Chapter 1

Advanced Engineering
Economics for Engineer
Managers

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Why this book?
• Fundamentals of Corporate Finance is
the market leader.
• Current examples that reflect
Corporate Finance - Engineering
Economics in today’s world.
• WACC – Weighted Average Cost of
Capital
• Very well recognized authors.
 Authors
• [Link]
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• [Link]
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Advanced Engineering Economics

• Some important questions that are

answered using Advanced
Engineering Economics:
– What projects should the firm take on?
– Where will we get the long-term
financing to pay for the investment?
– How will we manage the everyday
financial activities of the project/firm?
– Pricing and Bidding/Negotiations
1-4
 Some Engineer Managers
are also Financial Managers
• Financial managers try to answer some or all
of these questions
• The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
– Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning
– Controller – oversees taxes, cost accounting,
financial accounting and data processing
• It is about Decision-Making!
1-5
 Success
• Successful engineering
managers typically require
training and experience in
business and engineering.
• Financial Engineering is one of
the new hot topics!
 Success
• Engineering managers, who direct engineering
or architecture departments, are a prime
example. Using advanced experience and/or
training in business and engineering, these
managers guide their teams from product
creation to completion. Engineering managers
oversee the technical development of a product
while keeping the team organized and
supported, and in sync with corporate strategy.
 Success
• Engineering managers oversee the technical
development of a product while keeping the
team organized and supported, and in sync
with corporate strategy. Engineering
managers may oversee research and
development, manufacturing, product
development and design, among others.
Engineering managers must bridge two
worlds, that of the techie and that of the
corporation. They should be excellent both
technically and as communicators and
planners.
 Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operating Officer (COO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

 Engineering Economics
Management Decisions
• Capital budgeting
– What long-term investments or projects
should the business take on?
• Capital structure
– How should we pay for our assets?
– Should we use debt or equity?
• Working capital management
– How do we manage the day-to-day
finances of the firm?

1-10
WACC = Weighted Average Cost of Capital
WACC is used to discount the Free Cash
Flows on all new projects.
ROA = Return on Assets
ROA > WACC
 APPLE
• Let’s go to Yahoo Finance
– [Link]
• Sign: AAPL
– Check finance
– Check Profile and Key Statistics
 Forms of Business
Organization
• Three major forms in the United
States
– Sole Proprietorship
– Partnership
• General
• Limited
– Corporation
• Limited Liability Company

1-13
 Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of
– Least regulated owner
– Single owner keeps – Equity capital
all the profits limited to owner’s
– Taxed once as personal wealth
personal income – Unlimited liability
– Difficult to sell
ownership interest

1-14
 Partnership
• Advantages • Disadvantages
– Two or more – Unlimited liability
owners • General partnership
– More capital • Limited partnership
available – Partnership
– Relatively easy to dissolves when one
start partner dies or
– Income taxed once wishes to sell
as personal income – Difficult to transfer
ownership

1-15
 Corporation
• Advantages • Disadvantages
– Limited liability – Separation of
– Unlimited life ownership and
– Separation of management
ownership and – Double taxation
management (income taxed at
– Transfer of the corporate rate
ownership is easy and then dividends
taxed at the
– Easier to raise personal rate)
capital

1-16
Taxes Rates (IRS – USA)
[Link]
Taxable Income ($)
Tax Rate Of amount over
Over But not over

$0 $50,000 15% $0

50,000 75,000 25% 50,000

75,000 100,000 34% 75,000

100,000 335,000 39% 100,000

335,000 10,000,000 34% 335,000

10,000,000 15,000,000 35% 10,000,000

15,000,000 18,333,333 38% 15,000,000

18,333,333 — 35% 0
 Goal of Financial
Management
• What should be the goal of a corporation?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company’s
stock?

1-18
 Goal of Financial
Management
• What should be the goal of a corporation?
– Maximize profit? Are we talking about long-run
or short-run profits?
– Minimize costs? We can minimize costs today
by not purchasing new equipment or delaying
maintenance, but this may not be in the best
interest of the firm or its owners.

1-19
 Goal of Financial
Management
• What should be the goal of a corporation?
– Maximize market share? This has been a
strategy of many of the “[Link]”
companies. They issued stock and then
used it primarily for advertising to increase
the number of “hits” to their web sites.
Even though many of the companies have
a huge market share, they still do not
have positive earnings and their owners
are not happy.

1-20
 Goal of Financial
Management
• What should be the goal of a corporation?
– Maximize the current value of the company’s
stock? There is no short run vs. long run here.
The stock price should incorporate expectations
about the future of the company and consider
the trade-off between short-run profits and long-
run profits.

1-21
 Goal of Financial
Management
• What should be the goal of a corporation?
– Does this mean we should do anything
and everything to maximize owner
wealth? The purpose of a for-profit business
should be to make money for its owners.
Maximizing the current stock price increases the
wealth of the owners of the firm.
– This is analogous to maximizing owners’ equity
for firms that do not have publicly traded stock.
– Non-profits can also follow the same principle,
but their “owners” are the constituencies that
they were created to help. 1-22
 The Agency Problem
• Agency relationship
– Principal hires an agent to represent
his/her interests
– Stockholders (principals) hire managers
(agents) to run the company
• Agency problem
– Conflict of interest between principal and
agent
• Management goals and agency costs

1-23
 Managing Managers
• Managerial compensation
– Incentives can be used to align management
and stockholder interests
– The incentives need to be structured carefully to
make sure that they achieve their goal
• Corporate control
– The threat of a takeover may result in better
management
• Other stakeholders

1-24
 Work the Web Example
• The Internet provides a wealth of information
about individual companies
• One excellent site is [Link]
• Another one is
[Link]
• Another one is
• [Link]
• Click on the web surfer to go to the site,
choose a company and see what information
you can find!
1-25
 Financial Markets

• Cash flows to the firm

• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over-the-counter securities
• NYSE
• NASDAQ

1-26
 Video

Financial Markets
[Link]
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