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Engineering Economics

Chapter · December 2016

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Engineering Economics
Economic analysis, or the understanding and prediction of decision making
under conditions of resource scarcity, plays a major role in the planning,
design and management of sustainable water resource systems. Allocation of
water among competing uses to obtain an optimum value in terms of market
or welfare measures is one of the main problems of water resources planner

Choice:
Identifying alternatives to be considered;

Predicting the consequences resulting from these alternatives;

Converting the consequences into some commensurable units (e.g., $’s); and

Choosing among the alternatives

Important Points:
Investors often prefer early return on investments since it provides them with
more flexibility in making future investment decisions;

Benefits and costs at different times should not be directly compared or

combined, since they are not in common units

Future benefits and costs must be multiplied by a factor that becomes

progressively smaller for times further into the future. This multiplicative
factor is called the discount rate and it has a great impact on the alternative
selected
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Future benefits and costs are given more weight with lower discount rates and
less weight with higher discount rates; and

Committing resources to one project may deny the possibility of investing in

some other project. This brings up the question of opportunity costs, or what
must be foregone in order to undertake some alternative

Different Methods:
Cost-effectiveness analysis

Benefit-cost analysis

Financial Analysis

Discount Rate

Benefit – Cost Analysis:

Goals:
Ensure that projects use capital efficiently

Provide a framework for comparing alternative

projects

Estimate the impacts of regulatory changes

Basic principle:
Project benefits must exceed costs
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Costs and Benefits:

• Express in similar units (e.g., $’s)

• Compare for each alternative

• Viewpoint is important

– Some groups are concerned with benefits, others with

costs

• Compare differences between alternatives

• Do not consider effects not attributable to

alternatives

• Opportunity Cost

– What you’re NOT going to get if you spend your

money to build the project

Benefits and Costs:

• Direct costs of alternative

– Capital costs

• Acquisition of land and materials, construction costs

• Opportunity costs

– Operation, maintenance, and replacement costs

• Indirect costs of alternative

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– Costs imposed on society or the environment

• Valuation techniques

– Market value

• Capital costs and O&M costs

• Benefits from revenues from future deliveries of water

– No market value? Then what?

• Value = cost of cheapest alternative

• Value can be estimated in other ways

Benefit - Cost Method:

1. For each alternative

– Define consequences

– Estimate value of consequences

– Calculate B/C ratio, Discard if B/C < 1

2. Order alternatives: lowest to highest cost

3. Select lowest cost alternative as Best

4. Compare Best to Contender (next costliest alternative)

– Compute ΔB/ΔC, If ΔB/ΔC > 1, Contender becomes Best

5. Repeat Step 4 for all alternatives

6. Final Best is preferred alternative

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Economics Analysis of Water Resources

Example: Pumping Plant

$100 invested for a year at a rate of 5% would be worth

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Interest Rate Formulas:

P = present value

F = Future payment

A = annual series
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Cash Flow
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