An engineering economy study involves many elements: problem identification, definition of the objective, cash flow estimation, financial analysis, and decision making. Implementing a structured procedure is the best approach to select the best solution to the problem. Alternatives These are stand-alone descriptions of viable solutions to problems that can meet the objectives. Words, pictures, graphs, equipment and service descriptions, simulations, etc. define each alternative. The best estimates for parameters are also part of the alternative.
Some parameters include equipment first cost, expected life, salvage value (estimated trade-in, resale, or market value), and annual operating cost (AOC), which can also be termed maintenance and operating(M&O) cost, and subcontract cost for specific services. If changes in income (revenue) may occur, this parameter must be estimated. Detailing all viable alternatives at this stage is crucial. For example, if two alternatives are described and analyzed, one will likely be selected and implementation initiated. If a third, more attractive method that was available is later recognized, a wrong decision was made.
Cash Flows All cash flows are estimated for each alternative. Since these are future expenditures and revenues, the results usually prove to be inaccurate when an alternative is actually in place and operating. When cash flow estimates for specific parameters are expected to vary significantly from a point estimatemade now, risk and sensitivity analyses are needed to improve the chances of selecting the best alternative. Sizable variation is usually expected in estimates of revenues, AOC, salvage values, and subcontractor costs.
Engineering Economy Analysis The techniques and computations that you will learn and use throughout this text utilize the cash flow estimates, time value of money, and a selected measure of worth. The result of the analysis will be one or more numerical values; this can be in one of several terms, such as money, an interest rate, number of years, or a probability. In the end, a selected measure of worth mentioned in the previous section will be used to select the best alternative. Before an economic analysis technique is applied to the cash flows, some decisions about what to include in the analysis must be made.
Two important possibilities are taxes and inflation. Federal, state or provincial, county, and city taxes will impact the costs of every alternative. An after-tax analysis includes some additional estimates and methods compared to a before-tax analysis. If taxes and inflation are expected to impact all alternatives equally, they may be disregarded in the analysis. However, if the size of these projected costs is important, taxes and inflation should be considered. Also, if the impact of inflation over time is important to the decision, an additional set of computations must be added to the analysis.