ENGINEERING ECONOMICS

ENGINEERING ECONOMICS

SOLUTIONS TO END OF CHAPTER PROBLEMS

CHAPTER ONE

1.1 Explain the steps managers of firms perform during the capital budgeting process.

The first step in determining a capital budget is to estimate the cash flow for the project and then the value of the asset or project at a specific terminal date, which is the asset or project salvage value. The second step is to estimate the risks involved in the project by developing an engineer’s estimate and a project cash flow.

The third step is to select an appropriate discount rate or minimum attractive rate of return (MARR), both of which are the cost of capital. The MARR is the lowest acceptable interest rate a project would earn in order for a firm to undertake the project.

The fourth step requires reviewing the intangibles associated with the project.

Intangibles includes:

• Environmental issues effecting or delaying execution of a project • Issues either negatively or positively effecting the corporate image of a firm • Legal constraints negatively effecting a project • Potential product liability issues that might lead to litigation • Ways to save time during the execution of a project, which in turn helps save money

1.2 What are sources of funding for projects internal to a firm?

Internal sources include (1) capital earned from operations, (2) retained earnings (reserves), (3) retained earnings in excess of the after tax net earnings divided by the dividends paid to stockholders.

1.3 Discuss what hyperinflation is and why it occurs in economies.

If too much paper money is in circulation it could lead to hyperinflation where the value of the paper currency decreases rapidly.

1.4 What are the five commonly used accounting ratios?

• Current ratio = current assets current liabilities

• Acid test ratio = quick assets current liabilities

• Equity ratio = stockholder ′ s equity total assets

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• Operating ratio = total revenue total expenses

• Income ratio = net profit total revenue

1.5 What types of transactions are banks involved in throughout the world?

Banks were created to foster the movement of money around countries and the world. They extend credit to firms or individuals, they provide loans, and they use deposits to buy securities and other investments to increase the assets of the bank.

1.6 Explain how trade credits are used as a means of commerce.

Firms involved in a substantial amount of business with a particular supplier or vendor use trade credits. Rather than having to pay cash, or use a charge card, to pay for their purchases the vendor or supplier establishes an open account for the purchaser. Whenever the purchaser needs to buy items they contact the seller and then send the seller a purchase order (commercial document issued by a buyer to a seller, indicating types, quantities, and prices agreed upon for products or services).The seller then sends an invoice with the merchandise describing the items shipped and the selling price. Purchase orders are tracked by entering information about the purchase orders into a purchase order log and information about invoices is entered into an invoice log.

1.7 What are some of the processes that help manage costs during projects?

• Closely monitoring the project • Controlling project costs⎯having a viable project controls system • Improving profitability • Setting a reasonable labor burden mark-up rate (overhead) • Setting minimum profit margins • Tracking overhead for budgets • Using management by exception reporting⎯only reporting items that are behind schedule or over the budgeted amount for each stage of the project

1.8 In addition to setting monetary policies, what else is the U.S. Federal Reserve System responsible for doing in the United States?

The Federal Reserve is responsible for preventing deflation and high levels of inflation.

1.9 Explain the difference between cash and accrual accounting systems.

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In cash accounting systems income or expenses are only included when they are received or expended by a firm. Income is calculated as the difference between the cash collected and the cash expended to date.

In accrual accounting systems expenses are recognized when events occur that establish the firm has incurred a liability and the amount of the liability is known.Income is calculated as the difference between the amounts billed to customers and the expenditures paid and not yet paid.

1.10 What are the three main types of ledgers used during a project?

The three main types of ledgers used during projects are general, job, and equipment.

1.11 How are promissory notes used to cover the cost of goods and services?

Promissory notes are a written promise by one person to another person, such as a vendor or a supplier, to pay on demand or at a specified date, a certain sum of money and then the note is presented by the seller to the bank of the purchaser for collection.

1.12 How does the trade acceptance process facilitate monetary transactions?

Trade acceptance is a process whereby a supplier submits shipping documents through a local bank, and this is called a draft. The trade acceptance is an order for the person making the purchase to pay the amount owed to the supplier. The purchaser assigns the debt to the supplier and it is payable by a specific date. Then the bank returns the trade acceptance to the supplier and the supplier sells it to his or her bank and is paid the amount owed by the purchaser.

1.13 What items that help increase cost savings could be incorporated during the design stage of projects?

• Designing to minimize labor use.• Eliminating unnecessary production requirements.• Furnishing adequate foundation information.• Simplifying the design.• Using duplicated elements for items such as formwork where a steel form could be used to create numerous elements with the same formwork.• Using inspectors with sufficient experience.• Specifying local materials, if possible.• Using standard specifications.• Writing simplified specifications.

1.14 Discuss what types of items are tracked with accounting systems.

• Direct costs⎯labor, material, and equipment 3 / 4

• Employee pay • Equipment bought or leased • Indirect costs and overhead • Money borrowed including how much, when, and how it has to be repaid • Purchases

1.15 What types of project funding are external to firms?

Borrowing money through a commercial loan.

Borrowing funds on the open market, which entails drawing up a note to the order of the bearer of the note and discounting it through a dealer. Notes are sold to private individuals or companies that are essentially funding the project through their purchase of the notes. The notes are repaid with interest at a future date specified in the note.

Open market paper or a banker’s acceptance (bank vouchers), which after being approved by the bank provide funds to a firm as the firm orders items and they are delivered to the firm.

Deferred payment contracts. This type of a contract requires borrowers to sign a note for a series of payments over a set period of time. In some instances, the note holder holds title to the borrower’s equipment until the debt is repaid.

Term loans, which are regular bank loans with a maturity date and either a set or variable interest rate.

Long-term loans, which are loans maturing beyond ten years. There are several

different types of long-term loans including the following:

• Bonds⎯when bonds are sold they either pay dividends to the bondholders or they are purchased at a discount rate and paid in full at maturity or both.• Convertible bonds⎯bonds that could be converted to a specified number of shares of common stock in the issuing company or cash of equal value.• Debentures⎯debt instruments not backed by assets or collateral, but backed only on the creditworthiness and reputation of the issuer.• Mortgages⎯secured by assets such as real property.• Stockholder’s equity⎯stockholders receive dividends before the firm reinvests funds.

1.16 What happens when one country is paying higher interest rates on the debt it issues than other countries?

When interest rates increase in one country the governments or investors in other countries purchase the debt of the higher interest-bearing country since it means they

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