Books for engineering economics education

Books for engineering economics education

231 Enginecrin~andProcess Economics 1 (1976) 231. 230 0 Elsevier Scientific Publishing Company, Amsterdam - Printed in The Netherlands BOOKS FOR ENG...

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231 Enginecrin~andProcess

Economics 1 (1976) 231. 230 0 Elsevier Scientific Publishing Company, Amsterdam - Printed in The Netherlands

BOOKS FOR ENGINEERING A REGULAR

BOOK REVIEW

ECONOMICS EDUCATION

(PART II)

RF. de :a Mare Tecirnologir~l Management Department.

University of Bradford, Bradford BD 7 IDP (U.K.)

INTRODUCTION

The basis for the assessment of the books reviewed in this article can be found in Vol. 1 NO. 2 (June 1976) of this international journal. In this article, five of the previously listed books are assessed, first qualitatively and then quantitatively. The quantitative assessment for each book appears in Table 2 on p. 234. An overall rating is calculated for each book. This is based upon the six-point ranking system and the subject area weights as described

in the previous article. The overall rating is computed from the following relationship:

A. CAPITAL BUDGETING AND COMPANY FINANCE by Merrett and Sykes, Longman, Second Edition, Second Impression 1974, 170 pages,f 2.50

and RTZ respectively, where they were both responsible for giving their companies a lead in this field (both companies have exercised explicit procedures for the appraisal of capita! projects since the early 1960’s and have manuals prepared to assist in these procedures). This book and that discussed under E (see below) presents data which can actually be found in those manuals. This book is an abridged version of the much larger and more profound book: The Finance and Analysis of Capital Projects which is assessed under E in this series of reviews. The book makes no reference to being applicable for engineers, the claimed audience being senior management (financial and nonfinancial), accountants, corporate planners and business school students. However, it does

Although the techniques of proper capital appraisal have been known for centuries, in so much that they are based on the mortgage principle, it would appear that they were not effectively promoted until Joel Dean took up the crusade in the U.S.A. in the late 1950’s. Merrett and Sjrkes can probably claim the honour of being the first protagonists to effectively promote these techniques in the U.K. during the early 1960’s. Both authors have had considerable industrial experience in the use and application of capital appraisal techniques, being from the Treasurers’ Departments of Esso

c Overall wting = ~--------x

100% 500

where a score of 500 represents the maximum possible score that can be achieved by any book using the chosen assessment scheme. The books have been selected at random, as they have arrived on the author’s desk.

General description of the business

A description of the total business, its goals, psychology and disciplines and a statement of the disciplines of special interest to a module in Engineering Economics.

Microeconomic Theory

Economics of the firm. The production function, law of diminishing returns, returns to scale. Costs, revenues and profit.

Di:to

An examination of the corporate planning function.

Law of profit maximisation. Elasticity of demand. Economic breakeven. Sunk cost. Accounting Theory and Cost Control

Accounting Theory and its concepts and conventions. The Balance Sheet and the Income Statement. Fixed and Variable Costs. Breakeven Analysis.

Accounting Theory and its concepts and coiilentions.

The year by year construction of balance sheets, income statements and funds flow statements. The use and limitations of accounting ratios as applied to measuring business performance. Fixed and Variable Costs.Accounting breakeven. Budgets. Standard Cost Accounting. Variance and Functional Cost Analysis. Budget and cnpt control. The cost control of capital and expense projects. Capital Cost Estimation

The tcchrdques of capital cost estimation.

Ditto

Project Appraisal dnl. Profitability

Economic evaluation of projects and its implication within the framework of corporate planning. The mortgage principle. Crude methods of capital appraisal and their limitations. The DCF and NPV techniques, the cost of capital The choice between mutually exclusive alternalire projects and the problem of different choices.

Ditto

Risk Analysis

Sensitil ity Analysis. Application of probability theory to decision-making. Seque.*tial Decision Making. Risk Analysis and the use of simulation techn.Jues.

Replacemeidt Theory

Basic introduction to the economics of plant replacement and retirene .?t.

Ditto and the economics of plant reliability.

Programming Techniques

The appii. ation of Linear Programming (graphical method, Transportation algorithm, Sim&x and Dual algorithms). The sensitivity of optimized solutions and the use of Shaddow Prices. Dynamic Programming and an introduction to Geometric Programming.

Inventory Analysis --

The development of mathematical models to help engineers to select inventory levels.

233 the most recent taxation legislation and its influence on the cost of capital. Chapter 5 (The analysis of risk) treats risk at an operational level, as opposed to the somewhat blase mathematical approach which appears in many books. Chapter 6 describes three case studies, two of which are of immeuiate engineering interest, as is the treatment of replacement decisions in Chapter 7. Cr apter 9 incorporates a resounding attack on the mom conventional (and often used) methods of capital appraisal and shows, without doubt, how such methods can be most misleading and very much in error. Chapter 10 (The Annual Capital Charge method) explains a third method of capital appraisal which is analogous to the DCF/NPV methods. This method is often used in texts on Engineering Economy. Chapter 11 gives a good treatment of the relative merits of the three recommended appraisal techniques and comes out in favour of the DCF method as used for incremental analysis. Chapter 8 (Evaluating companies for acquisitions) and Chapter 12 (Special problems: optimal financing) are really inappropriate to the needs of the engineer. Throughout the book, reference :PImade to accounting concepts which might be meaningless to an engineer. Appendix A (Basic accounting principles and terminologqr) is presented in the hope of overcoming this communication problem, although it must be stressed that in the opinion of the Many books on Engineering Economy give author this appendix appears to be a last minute scant treatment of the real meaning and probidea which is inadequate. lems which go to effectively evaluate the cost The book does not really give sufficient stress of capital (in our case r) to a particular comfor the need to look for the incremental cash pany. Such books often seem to “pluck a numflow differences between projects, the topic ber from the air” and that is usually 1O%,withbeing delayed until page 62. Likewise the out any explanation of how the statistic was problem of “Sunk Cost” and the choice bederived or the conditions under which it might tween projects with different lives 1squire in__ be appropriate. Merrett and Sykes have addressed adequate. themselves positively to the problem of “little Because of its specialist nature, the book does r” and have updated their book to incorporate not refer to several of the modular training

234 needs of the student of engineering economy. Nevertheless, it is a very good book in those areas which it covers and because of this quality achieves the overall rating of: 62% for Course A 46% for Course B Where Course A and Course B refer to the training modules which were described in detail in the previous article, and are summarised in Table 1. B. ECONOMIC DECISION MODELS; by Riggs, McGraw-Hill, t968,4 16pages, f 9.55

This book professes to be a quantitative approach to engineering and management problems and has been included in the book list, because it incorporates much of the contents of modules A and B. The author makes the point that in this day and age of high speed computers and algorithms, for solving complex economic problems, it is often difficult to

distinguish between the responsibrlities of the manager and the engineer: a point that I would like to endorse, except to say that “the buck” rests with the manager. Knowing the American yen (not the Japanese type) for economy, it is extraordinary that this book uses less than two-thirds of each page for its type-script. Per detail therefore, this is an expensive book. The book commences by addressing itself to the nature of decision making: involving the relationship between objective, strategy and tactic and the part that model building has to play in the decision making process. It then continues with some rather abstract material on the nature of the decision making process itself. Chapter 2 is concerned with accounting breakeven analysis, both for singular and multiple product systems and with the microeconomic analysis of profit maximization, (as applied to inventory analysis). With the exception of some poor visua! aids this is quite a good chapter.

TABLE 2 Overall ratings for those books assessed in this article Subject area description

General description of the business Microeconomic theory Accounting theory and cost control Capital cost estimation Project aopraisal and profitability Risk analysis Replacement theory Programming techniques lnvcstory analysis Case study examples Book presentation Overall rating for course A Overall rating for court B

Weighting (%)

Subject area rank scores (O-5) for booka

Course A

Course B

A

5 10 10 10 35 15 5 -

5 10 10

10

2: 10 5 15 5 5 10

0 0 2 0 5 4 3 0 0 3 4

B __ 2 2 1 0 2 3 2 2. 1 0 3

62 46

39 31

C

D

E

2 2 3 1 3 3 2 2 1 1 3

1 0 0 0 0 1 0 4 0 0 2

2 1 3 0 5 4 3 0 0 1 3

52 47

i3 19

66 48

“A: Capital Budgeting and Company Finance, by Merrett and Sykes. B: Economic Decision Models, by Riggs. C: Engineering Economy, by Thuesen, Fab@cky and Thuesen. D: Economic Decision Making, by Menges. E: The Finance and Analysis of Capital Projects, by Merrett and Sykes.

23.5 Chapter 3 (Allocation of resources) deals with some of the management science needs of module B. Three models are discussed: linear programming (graphical method only) allocation techniques and the transportation linear programme mode: (the profound algorithm however, is not included). In conclusion therefore, this chapter is not really adequate for the needs of module R. Chapter 4 (Scheduling of resources) gives an excellent treatment of Critical Path Phnnins. Chapters 5,6 and 7 deal with the capital appraisal and replacement needs of modules A and B, but unfortunately, the treatment is inadequate. Chapters 8 and 9 deal with risk analysis and in this area the book is peculiar in that tbe Former chapter is very much ilivolved with the calculus of risk (and in this respect is heakdy dependent on Bayes theorem - which might not be readi!y digestible to the professional engineer attempting to come to grips with engineering zconomics) whilst the latter chapter is quite “down-to-earth”, readable and readily acceptable. Chapter 10(Concepts of uncertainty) is a natural extension of the theme that pervades the book; namely the building of models to cater for the known (deterministic) through to the unknown (uncertain) situation. This chapter thei-efore, involves some of the theory of games, which although useful from an educational poinl of view, falls outside of the remit of tke mod%.desunder discussion. The Overall Ratings received by this book are : 39% for Course A 37% for Course B C. ENGINEERING ECONOMY;by Thuesen, Fabrycky end Thuesen, Prentice Hall, 4 th Edition 197 1,490 pages,f 10.35 During

the past four years, this book has

been used to supplement the lecture/seminar programme on Economic Decision Making to the graduating classes of Electrical, Electronic and Mechanical Engineering students at the University of Bradford (U.K.). It has proved to be quite useful for this course, which resembles module B (as described in detail in the previous article), since the book covers most of the aspects of that module in reasonable detail. However, the book does have its shortcomings. The book caters especially for the engineer and its contents are reckoned appropriate for a three semester hour course. Chapters 1 and 2 deal with the differences between engineering (physical) efficiency and economic efficiency and stress the need to relate most engineering endeavours in economic terms. Also included is some treatment of microeconomic theory which is related to elsewhere in the book but the sulbject is inadequately covered. Chapter 3 deals with some trivial aspects of value analysis. The capital appraisal section starts in Chapter 4 and extends through Chapter 9. Furthermore. this section is supported by a 35 )age appendix of very detailed compound/discount tables. The section is quite good in that it covers many of the aspects which would normally be expected. Unfortunately, however, the subject of tl-.e cost of capital is hardly mentioned and taxation effects are postponed until Chapter 13. Like most books with the title “Engineerin? Economy”, the book (in general) and this section (in particular) suffers from an overdose of mathematical formulae; many of are quite unnecessary. Chapter 8 is exclusively concerned with the replacement decision and addresses itself directly to the problem of “Sunk Cost”. From a descriptive point of view the rational and proper managerial view to take concerning sunk cost is very good but the examples which are used to support this thesis are both confused and incorrect. The remainder of the book considers many of the other topic areas reiated in module B, but

unfortunately, they do not appear in any really coherent order: in this respect the design of the book appears somewhat haphazard and it requires a tutor to guide the would-be-student through the book in a logical manner. Chapter 9 is really a continuation of the microeconomics discussed in Chapters 1 and 2. Chapter 10 relates to engineering economy as applied in the public sector with particular reference to cost-benefit analysis. Chapters 11 and 12 are two quite good chapters on accounting theory. In particular the problems of overhead cost allocation and the method of depreciation are particularly good. With hindsight, however, it might have been a better idea if these chapters had appeared nearer to the front of the book, thereby allowing the reader to become acquainted with the accounting jargon, which is used extensively throughout the book, at an early stage. Chapter 13 deals with the effects of tax and tax allowances on the NPV/DCF sum. Unfortunately, the details pertain only to the U.S.A. and are inappropriate for the U.K. In so much that the tax effects can have a profound bearing 01, the e onomic merits of a project, it is difficult lo understand why the authors separated this material from the main body of the NPV/ DCF material discussed in Chapters 4 through to 7. Chapters 14 and 15 are concerned with risk and uncertainty and although a little complex in parts, this treatment is quite good, in a “downto-earth” sense. Chapters 16 and 17 deal with organisational and administrative matters: two aspects which could have been left out of the book withcsrt affecting the quality of the book. Chapter 18 returns, yet again, to breakeven snalysis and as such appears out of order. Chapter 19 (Mathematical models for operations) deals with the Operational research model requirements of module B in that it gives a cursory treatment of inventory problems and linear programming. In summary, therefore, this book provides

a good coverage of the material requirements of modules A and B. The major criticism of the book is its somewhat disjoint presentation. It will be interesting to see if its continued use at Bradford will survive the test of this assessment series of reviews. The Overall Ratings achieved are: 52% for Course A 47% for Course B D. ECONOMIC DECISION MAKING; by Menges (English translation of the German book), Longmans, 1974,236 pages, f 4.50

This book was enthusiastically recommended to me by a colleague who, having read the book, recognised that it bore the same title as one of the courses which I teach at Bradford. It is the English translation of a German book which was first published in 1969: unfortunately, the rrflo~” of the translation is somewhat staccato in parts. The title is misleading arid somewhat incorrect. Economic Decision Making suggests an active effort to make decisions based upon a rigorous approach, with information of varying degrees of accuracy, realising that the attainment of the maximum economic advantage might violate other (less numerate) objectives. In such a book one would at least expect to see some case studies relating the ways in which economic decisions were formulated and executed. Moreover, one might hope to read the post-audits of some projects with a view to discovering what can go wrong with such decision making and the lessons to be learnt from such an exercise. By contrast this book is more concerned with Decision Theory, a subject firmly based upon Probabilit! Theory and notions of Utility, the combination of which is supposed to help people understand why a partcular person makes decisions in a particular way. As such, this book is not of direct relevance to the educational needs of the engineer or student engineer who wishes

to improve his understanding of engineering economics, although it should be mentioned that the book does cover some aspects of operational research which are included in module B. The book is meant to be appropriate for students of economics, business administration and “practicians” (although 1 do not know what they are supposed to do with it!). Chapter ,4 (Decisions under certainty) incorporates linear programming and offers the best treatment of the subject by the five books considered in this article. The graphical method is given and the Simplex algorithm is treated in reasonable detail. Also included is a reasonable discussion of the Transportation linear programming algorithm and an inadequate treatment of non-linear programming. Chapter 5 (Decisions under risk) is a difficult chapter to read and quite unsuitable for the trai-ung needs of the engineer. Chapter 7 incorporates quite a good discussion of the Dynamic Programming algorithm. In summary therefore, although this boJk has scored modestly in parts of the modular requirements, it is not appropriate for the engineer or student engineer wishing to understand engir.eering economy. To some extent it is regretted that this book was included in the book list. The Overall Ratings achieved by this book are: 8% for Course A 19% for Course B

E. THE FINANCE AND ANAL lSlS OF CAPITAL PROJECTS; by Merrett and Sykes, Second

Edition,

Second

Impression,

1974,

573 pages, f 9.50 This book is the extended version of the book discussed above under A. Much of the subject matter is the same as the other book but the trtiatment is much more profound. The wouldbe-student of engineering economy would

read this book if he really wished tc understand the subtleties of how the financial structure of a company and the reaction of the stock market affected the actual cost of capital to a company and hence the economic merits of a proposed new engineering project. This Look is not so readable as the other book because it is a massive treatise on the subject of capital appraisal. However, it is an excellent reference book. Chapters 1 and 2 deal with the time of money, the DCF/NPV criteria and the effect of taxes and tax allowances. Chapter 3, however, is a considerable departure from the normal subject contents of books on engineering economics in that it deals with the various methods of financing a company. the cost of these alternative forms of finance and gives forecasted costs of capital for both the U.K. and U.S.A. Chnpter 4 crmbines the previous chapters by analysing the merits of projects under alternative financing policies. Chapter 5 deals with the advantages and disadvantages of the NPV, DCF and annual capital charge methods. In particular the multiple root problem, which can be associated with the DCF computation, is discussed in detail along with a method for overcoming this problem Chapters 6 and 7 deal with capita1 project decision making under conditions of risk. Included in these chapters are the rudiments of sensitivity analysis as well as some more advanced aspects based upon probability. Utility theory is also discussed but in a much more “down-to-earth” manner than the previously assessed book. Chapter 8. As with their other book. this chapter is devoted to an attack on the use of conventional accounting decision making Chapters 9 (Investment and valuation problems when shares are under or overvalued) and 10 (Leasing decisions and property analysis) would, quite obviously, be immediate concern to the engineer.

Chapter 1I (Analysing expansion opportunities and major construction problems) is of concern to the engineer however, in that it points to the need for proper economic appraisal even at the sub-system level of projects. Chapter 12, 13 and 14 deal with company acquisitions. Chapter 15 is directly relevant to engineering ecormnics being a case study of an overseas mining project. Chapt :r 16 (The capital budgeting organization) might at first sight appear to be irrelevant to the needs of the engineering economist. In so much that many an engineering course now incorporates a substantial element of business theory however, it might be said that in the future the establishment and effective operation of proper capital budgeting organiza-

tions may rest upon the abilities of engineers in many a firm. Chapter 20 is the last chapter of the blook. It includes some treatment of the replacement decisron but this treatment is far from adequate. In summary therefore, this is a fine book (as indicated by some of the scores which it achieved in the numeric assessment shown in Table 2). However, it is thought to be too detailed for the needs of most students of engineering economics for the purposes of a “book to work with” and instead is an excellent reference book pertaining to those parts of the modules which it covers well. The Overall Ratings received by this book are: 66% for Course A 48% for Course B