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Session 3557

INTEGRATING RISK INTO AN ENGINEERING ECONOMY COURSE WITH SIMULATION SOFTWARE

Eyler R. Coates, Rita L. Endt

The University of Southern Mississippi

Abstract

Engineering economy problems with all deterministic inputs are actually rare. Some information required for solving engineering economy problems can be defined fairly well, but much information is uncertain, such as the actual cash flows from revenues and costs, the salvage value of equipment, the interest rate or even the project life. The use of simulation software with Monte Carlo techniques makes engineering economy problem solutions more realistic. Probability descriptions of input variables and Monte Carlo sampling together provide a practical method of finding the distribution of the desired output given the various random and deterministic input variables. The results of such analyses give better information for making decisions.

This paper provides two examples that demonstrate how commonly available simulation software could be used in engineering economy problems to reduce the risk associated with the solutions. One example demonstrates the future worth distribution of an annual series of payments when there is uncertainty about the future earning power (interest rate) from year to year. Also, another example extends the first example to include an input variable that is dependent upon another random input variable. The second example also demonstrates how a discontinuous function can be easily incorporated in the economic model using simulation. These examples can be used to demonstrate how risk is handled in an engineering economy course. The examples can also be used as additional applications in an industrial simulation course.

Introduction

Some information required for an engineering economic problem can be well defined, like the cost of new machinery, labor rates or the current tax rate structure. Much required information is uncertain, such as the actual cash flows from revenues and costs, the salvage value of equipment, the interest rate or even the project life. In most undergraduate engineering economy courses, the concept of risk is either not introduced at all or is mentioned briefly at the end of a course and in final chapters of a textbook5. Yet, engineering economy problems with all deterministic inputs are actually rare in “real life.”

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Endt, R. L., & Coates, E. R. (2000, June), Integrating Risk Into An Engineering Economy Course With Simulation Software Paper presented at 2000 Annual Conference, St. Louis, Missouri. 10.18260/1-2--8474