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 constructionMUST 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