Engineering Finance
Lessons


Introduction
Review

This is a review of the Project Finance section of the course. We repeat the goals of the section and emphasize the tasks that a student should be able to do for the first examination. To prepare for the exam you should study carefully the contents of each of the first seven lessons on this site. The answer keys for the Events and Homework assignments are on the Canvas site. You should study these before the exam, but you may not view the keys during the exam.

Goals

Each lesson in the section has a collection of goals. Most of them describe activities that you should understand and be able to perform. The paragraphs below describe the purpose of each lesson. Click the bush icon to see the goals of the individual lessons.

Browser Page
  • Economics and the Engineer
    This lesson describes how economics and finance pervade the modern world and how they are important for engineering practice. Corporations show their financial status and activities with financial statements. The lesson provides an introduction.
  • Engineering Projects
    This lesson identifies the features of projects and focuses on aspects of particular interest to this course. The work of an engineer is often organized into projects.
  • Capital Costs
    This lesson is about estimating the expenses associated with capital projects. The cash flow of the capital costs indicates how the expenditures are distributed in time.
  • Life-Cycle Costs
    This lesson is about estimating the life-cycle costs (and revenues) for the project. When comparing alternative solutions it is important to consider the costs and revenues associated with the project from the initial financial investment through the disposal of assets associated with the project. This interval between birth and death is the life cycle.
  • Estimates
    This lesson addresses the question on how individual cost estimates should be made. Since the methods of this course are used primarily for planning, the expenditures and receipts associated with capital and life-cycle costs are always estimates of future events.
  • Estimation with Risk
    This lesson introduces probability models for describing uncertain estimates. Estimates of a cash flow, where most of the amounts are realized in the future, always involve uncertainty or risk.
  • Project Cost with Risk
    This lesson uses probability theory and simulation for assessing the risks associated the capital cost of a project.
Exam Format

The first midterm exam will be administered during the regular class meetings. The exam will have both closed and open book parts. The closed-book part will be distributed first. When you turn in this part, you will receive the open-book part. No strict time limit is enforced for the completion of the closed book-part, but leave at least one hour for the open-book part. The open-book part must be submitted by the end of the class meeting. You will have a 1.75 hours to complete both parts.

Closed Book

The closed-book part will have questions mostly of a conceptual nature. You may use calculators, but no other materials are allowed. Some problem types are listed below to help focus your studies for the closed-book part.

The closed-book part might ask you to replicate the computations of the Estimate add-in. One example is illustrated below. Given the data, you may be asked to fill in the Cost column on the far right and the Cash Flow row on the bottom. Similar questions might be asked about other forms created by the Estimate add-in. We will use interest rates of zero, so all P/F factors are 1.

The closed-book part may also have simple balance sheet questions as illustrated at the end of Lesson 1 (Economics and Engineers).

You should study the textbook with regard to the characteristics of projects and the definition and characteristics of the WBS and CBS. These topics are also discussed in Lessons 3 and 4.

You should know and be able to use the Cost Estimating Relations described in Lesson 5 (Estimates). You should also understand the difference between fixed and variable costs with regard to estimation.

Open Book

For the open-book part, you may use calculators, computers, Excel, the ME353 website, the Excel add-ins and the course textbook. You may not use cell phones, iPads, the Canvas site or any files such as event keys, homework keys or summary sheets prepared before the exam. Any device not mentioned is not permitted. A hard copy of the exam will be distribued and space on th exam sheets will be provided for your answers. To receive credit you must write your answers on the paper form.

You will be able to submit an Excel workbook through Canvas when you are finished with the exam. We will only refer to that workbook for questions of partial credit.

Problems will be similar to those given in the events and homework. Be sure that you are able to use the Estimate and Random Variables add-ins as described in the lessons.

 
Text

Review the textbook chapters and sections referenced in the lessons. Some questions may relate to items in the Goals covered in the text, but not emphasized in the web-based materials.

Economics and Engineers

The primary skills taught in this Lesson 1 regard the construction and interpretation of simple financial statements including the balance sheet, income statement and cash flow statements.

Click the Q icon below to open a quiz on financial statements. This quiz was also in Lesson 1. It is a PDF document. The quiz is made up of old exam questions. Work the problems to the best of your ability. Then open the Scorecard. This is a Flash movie that you can use to self-grade your quiz. Then click on the Q/A icon to open the key to the quiz. Again, this is a PDF document. The quiz has three questions with a total of 11 parts. Enter 11 on the appropriate scorecard field and follow the instructions to grade yourself on the quiz. If you do well, the scorecard will give you a graphic award.

. Quiz Icon
Financial Statements Quiz
.
. Window Icon
Scorecard
.
. Quiz Icon
Financial Statements Quiz Key
.
Engineering Projects

Lesson 2 describes the characteristics of a project and the activities that take place during the project life cycle. Chapter 1 of the textbook provides a considerable discussion about the characteristics of projects.

Capital Costs

In Lesson 3 we learn the phases of the life cycle and how to estimate capital costs. These are the costs (and perhaps revenues) associating with installing or completing a project. They do not include the entire cash flow associated with the project. These are the life-cycle costs and are described in the next lesson.

The lesson introduces the work breakdown schedule (WBS) used to describe, organize and estimate the costs of a project. The Estimate add-in is used to construct the WBS.

Life-Cycle Costs

Lesson 4 considers the life-cycle cost (LCC), which is the sum of all expenditures less receipts from origination of the project to disposal of the system. In additional to the capital costs considered in the Lesson 3, the LCC includes the operating costs and revenues for each year of the life cycle as well as the disposal costs. The lesson introduces cost breakdown schedule (CBS) for organizing the estimation of the LCC for a system. The Estimate add-in is used to construct an LCC model.

Estimates

Lessons 3 and 4 introduce the work breakdown schedule (WBS) and cost breakdown schedule (CBS) for organizing the estimation of costs for projects and systems, respectively. A question that remains to be answered is how does one find estimates for the activities or components at the lowest level of these two schedules? Lesson 5 introduces some methods and models that have been used for cost estimation. The methods that use mathematical models are called cost estimating relationships or CERs.

Estimates with Risk

Lesson 6 describes the risks associated with a project, particularly focusing on the risks regarding cash flows. Uncertainty of estimation is always present and in our view, it is better to account for uncertainty explicitly rather than simply neglect it. The methods for dealing with risk introduced here will be used throughout the course. This lesson uses the Random Variables add-in.

Four distributions are considered when associating random variables to estimates: Uniform, Triangular, Beta and Normal. Distribution parameters affect the shape of their density functions. Features of the distributions are used for point estimates of uncertain quantities. These include the mean, median and percentiles. Simulation can also be used for point estimates, but simulated values are only useful when used as part of a simulation study, as described in the next lesson.

Project Cost with Risk

Lesson 7 combines the results of previous lessons to obtain estimates for the capital cost of a project. The estimates explicitly consider risk. The WBS model is adapted to include probability distributions for cost components. Using formulas from probability theory we compute the mean and variance of the project cost. With these results we can compute several measures that assist decision-makers in risky circumstances. For most situations, the results obtained are approximate in that the normal distribution is used to model the capital cost. When this approximation is unacceptable, Monte-Carlo simulation is used to obtain results.

The lesson uses both the Estimate and the Random Variables add-ins. Although these add-ins allow risk to be included in the LCC estimates, this topic is not addressed here.

Summary

 

. Browser Page
Project Finance Summary
.

Navigation

Return to Top of Page

Engineering Finance
by Paul A. Jensen
Copyright 2005 - All rights reserved

Front Page Lessons Resources