M.J.M. van den Beld
A Course for Economic Evaluation of Alternatives
Report 2003.TL.6787, Transport Technology, Logistic Engineering.
The objective of this document is to serve as a manual and reference guide
for evaluating different alternatives based on economic performance. The
reader should be aware that the document is primarily written for
Mechanical Engineering students in their final stage of their study.
The seven steps procedure for evaluating alternatives forms the structure
of the guide. Every step is subsequently reviewed. Finally an extensive
case study applies the same steps as an example. Following are the
different steps in the procedure:
1. Recognition and formulation of the problem
The first step in the procedure is to recognise and formulate the problem,
its boundaries and internal / external requirements. This is however a
continuous process and information from the evaluation phase may change
the original formulation of the problem.
2. Development of feasible alternatives
The second stage of the analysis is dedicated to the development of
feasible alternatives. This process is very important as the quality of
the different alternatives have a very high impact on the final outcome of
the project. Creativity and innovation are essential in this stage.
3. Development of the net cash flow for each of the alternatives
As engineering economy studies deal with outcomes that extend into the
future, estimating the future cash flow is a critical step in the
evaluation. The estimates for future cash flows for each alternative are
based on the Work Breakdown Structure, the Cost and Revenue Structure and
several Estimating Techniques.
4. Selection of criteria
The actual assessment of the different alternatives should be based on a
stated reference performance indicator, which is the Minimum Attractive
Rate of Return. Then before the actual comparison can be made the cash
flows resulting from the different alternatives have to be converted into
their equivalent worth value in time. The reader should then decide on the
preferred selection criteria, such as the present, the future or the
annual worth, internal rate of return or payback period.
5. Analysis and comparison of the alternatives
Before the actual assessment of the different alternatives can be made, it
is crucial to ensure that the alternatives are compared on a comparable
basis. Therefore the alternatives should be compared on the same analysis
period. If the alternatives have different lives, the comparison should be
made based on the repeatability and co-terminated assumption. Finally the
reader should verify that the same depreciation and tax schemas are used
before the actual comparison takes place.
6. Selection of the preferred alternative
Most of the comparison methods involve a variety of estimates such as
revenues, costs etc. Certainly these estimates are not always fully
reliable; therefore it is important to quantify the risks involved in the
projections before a decision can be made. Methods for assessing these
risks are the sensitivity, the optimistic-pessimistic, probabilities and
expected value analysis. Finally the student should be aware of the
possible conflict of interest between shareholders and current managers
when selecting the preferred alternative.
7. Performance monitoring and post-evaluation of results
While perhaps not strictly central to the decision-making process, good
decision-making between alternatives requires that the effects of previous
decisions be closely monitored. Cost control and status reporting are very
useful tools to measure and evaluate the performance
The document concludes with an economic evaluation case study based on
technical alternatives for chemical transport in the 21st century. The
information for this case is gathered from a Logistics Engineering graduation
project [B.C. Bührmann "Chemicaliëntransport in de
21ste eeuw"]. All reviewed steps of the economic engineering
procedure are applied in that case study.
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