equivalent value
F= Future equivalent value

47
Example: Value and Interest
 The “value” of money depends on the amount and when it is received or spent.

Example: What amount must be paid to settle a current

debt of $1000 in two years at an interest rate of 8% ?

Solution: $1000 (1 + 0.08) (1 + 0.08) = $1166

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 $1000

 1  2

 $1166
 Example 2
 Boney (right) borrowed $1,000 from a bank at
8% interest.
 Two end-of-year payments: at the end of the
first year, he will repay half of the $1000
principal plus the interest that is due.
 At the end of the second year, he will repay
the remaining half plus the interest for the
second year.

50
Example 2
 Cash flow for this problem is:
End of year Cash flow
0 +$1000
1 -$580 ….(-$500 - $80)
2 -$540 ….. (-$500 - $40)

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Cash Flow Diagram
$1,000

Time (# of interest periods)

1 2

$540
$580

52
Uneven Payment Series
Find the present worth of any uneven stream of
payments by calculating the present value of each
individual payment and summing the results

Future worth can then be calculated by using the

interest formula
P5
P1 P2 P6
P3 F
P0 P4 P
(1  i) N
0 Years

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Equal Payment Series
F

0 1 2 3 N-1
N

A A A A A A

N 1 N 2
F  A(1  i)  A(1  i)  ......A(1  i)  A

F A  A(1 i)  A(1 i)2 .....  A(1 i) N  1

2 N
(1  i)F  A(1  i)  A(1  i)  ....  A(1  i)
Subtracting two above equations from each other yields:
 N 
(1 i)  1

F A  
N 
i 
F(1  i)  F - A  A(1  i)  


54
Linear Gradient Series
(N-1)G
A1
2G
G
Uniform Series

0
0 1 2 N-1 N

 (1  i) N  iN  1
P G  2 N 
 i (1  i) 

Composite Series: uniform series + linear gradient

Find P, given A1, G, I, N
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 Geometric Gradient Series
•Particularly relevant to construction costs
•Cash flows increase by a constant %(g); compound growth
•Example: price changes due to inflation

A1(1+g)N-1 Present Worth, Pn, of any Cash Flow An

Pn A n (1  i)  n A 1 (1  g)n  1 (1  i)  n
A1(1+g)
A1 N (1  g)n  1
P   A1 If i=g, then P=?
0 n 1 (1  i) n
1 2 3 N-1 N
g>0
P
 1 (1g)N (1i) N 
P A   ....i g
1  i g 
Find P, given A1, g, i, N
56
 Note;

 The initial cost, the purchase price, is recorded at the

beginning of Year 1, sometimes referred to as end-of-year 0,
or EOY 0.

 Operating and maintenance costs actually will occur during a

year, but they are recorded at EOY, and so forth.
Example 2; A truck is going to be purchased for $55,000. It will
cost $9,500 each year to operate including fuel and maintenance.
It will need to have its engine rebuilt in 6 years for a cost of
$22,000 and it will be sold at year 9 for $6,000. Here is the cash
flow diagram:
I. Question 1.
Given the cash flow diagram below, answer the questions

What is the initial cost of this new machine?

A. $122,000
B. $19,500.
C. $175,000
D. $36,000
Answer

 C
 It is the cost incurred at the beginning of the first year.
What is the rebuild cost of the machine?

A. $122,000
B. $19,500
C. $175,000
D. $36,000
 A

 The rebuild cost will be incurred several years into the use of
the equipment.
What is the salvage value for the machine?

A. $122,000
B. $19,500
C. $175,000
D. $36,000
 D

 The salvage value is what the equipment brings (the owner

receives) when it is sold.
In what single year is the total combined value of the machine
positive?

A. 2
B. 4
C. 6
D. 9
 D

 In year 9, there are two cash flows, the annual cost of $19,500
and the salvage value, which is revenue and is $36,000. The net
is $16,500 positive.
 The uniform series cash flow, illustrated in the fig
bellow consists of a series of equal transactions
starting at t=1 and ending at t=n. The symbol A
(representing an annual amount) is typically given to
the magnitude of each individual cash flow.
Note
 Cash flows do not begin at the beginning of a year
 Ex: The year 1 cash flow at t=1 , not t=0

The exception to the year-end convention are;

 Initial project cost (purchase cost),trade-in allowance

& other cash flows that are associated with the
inception of the project at t=0
 The gradient series cash flow (illustrated in the fig
51.3) stars with a cash flow ( symbol G) at t=2 and
increases by G each year until t=n, at which time the
final cash flow is (n-1)G. The value of the gradient at
t=1 is zero
Example:

 You are 40 years old and have accumulated $50,000 in

your savings account. You can add $100 at the end of
each month to your account which pays an annual
interest rate of 6% compounded monthly.

 Will you be able to retire in 20 years?

 The time line is divided into 240 monthly periods (20 years
times 12 payments per year) since the payments are made
monthly and the interest is also compounded monthly.

 The $50,000 that you have now ( present value) is a negative

cash outflow since you will treat it as though you were just
now depositing it into the account. It is represented with a
downward pointing arrow with its base at the beginning of the
first period.

 The 240 monthly $100 deposits are also negative outflows

represented with downward pointing arrows placed at the end
of each period.
 Finally you will withdraw some unknown amount
(the future value) after 20 years. Represent this
positive inflow with an upward pointing arrow with
its base at the very end of the last period.

 This diagram was drawn from your point of view.

From the bank's point of view, the present value and
the series of deposits are positive cash inflows, and
the final withdrawal of the future value will be a
negative outflow.
Discount Factors and Equivalence
If you will have no need for money during the next two years,
and any money you receive will immediately go into your
account and earn a 5% effective annual interest rate. Which
of the following options - would be more desirable to you?
 None of the options is superior under the assumptions given.

 If you choose the first option, you will immediately place

$100 into a 5% account, and in two years the account will
have grown to $110.25.

 In fact, the account will contain $110.25 at the end of two

years regardless of
which option you choose.

Therefore, these alternatives are said to be equivalent.

Economic Equivalence
 A combination of time value of money and interest rate
that makes different sums of money at different times
have equal economic value
 The three options are equivalent only for money earning
5% effective annual interest rate.

 If a higher interest rate can be obtained, then the first option will
yield the most money after two years.

 Thus, equivalence depends on the interest rate, and an

alternative that is acceptable to one decision maker may be
unacceptable to another who invests at a higher rate.

 The procedure for determining the equivalent amount is known

as discounting.
Factor Table
Ex
Suppose you deposited $200 at the end of every year for
seven years in an account that earned 6% annual
effective
interest. At the end of seven years, how much would
the account be worth?
Solution
Ex
Suppose you want exactly $1600 in the previous
investment
account at the end of the seventh year. By using
the sinking fund factor, you could calculate the necessary
annual amount you would need to deposit.
Solution
Ex
Suppose you will retire in exactly one year and want
an account that will pay you $20,000 a year for the next
15 years. (The fund will be depleted at the end f
the fifteenth year.) Assuming a 6% annual effective
interest rate, what is the amount you would need to
deposit now?
Solution
Nonannual compounding
Comparison of Alternatives
Present Worth;

 When alternatives do the same job and have the same

lifetimes,

 compare them by converting each to its cash value

today.

 The superior alternative will have the highest present

worth.
Example
 Investment A costs $10000 today and pays back
$11500 two years from now. Investment B costs $8000
today and pays back $4500 each year for two years. If
an interest rate of 5% is used witch alternative is
superior ?
Solution
Example 2

MIT is considering building a new car park near Kendall

Square. No university funds are available (overhead rates are
under pressure) and the new facility would have to pay for
itself from parking fees over a 15 year period. A minimum rate
of return of 10% (before taxes) is required for the project. The
architect has developed four alternative designs for different
numbers of parking levels in the structure. Based on the
income and cost data in the Table below, how many levels
should be built?

 (NOTE: Prepare your analysis on a before-tax basis.)

 Since the lifetime of each facility is 15 years, we can use the PW criterion
to compare the alternatives.

Construct the generic cash flow diagram

Calculate the PW based on the following
formula
The PW for each option is calculated below
Since PW(3) is the greatest it is to our advantage to build
the 3 level parking garage.
Example 2:

 A small dam is being planned for a river tributary

(branch) that is subject to frequent flooding. From past
experience, the probabilities that water flow will
exceed the design capacity of the dam during a year,
plus relevant cost information, are as follows:
Ex 2 conti…
Ex 2 conti…
 Estimated annual damages that occur if water flows
exceed design capacity are $150000, $160000,
$175000, $190,000, and $210000 for design A, B, C,
D, and E, respectively. The life of the dam is expected
to be 50 years, with negligible salvage value. For an
interest rate of 8% per year, determine which design
should be implemented. What non monetary
considerations might be important to the selection?
The design to be chosen should have the minimum PW.

The present worth of the total cost includes;

the initial investment and

the annual damages resulting from the probability of
the overflow.

The PW can be calculated according to the following

formula
Where i% is the interest rate,
N is the lifetime of the project,
A is the annual repair cost,
p is the probability of an overflow and
Io is the initial investment
Important Concepts and Guidelines
Time Value of Money
 Money makes money.

 This concept explains the change in the amount of

money over time for both owned and borrowed funds
Cash Flow
 The flow of money into and out of a company, project,
or activity.

 Revenues are cash inflows and carry a positive (+)

sign;

 Expenses are outflows and carry a negative (−) sign.

 If only costs are involved, the − sign may be omitted,

e.g., benefit/cost (B/C) analysis
End-of-Period Convention
 To simplify calculations, cash flows (revenues and
costs) are assumed to occur at the end of a time period .

 An interest period or fiscal period is commonly 1

year .

 A half-year convention is often used in depreciation

calculations.
Cost of Capital
 The interest rate incurred to obtain capital investment
funds.

 COC is a weighted average that involves the cost of

debt capital (loans, bonds, and mortgages) and equity
capital (stocks and retained earnings)
Minimum Attractive Rate of Return
(MARR)

 A reasonable rate of return established for the evaluation of an

economic alternative (choice).

 Also called the hurdle rate,

 MARR is based on cost of capital, market trend, risk, etc.

 The inequality ROR ≥ MARR > COC is correct for an

economically viable project.
Opportunity Cost
 A forgone (given up) opportunity caused by the
inability to pursue (follow) a project.

 Numerically, it is the largest rate of return of all the

projects not funded due to the lack of capital funds.

 Stated differently, it is the ROR of the first project

rejected because of unavailability of funds.
Nominal or Effective Interest Rate ( r or i )
 A nominal interest rate does not include any
compounding;
 Example: 1% per month is the same as nominal 12% per
year.

 Effective interest rate ; actual rate over a period of time

because compounding is imputed;

 Example;
1% per month, compounded monthly, is an effective
12.683% per year. Inflation or deflation is not considered.
Placement of Present Worth ( P ; PW)
 In applying the ( P/A , i %, n ) factor, P or PW is
always located one interest period (year) prior to the
first A amount . The A or AW is a series of equal, end-of-
period cash flows for n consecutive periods, expressed
as money per time (say, $/year; /year).
Placement of Future Worth ( F ; FW)
 In applying the ( F/A , i %, n ) factor, F or FW is
always located at the end of the last interest period
(year) of the A series
Placement of Gradient Present Worth (P G ; P g)

 The ( P / G , i %, n ) factor for an arithmetic gradient

finds the P G of only the gradient series 2 years prior to the first
appearance of the constant gradient G.

The base amount A is treated separately from the gradient series.

The ( P / A , g , i , n ) factor for a geometric gradient determines

P g for the gradient and initial amount A1 two years prior to
the appearance of the first gradient amount.

The initial amount A1 is included in the value of P g .

Payback Period
 Amount of time n before recovery of the initial capital
investment is expected.

 (Payback with i > 0 or simple payback at i = 0 is useful

for preliminary or screening analysis to determine if a
full PW, AW, or ROR analysis is needed)
Salvage/Market Value
 Expected trade-in, market, or scrap value at the end of
the estimated life or the study period .

 ( In a replacement study, the defender’s estimated market value at the end

of a year is considered its “first cost” at the beginning of the next year.

 MACRS depreciation always reduces the book value to a salvage of zero)

Equal-Service Requirement
 Identical capacity of all alternatives operating over the same amount
of time is mandated by the equal-service requirement.

 Estimated costs and revenues for equal service must be evaluated.

 PW analysis requires evaluation over the same number of years

(periods) using the LCM (least common multiple) of lives;

 AW analysis is performed over one life cycle.

 Further, equal service assumes that all costs and revenues rise and
fall in accordance with the overall rate of inflation or deflation over
the total time period of the evaluation.
LCM or Study Period
 To select from mutually exclusive alternatives under
the equal-service requirement for PW computations,
use the LCM of lives with repurchase(s) as necessary.

 For a stated study period (planning horizon), evaluate

cash flows only over this period , neglecting any
beyond this time; estimated market values at
termination of the study period are the salvage values.
Do Nothing
 The DN alternative is always an option, unless one of
the defined alternatives must be selected.

 DN is status quo; it generates no new costs, revenues,

or savings
Revenue or Cost Alternative
 Revenue alternatives have costs and revenues
estimated; savings are considered negative costs and
carry a + sign.

 Incremental evaluation requires comparison with DN

for revenue alternatives.

 Cost (or service) alternatives have only costs estimated;

revenues and savings are assumed equal between
alternatives
Rate of Return
 An interest rate that equates a PW or AW relation to
zero .

 Also defined as the rate on the unpaid balance of

borrowed money, or

 Rate earned on the unrecovered balance of an

investment such that the last cash flow brings the
balance exactly to zero
Project Evaluation
 For a specified MARR, determine a measure of worth
for net cash flow series over the life or study period.
Guidelines for a single project to be economically
justified at the MARR (or discount rate) follow

 Present worth: If PW ≥ 0 Annual worth: If AW ≥ 0 Future worth: If FW ≥

0 Rate of return: If i * ≥ MARR Benefi t/cost: If B/C ≥ 1.0 Profi tability
index: If PI ≥ 1.0
ME Alternative Selection F
 For mutually exclusive (select only one) alternatives,
compare two alternatives at a time by determining a
measure of worth for the incremental (∆) cash flow
series over the life or study period, adhering to the
equal-service requirement. (5, 6, 8, 9, 10, 17)
Conti..
 Present worth or annual worth: Find PW or AW values at MARR;
select numerically l argest (least negative or most positive).

 Rate of return: Order by initial cost, perform pairwise ∆i *

comparison; if ∆i * ≥ MARR, select larger cost alternative;
continue until one remains.

 Benefit/cost: Order by total equivalent cost, perform pairwise

∆B/C comparison; if ∆B/C ≥ 1.0, select larger cost alternative;
continue until one remains.

 Cost-effectiveness ratio: For service sector alternatives; order by

effectiveness measure; perform pairwise ∆C/E comparison using
dominance; select from nondominated alternatives without
exceeding budget.
Independent Project Selection
 No comparison between projects; only against DN.
Calculate a measure of worth and select using the
guidelines below. (5, 6, 8, 9, 12)
Conti..
 Present worth or annual worth: Find PW or AW at
MARR; select all projects with PW or AW ≥ 0. Rate of
return: No incremental comparison; select all projects
with overall i * ≥ MARR. Benefi t/cost: No
incremental comparison; select all projects with overall
B/C ≥ 1.0. Cost-effectiveness ratio: For service sector
projects; no incremental comparison; order by CER
and select projects to not exceed budget.
 When a capital budget limit is defined, independent
projects are selected using the capital budgeting
process based on PW values . The Solver spreadsheet
tool is useful here.
Capital Recovery
 CR is the equivalent annual amount an
asset or system must earn to recover the
initial investment plus a stated rate of
return.

 Numerically, it is the AW value of the initial

investment at a stated rate of return. The
salvage value is considered in CR
calculations
Economic Service Life
 The ESL is the number of years n at which
the total AW of costs, including salvage and
AOC, is at its minimum, considering all the
years the asset may provide service.
Sunk Cost
 Capital (money) that is lost and cannot be recovered.
Sunk costs are not included when making decisions
about the future. They should be handled using tax
laws and write-off allowances, not the economic study.
Inflation
 Expressed as a percentage per time (% per year), it is
an increase in the amount of money required to
purchase the same amount of goods or services over
time . Infl ation occurs when the value of a currency
decreases. Economic evaluations are performed using
either a market (infl ation-adjusted) interest rate or an
infl ation-free rate (constant-value terms)
Breakeven
 For a single project, the value of a parameter that makes two
elements equal,

 e.g., sales necessary to equate revenues and costs. For two

alternatives, breakeven is the value of a common variable at
which the two are equally acceptable.

 Breakeven analysis is fundamental to make-buy decisions,

replacement studies, payback analysis, sensitivity analysis,
breakeven ROR analysis, and many others. The Goal Seek
spreadsheet tool is useful in breakeven analysis
Direct / Indirect Costs
 Direct costs are primarily human labor, machines, and
materials associated with a product, process, system, or
service. Indirect costs, which include support functions,
utilities, management, legal, taxes, and the like, are
more difficult to associate with a specific product or
process.
Value Added
 Activities have added worth to a product or
service from the perspective of a consumer,
owner, or investor who is willing to pay
more for an enhanced value
Sensitivity Analysis
 Determination of how a measure of worth is
affected by changes in estimated values of
a parameter over a stated range.
Parameters may be any cost factor,
revenue, life, salvage value, infl ation rate,
etc.
Risk
 Variation from an expected, desirable, or
predicted value that may be detrimental to
the product, process, or system. Risk
represents an absence of or deviation from
certainty . Probability estimates of variation
(values) help evaluate risk and uncertainty
using statistics and simulation
Comparison of alternatives
conti..
 Tomato peeling machines

 Machine A Machine B
 Purchase cost=$52,000 $63,000
 Annual cost=$15,000/year $9,000/year
 Annual benefit= $38,000/year $31,000 /year
Salvage value= $13,000 $19,000
 Useful life= 4 years 6 years
 CML 2202 . Engineering Economics