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Economics of Project Management

written by: Ramachandran V • edited by: Ginny Edwards • updated: 8/21/2010

Engineering economic analysis is the science of applying economic criterion to select the best economical alternative of a project.

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    Project Management Economics

    Alternate Engineering Designs 

    Economics of Project Management plays a very vital role in the in the successful implementation of the proposal.The analysis is the science of applying economic criteria to select alternate engineering designs or proposals. The available resources have to be managed properly and efficiently. For this, knowledge in the particular domain, skill and necessary tools are required.

    The steps of engineering economic analysis are:

    1. Formulation of the problem: The objectives should be clearly understood and well defined. It should be written in a clear and logical format.
    2. Development of alternatives: The number of alternatives has to be reduced for further detailed analysis.
    3. Net cash flow for each alternative: Net cash flow for an alternative is based on the economic impacts in terms of the estimated changes in revenues and costs.
    4. Criterion for determining the preferred alternative.

    The criteria for selection of preferred alternative must commensurate with the actual situation. It should be seen that the best alternative should serve the long term interest of the organization.

    1. Comparison of the feasible alternatives: The net cash flow with the economic criterion provides the basis for the economic evaluation and comparison of the alternatives.
    2. Selection of the preferred alternative: Based on the result of the analysis, the alternative best suited for the situation should be recommended.
    3. Post evaluation analysis: The purpose is to continuously improve the operations based on the feedback received.

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    Economic Studies

    The construction economic studies can be classified into the following two types:

    1. Primary economic comparisons
    2. Time based studies

    Primary economic comparisons

    Here the effects of time are irrelevant. All the factors influencing the decisions are already present. There are two types of economic comparisons: Present economic studies and Break-even analysis

    A) Present economic studies

    Important applications of present economic studies in construction are

    - selection of plant and equipment

    - selection of material and construction methods

    B) Break-even analysis

    The break-even analysis is a graphical representation which shows the variation of costs for different processes to achieve the same objective. The analysis can be employed in the selection among the alternatives.

    Time based studies

    A) Cash flow forecasting

    Cash flow is the movement of money into or out the company. Purposes of cash flow are:

    - It ensures the availability of cash to meet the demand

    - It provides an indicator to the lending institutions that the company is capable of the repaying the advances made

    - It ensures that cash resources are fully utilized for the benefit of the owner and the investors

    B) Investment Appraisal

    This may be classified according to the managerial problems.

    - New construction

    - Replacement and modernization

    - Economic choice

    - Financing problems

    The actual decision is made based on economic comparison of the various alternatives. But sometimes expenditure may override an optimum solution.

    The expenditure can be evaluated by different approaches:

    1. Payback
    2. Return on capital employed
    3. Discounted cash flow method

    1. Pay back: In this method, the number of years it takes to payback the original investments from profits arising out of the investments is considered.

    2. Return on capital employed: This method is based on annual profit which is a percentage of the capital required to produce that profit.

    3. Discounted cash flow method: The basic principle of this method is that a sum of money received today is worth more than the same sum received at some future date.

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    Sensitivity Analysis

    The primary purpose of sensitivity analysis is to give the management about the effects which the variations in estimation would cause. This will enable the management to take appropriate decisions.

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    For finalization of a project, proper economic analysis is to be done. The best alternatives available should be identified and then analyzed so as to arrive at the correct decision.

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