CVE 411

METHOD OF ECONOMIC EVALUATION AND SELECTION BETWEEN

ALTERNATIVES
Engineering economics is a tool used to provide relatively simple mathematical techniques
for decision making about capital projects by comparisons of various alternatives. This
principle allows for comparisons by accounting for the time value of money and it is the
primary economic analysis technique.
In todays world, engineers work on multi-disciplined projects that include finance , design,
construction, operation, maintenance and retirement. To compete in regional and international
market, all industries face and they must respond to an increased competition because of
lower cost operations from non-traditional sources.
Economic analysis will become the key business driver for every engineer. An indebt
understanding of economic factors affecting a project allows the engineer to remain
competitive in todays ever changing market.
PARAMETERS OF ECONOMIC DECISION

Opportunity costs
Stakeholder objective
External economic conditions
Time horizon
Alternatives
Risks and uncertainties

Capital Budgeting Decisions

The ability to plan and evaluate economically major projects is a part of most government
agencies and engineering firms. Most agencies have guidelines and regulations to evaluate
proposed project rationally with regards to their economic feasibility. Almost all guidelines
and regulations would require that the benefits of the proposed project exceed the cost of the
proposed project. Private sector projects are often easier to evaluate than their public sector
counterparts. Cooperate policies require rational and deliberate analysis of the capital
budgeting decision before such projects are approved. Cooperate investment is different from
government investment in major capital project because cooperate entities must consider their
source of funding. Capital projects can be financed through cooperate bonds or other means.

Economic evaluation therefore involves developing the cash flows that represents the benefits
and the cost associated with their precision and/or operation of the system.
Basic Concepts in Capital Budgeting
The objective of economic evaluation is to select the most cost effective alternative that will
satisfy the stakeholders requirements. Before performing the economic analysis, one must
identify the alternatives. To analyse the investment under consideration one needs to collect
stakeholders requirements and then establish a lifecycle. For some agencies and types of
projects, regulations govern the lifecycle. For instance, most federal and state projects have a
lifecycle of 50 years.
In economic evaluation, project alternatives are analysed with respect to their cash flow
profiles over n period in the lifecycle. To determine whether a project is feasible or not, you
must compare its rate of return with its minimum attractive rate of return (MARR). The
MARR must be greater than the rate of return that one is expecting with roughly the same
risk in another venture. Once money is invested in a project, those funds are no longer
available for investment. The term opportunity cost refers to the return that could have been
realized by investing in the next best alternative. In general, MARR reflects the opportunity
cost of capital, the market interest rate for borrowing or lending and the risk which is
associated with the capital project.