Economic Analysis

Construction Engineering 221

Economic Analysis

• Another means of risk assessment• Virtually every decision your make

involves an assessment of risk– Whether to drive or fly– Whether to buy at WalMart or Marshall Field– Whether to have sex with someone– Whether to buy a new vehicle or keep your

old one– Whether to major in Con E or History

Economic Analysis

• Risk assessments are trade-offs between sub-optimal choices

• Different forms of risk in construction– Financial– Contractual (liability and tort)– Design (in some deliveries)– Method of construction– productivity

Economic Analysis

• Use contract language and legal documentation to protect against contractual risk

• Use economic analysis to make risk decisions regarding financial trade-offs

• Use probability for process risk (covered later)

Economic Analysis

• Can be used for personal or corporate decisions (although personal decisions are affected by irrationality constraints)

• Can be used for any currency, and even cross-currencies with appropriate assumptions

• Can be used across a variety of terms

Economic Analysis

• Many methods can be used to arrive at the “correct answer”

• Precision is senseless in the face of gross assumptions

• Year –end convention keeps things simple and is robust over the long term (equivalent treatment of options)

• Introduction of non-quantifiable factors can be problematic -there are ways to handle it

Economic Analysis

• Cash Flow is the blood of construction- MUST know how to predict and value cash flow

• Use cash flow timelines to help visually structure the problem and alternatives

Economic Analysis

• Receipts point up, disbursements point down, vector length represents size of cash transfer

• Ignore sunk costs (frequently “irrational”)• Types of cash flows

– Single payment (lump sum)– Uniform series (equal payments at set times)– Gradient (increasing payments)– Exponential gradient (decaying stream)

Economic Analysis

• Problems– Alternative projects– Replacement retirement of equipment– Rate of return– Loans and repayments– Capital budgets– Assumptions and equivilence tomorrow