# Engineering Economics for Aviation and Aerospace

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## Book Description

For all engineers and practitioners, it is essential to have a fundamental understanding of cost structure, estimating cash flows, and evaluating alternative projects and designs on an economic basis. *Engineering Economics for Aviation and Aerospace* provides the tools and techniques necessary for engineers to economically evaluate their projects and choices.

The focus of this book is on a comprehensive understanding of the theory and practical applications of engineering economics. It explains and demonstrates the principles and techniques of engineering economics and financial analysis as applied to the aviation and aerospace industries. Time value of money, interest factors, and spreadsheet functions are used to evaluate the cash flows associated with a single project or multiple projects. The alternative engineering economics tools and techniques are utilized in separate chapters to evaluate the attractiveness of a single project or to select the best of multiple alternatives.

Most of the engineering economics and financial mathematics books available in the market take either a pure theoretical approach or offer limited applications. This book incorporates both approaches, providing students of aviation and industrial economics, as well as practitioners, with the necessary mathematical knowledge to evaluate alternatives on an economic basis.

## Table of Contents

List of Figures

List of Tables

Preface

Foreword by Brian Pearce

Foreword by Zane Rowe

Foreword by Dr Barry Humphreys CBE

Acknowledgments

List of Abbreviations

1 Introduction to the Air Transport Industry

Airline Industry before Deregulation

Airline Industry after Deregulation

Airline Profitability

Air Transport Industry

Aircraft Manufacturers

Jet Engine Manufacturers

Aircraft Leasing Companies

Service Providers (MRO, Ground Handling, Catering)

Airports

Air Navigation Service Providers (ANSP)

Global Distribution System (GDS) and Computer Reservation System (CRS)

Freight Forwarders and Integrators

Airline Mergers and Bankruptcies

Summary

Discussion Questions and Problems

2 Foundations of Engineering Economics and Finance

Definition of Engineering Economics

Interest and Time Value of Money

Simple Interest

Compound Interest

The Connection between Interest Rates and Their Determinations

Short-term Interest Rates

Long-term Debt and Interest Rates

Future Value of a Single Present Amount

Present Value of a Single Future Sum

Future Value of an Unequal Cash Flow Series

The Rule of 72

The Rule of 100

Summary

Discussion Questions and Problems

3 Annuities and Gradient Series

Annuities or Uniform Series

Future Value of an Annuity

Annuity of a Future Value

Present Value of an Annuity

Annuity of a Present Value

Amortization and Amortization Schedule

Annuity Due

Capitalized Cost

Arithmetic Gradient Series

Present Value of an Arithmetic Gradient Series

Annuity of an Arithmetic Gradient Series

Future Value of an Arithmetic Gradient Series

Geometric Gradient Series

Present Value of a Geometric Gradient Series

Annuity of a Geometric Gradient Series

Future Value of a Geometric Gradient Series

Shifted Cash Flow Series

Using Spreadsheets for Equivalences Computation

Summary

Discussion Questions and Problems

4 Nominal and Effective Interest Rates

Nominal Versus Effective Interest Rates

Calculating Effective Interest Rate

Continuous Compounding

Effective Rate to Nominal Rate

Comparing Compounding Periods and Payment Periods

Computing Equivalences Involving Only Single-Amount Factors.

Computing Equivalences when Payment Period Equals Compounding Period

Computing Equivalences when Payment Period Exceeds Compounding Period

Computing Equivalences when Payment Period is Less Than Compounding Period

Using Spreadsheets for Effective Rate and Equivalences Computation

Summary

Discussion Questions and Problems

5 Analysis of Present Worth

Measuring Project Cash Flows

First Cost (P)

Net Annual Cash Flow (NACF)

Terminal Cash Flow (TCF)

Evaluation of Single Projects

Bond Valuation

Types of Project Alternatives

Mutually Exclusive (ME) Projects

Independent Projects (IP)

Do-nothing Alternative

Evaluation of Mutually Exclusive Equal-life Alternatives

Evaluation of Mutually Exclusive Different-life Alternatives

Study Period Approach

Least Common Multiple or Replacement Chain Approach

Capitalized Cost or Equivalent Annual Annuity Approach

Evaluation of Independent Projects

Using Spreadsheets for Present Worth Computation

Life Cycle Costing (LCC)

Summary

Discussion Questions and Problems

6 Analysis of Annual Worth

Motivation for Using Annual Worth Analysis

Evaluation of Single Projects

Capital Recovery

Annuity of Net Annual Cash Flows

Evaluation of Mutually Exclusive Projects

Annual Worth Analysis of Equal-life Alternatives

Annual Worth Analysis of Non-Equal-life Alternatives

Evaluation of Independent Projects

Annual Worth of Permanent Projects

Using Spreadsheets for Annual Worth Computation

Summary

Discussion Questions and Problems

7 Analysis of Rate of Return

Rate of Return Calculation

Interpretation of Rate of Return Values

Trial and Error Method

Rate of Return of Bonds

Evaluating Mutually Exclusive Projects

Incremental Cash Flows

Cost-based Alternatives

Revenue-based Alternatives

Equal-life Service Requirement

Evaluating Independent Projects

Complications with Rate of Return

Multiple Rates of Return Scenario

ROR Reinvestment Rate Assumption

Modified Rate of Return Analysis

Using Spreadsheets for Rate of Return Computation

Summary

Discussion Questions and Problems

8 Public Sector Projects and Benefit to Cost Analysis

Public Sector versus Private Sector Projects

Benefit/Cost Analysis of Single Projects

Evaluation of Cost-based Mutually Exclusive Alternatives

Evaluation of Benefit-based Mutually Exclusive Alternatives

Evaluation of Independent Projects

Modified Benefit and Cost Analysis

Using Spreadsheets for Benefit/Cost Ratio Computation

Summary

Discussion Questions and Problems

9 Analysis of Break-even and Payback Period

Introduction to Break-even Analysis

Elements of Break-even Analysis

Break-even Analysis of a Single Project when Interest is Equal to Zero

Break-even Analysis between Two Alternatives with Interest Rate of Zero

Break-even Analysis of a Single Project with Interest Rate Greater than Zero

Break-even Analysis of Mutually Exclusive Alternatives with Interest Rate Greater than Zero

Airline Break-even Load Factor

Introduction to Payback Period Analysis

Conventional Payback Period Analysis

Discounted Payback Period Analysis

Using Spreadsheets for Break-even

Analysis and Payback Periods

Summary

Discussion Questions and Problems

10 Uncertainty, Risk Analysis, and Simulation

Decision Making

Probability and Business Decisions

Cumulative Probability Distribution

Joint Probability Distribution

Measuring Risk and Reward

Sample Space

Expected Return or Mean

Variance

Standard Deviation

Calculating Variance and Standard Deviation Using Spreadsheets

Normal Distribution

Calculating Normal Distribution Probability Using Spreadsheets

Standard Normal Distribution

Portfolios

Portfolio Beta

Capital Asset Pricing Model (CAPM)

Security Market Line (SML)

Sensitivity Analysis

Break-even Analysis

Monte Carlo Analysis (Simulation)

Summary

Discussion Questions and Problems

11 Analysis of Depreciation, Replacement, and Abandonment

Introduction

Depreciation Methodologies

Straight Line Depreciation (SL) Method

Declining Balance Depreciation (DB)

Modified Accelerated Cost Recovery System (MACRS)

Sum-of-the-Years Digits (SYD) Method

Comparison of Different Approaches to Depreciation

Using Spreadsheets for Depreciation Computations

Basics of a Replacement Decision

Impairment

Abandonment

Summary

Discussion Questions and Problems

**12 Engineering Cost Estimation**Definition of Cost.

Fixed Costs (FC)

Variable Costs (VC)

Total Costs (TC)

Cubic Cost Function

Marginal Costs (MC)

Average Total Cost (ATC)

Average Fixed Cost (AFC)

Average Variable Cost (AVC)

Sunk Costs

Opportunity Costs

Relationship between Economic and Accounting Cost

Cost of Debt

Cost of Equity

Weighted Average Cost of Capital (WACC)

ROIC vs WACC

Cost Divisions and Categories

Direct Costs

Indirect Costs

Learning Curve

Estimating Costs

Cost Estimation Techniques

Unit Cost Method

Cost Index Method

Cost Capacity Equation

Cost Factor Method

Indirect Cost Estimation and Allocation

Airline Cost Structure

Operating Costs (OC)

Non-operating Costs (NOC)

Summary

Discussion Questions and Problems

13 Analysis of Financial Statements

The Income Statement: Measuring a Firm’s Profits

Revenue, Sales, or Income

Cost of Goods Sold (COGS)

Operating Expenses

Depreciation

Operating Profit

Financial Costs

Net Income

The Balance Sheet: Measuring a Firm’s Book Value

Current Assets

Fixed Assets (Non-current Assets)

Total Liabilities

Current Liabilities

Non-current

Liabilities

Stockholders’ Equity

Statement of Cash Flow

Cash Flow from Operating Activities

Cash Flow from Investing Activities

Cash Flow from Financing Activities

Measuring Free Cash Flow

Common Size Financial Statements

Common Size Income Statement

Common Size Balance Sheet

Summary

Discussion Questions and Problems

14 Analysis of Financial Ratios

Liquidity Ratios

Current Ratio (CR)

Quick Ratio (QR)

Asset Management Ratios

Accounts Receivable Turnover Ratio (ART)

Average Collection Period (ACP)

Inventory Turnover (ITO)

Fixed Asset Turnover Ratio (FAT)

Total Asset Turnover Ratio (TAT)

Financial Management Ratios

Debt Ratio (D/A)

Debt to Equity Ratio (D/E)

Times Interest Earned Ratio (TIE)

Profitability Ratios

Gross Profit Margin (GPM)

Operating Profit Margin (OPM)

Net Profit Margin (NPM)

Return on Total Assets (ROA)

Return on Equity (ROE)

Dividend Ratios

Dividend Payout Ratio (DPR)

Dividend Yield

Market Value Ratios

Market to Book Ratio

Price–Earnings Ratio (P/E Ratio)

DuPont System Ratios

Return on Assets (ROA)

Return on Equity (ROE)

Window Dressing

Altman Insolvency Index

Key Financial Ratios for the Airline Industry

Available Seat Mile (ASM)

Revenue Passenger Mile (RPM)

Cost per Available Seat Mile (CASM)

Revenue per Available Seat Mile (RASM)

Revenue per Revenue Passenger Mile (RRPM) or Passenger Yield

Average Stage Length (ASL)

CASM (Stage Length Adjusted)

Average Daily Block Hour Utilization

Load Factor (LF)

Break-even

Load Factor (LFb-e)

Summary

Discussion Questions and Problems

15 Fundamentals of Decision Theory

Decision-making Process

Decision Trees

Nodes

Branches

Decision Environments

Decisions under Certainty

Decisions under Uncertainty

Decisions under Risk

The Economic Theory of Information

Expected Value of Perfect Information (EVPI)

EV with PI

Queueing Theory

Customer Arrivals

Arrival Characteristics

Waiting Line Characteristics

Service Facility Characteristics

Cost–Capacity Tradeoff

Summary

Discussion Questions and Problems

Appendix A

Appendix B

Appendix C

Appendix D

Appendix E

Appendix F

Glossary

Index

## Author(s)

### Biography

**Bijan Vasigh** is Professor of Economics and Finance in the College of Business at Embry-Riddle Aeronautical University, Daytona Beach, Florida, USA.

**Javad Gorjidooz **is the Chair of the Business Administration Program and Professor of Finance in the School of Business at Embry-Riddle Aeronautical University, Prescott, Arizona, USA.