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I -+-. Session 1239

A Risk-Analytic Approach to Learning Engineering Economy

Anil K. Goyal, James M. Tien, Pieter A. Voss Department of Decision Sciences and Engineering Systems Rensselaer Polytechnic Institute, Troy, NY 12180-3590

Abstract. The traditional approach to learning Engineering Economy in the undergraduate program focuses on solving problems in a deterministic manner. Students generally have little exposure to the uncertain and stochastic nature of, as examples, project cash flows and interest rates. Unfortunately, this traditional approach does not provide students with the skills to deal with real world situations, which inherently involve uncertainty and thereby, risk. Typically, most Engineering Economy texts for undergraduate students deal with uncertainty and risk only in brief chapters, usually at the end of the book. The uncertain environment is introduced as a special case, rather than as the norm. In this paper, we propose an approach to learning Engineering Economy that is characterized by treatment of uncertainty and is motivated by risk; in fact, it considers the deterministic case as a special case. The availability of computers today ticilitates introducing this risk-analytic approach. Computer spreadsheets and software can provide students with the ability to analyze entire probability distributions. Such a junior or senior level Engineering Economy course would build on an earlier course in probability and statistics, as well as courses in design and computing. A new Engineering Economy text is also proposed and outlined herein.

1. Introduction

The purpose of Engineering Economy is to enable engineers and managers to accurately evaluate the economic consequences of capital investments in products, processes, and services. The time value of money, taxes and inflation are a few factors which can significantly impact the attractiveness of an investment. Undergraduate students -- usually in their junior or senior year -- learn about such factors and related analysis methods in a course on Engineering Economy.

However, evaluating capital investments is also about identifying, analyzing and managing risk. It is our view that Engineering Economy, as traditionally taught, does not provide students with sufficient tools for considering risk. Risk is an inherent part of any investment decision. By risk, we mean the possibility of economic or other loss resulting from the investment decision. Equipment costs, labor requirements, interest rates, and cash flows are all estimated quantities; the actual values may well differ from these estimates. Of course, the largest risk to a company is insolvency or bankruptcy due to a negative cash balance; this could occur from poor timings of uncertain cxh flows, even though the overall net present value may remain quite attractive.

The traditional approach to learning Engineering Economy assumes that all quantities are deterministic, 2 fixed, or “crisp.” While leading texts on Engineering Economy e.g., Blank and Tarquin ; DeGarmo et al.5; EschenbachG; ParklO; Tlmesen a n d Fabrycky13; ancl Young” note the practical importance of uncertainty, -.. .._ ?@zg> 1996 ASEE Annual Conference Proceedings ‘.JmlyL,’

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Voss, P. A., & Tien, J. M., & Goyal, A. K. (1996, June), A Risk Analytic Approach To Learning Engineering Economy Paper presented at 1996 Annual Conference, Washington, District of Columbia. 10.18260/1-2--6268