Engineering Economics
What to master
Cash-flow equivalence is the whole subject. Be fluent with F = P(1+i)^n, P = F(1+i)^(-n), and P = A[(1+i)^n - 1]/[i(1+i)^n]. Extend to gradient series, capital recovery, NPV, IRR, discounted payback, benefit/cost ratio, breakeven, and replacement analysis. Know depreciation: straight-line, declining balance, MACRS with the half-year convention, and the difference between book value and market value. Include income taxes - after-tax cash flow = (revenue - expenses - depreciation)(1 - t) + depreciation - and inflation, handled by (1 + i_nominal) = (1 + i_real)(1 + f).
Traps
- Treating an annuity due as an ordinary annuity (shift one period).
- Forgetting the gradient's base annuity: total present worth = A(P/A) + G(P/G).
- Comparing unequal-life alternatives without converting to a common basis.
- Using IRR when cash flows change sign more than once (multiple roots) - use NPV at MARR.
- Counting depreciation as a cash flow; only its tax shield is cash.
- Salvage sign errors, and mixing constant-dollar with actual-dollar analysis.
Worked example
$2,000 per year for 8 years at 10%: (P/A, 10%, 8) = (1.1^8 - 1)/(0.1 x 1.1^8) = 5.3349, so P = $10,670.
Rule of thumb
Convert every alternative to the same basis - usually annual worth - before choosing. For costs, the smaller annual cost wins; for revenues, the larger annual worth wins.