Ted Eschenbach

Technical Note: Constructing Tornado Diagrams with Spreadsheets

Abstract Tornado diagrams are a classic tool of sensitivity analysis for decision analysis, yet engineering economy texts and TEE articles rarely include them. It is suggested that this is due to apparent barriers in constructing them—particularly for problems with positive and negative values. While the texts and articles may not represent typical engineering economy practice, they certainly lay the foundation for it. This note summarizes how to construct tornado diagrams in Excel. A template for constructing these diagrams is available from the author at aftge@uaa.alaska.edu.

Real Options and Real Engineering Projects

Abstract: Real options analysis is a tool that has not fully justified itself in the face of real world complexity. It is intended to value flexibility in future choices; however, much of the literature focuses on the mathematical details of how to perform real options analyses, without taking the time to ask whether key characteristics of engineering projects have been properly recognized. In addition, many papers contrast real options analysis with a simple NPV analysis with deterministic data and no options. Because engineering economic analysis has long included decision trees, sensitivity analysis, simulation and other tools, the key question is, what does real options analysis add to this toolbox? A comparison of real and financial options and case studies of engineering projects led us to conclude that the value of real options is more limited than many suggest. Different recommendations due to the use of real options may be limited to near-zero NPV projects where the future benefit stream can be well forecasted and where uncertainty can be identified. This can lead to great difficulty in applying options to real engineering projects.

Which Interest Rate for Evaluating Projects

Abstract: Selecting the interest rate for evaluating potential projects is a key part of the capital budgeting problem. Approaches include (1) the marginal or weighted average cost of capital (WACC), (2) the opportunity cost of capital (from IRR ranking), (3) the theoretically optimal intersection of the first two, (4) risk adjusted rates for equity from capital asset pricing theory—which are usually folded into the WACC as the equity component of the WACC, and (5) portfolio selection models with organizational and political factors. This article describes each approachs theoretical basis, strengths, and weaknesses. The article then attempts to reconcile these disparate approaches into a practical and theoretically sound approach to the project selection problem.

Technical Note: Waiting Cost Models for Real Options

When real options are used to estimate the value of delaying an engineering project, it is necessary to consider the cash flows or project benefits that are lost due to the delay. This note describes various models of these cash flows and surveys previous TEE articles to see which are used and how often delay costs are ignored. The first model considered is based on the lost dividends Black-Scholes model for financial options, which is one of the most common models used in real options even though it does not explicitly consider cash flows. More realistic scenarios include the loss of initial cash flows, delays in starting to receive the same number of cash flows, loss of cash flows at the project horizon, and permanent loss of market share. The outcomes are compared with the often unrealistic case of omitting these delay costs. We assert that the common omission of waiting costs is rarely appropriate and offer models that better capture the costs of delaying real projects.

AN EMPIRICAL ANALYSIS OF ENGINEERING ECONOMY PEDAGOGY

Abstract This work presents the results of a recent two-part survey of how engineering economy is taught in U.S. universities. A mail and email survey of faculty and staff that teach engineering economy was conducted in 1995 through 1997. For the surveys two parts, this produced 45 and 28 complete responses, respectively. Three categories of questions were asked pertainingto 1) the faculty that teach it, 2) the course content and mechanics itself, and 3) the students that take the course. This paper also includes results from a previously unpublished survey done in 1989. All of these results are compared with two similar studies done in 1984 and 1989. Potential pedagogical implications are summarized as they relate to increasing the efficiency and effectiveness of engineering economy teaching in U.S. universities.

Engineering Ethics: A System Dynamics Approach

Abstract: Engineering practice takes place within the complex social, cultural, legal, economic, technological, and organizational system. Within this context, the engineer is expected not only to solve the technical design problem but also to satisfy broader norms and expectations, which may not be consistent with each other or with the highest standards of design. They also are not always explicitly expressed. These expectations may push the engineer toward unethical or even illegal behavior. The forces or factors in a particular instance include the values held by the engineering profession as a whole, the individual engineers value set, the values of the employing organization, and attendant socioeconomic pressures. Individual, professional, and organizational values are not static but rather evolving responses to both long-term and short-term environmental forces. Thus, engineering ethics, both on the individual and profession-as-a-whole scale, can usefully be understood and modeled as systems phenomena.

Role of technology in strategic management

Abstract The accelerating pace of technological change has made technology a major strategic factor for many organizations. Some firms respond defensively, seeing technology as a problem, while others through strategic use of technology gain permanent advantage. The engineering function typically contains the bulk of the firms technological expertise, yet engineers and engineering managers are seldom directly involved in strategic analysis. Strategy typically trickles down to engineering in the form of technological problems demanding solutions. This weak linkage between engineering activities and strategic thinking is far from optimal, and in the current turbulent technological environment it can even endanger the firms survival. The linkage can be strengthened, but it requires behavioral and managerial changes at the top of the firm and at the engineering level. First, both levels must understand the concepts of strategic management and commit to implementing them. Then the strategic nature of technology must be understood, including the limitations and potential traps of technology-based strategies. Finally, creative opportunities for considering technology strategically must be made available at the engineering level, and both design engineers and engineering managers must be rewarded for their strategic contributions.

Strategically focused engineering: Design and management

During the last ten years strategic analysis has become a major focus of management theory and practice. From this has emerged a general consensus on basic strategic principles and processes, which will play an ever larger role in engineering thought and practice. This article explores the interface between engineering and strategy. We outline the fundamental philosophy and basic method of strategic analysis and compare them to traditional engineering approaches. The addition of strategic criteria will often change the choice of a particular engineering solution. An engineering design may be technically correct but strategically wrong — as illustrated by the instant movie camera and the SST airliner. Also, failing to take advantage of engineering and technological possibilities may represent a major strategic error — e.g., NCR and the shift from mechanical to electronic registers. We conclude that tightening the linkage between engineering and strategy formulation will require changes in the thinking patterns of both engineers and the managements that employ them. Engineers and engineering managers will have to learn bow to shift back and forth between structured and unstructured problem solving, and managements will have to consciously increase the role of technologists in strategy formulation.

MULTIPLE ROOTS AND THE SUBSCRIPTION/MEMBERSHIP PROBLEM

Abstract This paper examines the uniqueness of the internal rate of return for the subscription/membership problem. This problem is characterized by the comparison of alternatives with different length lives, which produces a time series with multiple sign changes. A typical example would be solved using the equation

Determining When Simplified Agile Project Management Is Right for Small Teams

10(A/P, i, 2) =