Engineering Economic Analysis

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50 ENGINEERINGCOSTSAND COST ESTIMATING

Estimating Benefits

This chapter has focused on cost tenns and cost estimating. However, engineering

economists must often also estimate benefits. Example benefits include sales of products,

revenues from bridge tolls--and-electric power sales, cost reductions from reduced mate-

rial or labor costs, reduced time spent in traffic jams, and reduced risk of flooding. Many

engineering projects are undertaken precisely to secure these benefits.

The cost concepts and cost estimating models can also be applied to economic benefits.

Fixed and variable benefits, recurring and nonrecurring benefits, incremental benefits, and

life-cycle benefits all have meaning. Also, issues regarding the type of estimate (rough,

semidetailed, and detailed) as well as difficulties in estimation (one of a kind, time and

effort, and estimator expertise) all apply directly to estimating benefits. Last, per unit,

segmented, and indexed models are used to estimate benefits. The concept of triangulation

is particularly important for estimating benefits.

The uncertainty in benefit estimates is also typically asymmetric, with a broader limit

for negative outcomes. Benefits are more likely to be overestimated than underestimated,

so an example set of limits might be (-50%, +20%). One difference between cost and

benefit estimation is that many costs of engineering projects occur in the near future (for

design and construction), but the benefits are further in the future. Because benefits are often

further in the future, they are more difficult to estimate accurately, and more uncertainty is

typical.

The estimation of economic benefits for inclusion in our analysis is an important step

that should not be overlooked. Many of the models, concepts, and issues that apply in the

estimation of costs also apply in the estimation of economic benefits.

Cash Flow Diagrams

The costs and benefits of engineering projects occur over time and are summarized on a cash

flow diagram (CFD). Specifically, a CFD illustrates the size, sign, and timing of individual

cash flows. In this way the CFD is the basis for engineering economic analysis.

A cash flow diagram is created by first drawing a segmented time-based horizontal

line, divided into appropriate time units. The time units on the CFD can be years, months,

quarters, or any other consistent time unit. Then at each time at which a cash flow will

occur, a vertical arrow is added-pointing down for costs and up for revenues or benefits.

These cash flows are drawn to relative scale.

The cash flows are assumed to occur at time 0 or at the end of each period. Consider

Figure 2-7, the ~FD for a specific investment opportunity whose cash flows are described

as follows:

Timing of Cash Flow

At time zero (now or today)

1 time period from today

2 time periods from today

3 time periods from today

4 time periods from today

5 time periods from today

Size of Cash Flow

A positive cash flow of $100

A negative cash flow of $100

A positive cash flow of $100

A negative cash flow of $150

A negative cash flow of $150

A positive cash flow of $50

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