Engineering Economics, Costing, and Contracts
This domain tests economic comparison, cost estimating, and contract risk. Expect cash-flow, NPV, payback, depreciation, lifecycle cost, and contract-type questions tied to project decisions.
Core rules and concepts
- Convert cash flows to a common time basis using present worth, future worth, or equivalent annual worth at the MARR.
- NPV = PV benefits − PV costs; accept independent projects with NPV>0; for mutually exclusive alternatives, choose the highest NPV or equivalent annual worth when lives differ.
- IRR is the rate making NPV zero; do not rank mutually exclusive projects by IRR alone.
- Payback ignores time value and cash flows after payback; use it as a screening measure, not the sole decision rule.
- Contract types allocate risk: fixed-price shifts cost risk to the contractor; cost-reimbursable shifts it to the owner; T&M is suited to uncertain scope.
- Include escalation, taxes, salvage, and lifecycle costs only when they are relevant and consistent.
Worked example
Invest $100,000; savings $30,000/year for 5 years; MARR 10%. Annuity factor=(1−1.1^−5)/0.10=3.7908. PV savings=30,000×3.7908=$113,724. NPV=113,724−100,000=$13,724>0, so accept. Reasoning: compare all cash flows at the same discount rate; undiscounted savings of $150,000 overstates value.
Traps that cost marks
- Comparing alternatives with unequal lives by total NPV without annualizing.
- Including sunk costs in the decision.
- Mixing escalation rates with the discount rate.
- Treating IRR ranking as valid for mutually exclusive projects.
- Ignoring contract risk allocation.