Economic decision-making is designed to achieve the greatest profitability and cost-effectiveness in private as well as public economic organizations. Because profitability and cost-effectiveness are not well-defined, conventional methods of decision-making use multiple criteria, none of which are provably optimal. Consequently, different methods of decision-making are used by various organizations in the same industry, and also by different parts of an organization that compete for the same capital constraint. In contrast, a single profitability criterion is proposed for optimal economic decision-making that is independent of the structure of the organization. For this reason, the definitions of single and multiple profitability criteria are systematically confronted with observations in order to explain their similarities and differences in a more concrete fashion.

The book provides a method of selecting engineering and financial alternatives whose cash flows maximize the net present-value of an organization for a given capital constraint. All parts of an organization would use a single profitability criterion for selecting (1) the best way of doing each project, (2) the best projects to do and (3) which alternatives should be funded. Because forecasting errors are inherent in engineering and financial data, the proof of optimality assumes each alternative has accurate cash flow descriptions that account for engineering risks of input costs, marketing risks of output revenues and external costs of borrowing money after income taxes. The results of the convex-envelope proof of optimal economic decision-making presented here are applicable to industrial firms, financial institutions, government agencies and nonprofit organizations.

Conventional methods of economic decision-making evaluate engineering and financial risks by determining net present-values with internal discount rates such as minimum-attractive-rates-of-return (MARR) and weighted-average-costs-of-capital (WACC). Accounting for engineering and financial risks with internal discount rates can seriously distort the net present-values of cash flow forecasts derived from available engineering and financial information. Moreover, the proof of optimal economic decision-making cannot be verified by observations from future financial statements of an organization unless discount rates reflect the after-tax cost of interest incurred for borrowing money.

Single and multiple-variable optimization problems are treated in the eighth and ninth chapters of the book. Linear programming (LP) translates input and output variables that are subject to inequality and equality constraints into linear relationships from which some objective quantity can be optimized. The simplex algorithm for solving LP problems was developed by George B. Dantzig in 1947 and it is currently applied to many problems in industry and finance. The simplex algorithm is only one of a number of linear and nonlinear techniques used to solve constrained optimization problems.

Engineering production functions (EPF) provide more complete and accurate solutions of small-scale input/output production problems than LP analysis could provide. The EPF analysis uses a single budget constraint in optimizing input and output variables on the basis of their market prices. Consequently, the need for multiple input constraints used in LP analysis is eliminated. The EPF input and output variables may have increasing, decreasing as well as constant returns to scale that LP problems always require.

In writing this book, the author tried to provide a common language for engineers, accountants and economists in the study of optimal economic decision-making. A unified approach is provided for both private and public economic organizations. Because this book is designed for wide audiences of students and practitioners in engineering, accounting and finance, the main text assumes the reader has only a basic background in analytic geometry and calculus. A liberal use of appendices is made where more rigorous mathematical treatments are required. The basic theory of economic decision-making is developed in an intuitively logical fashion with simple computations and graphical displays. Practical examples have been selected from typical engineering and financial alternatives in public as well as private organizations where income taxes are involved.

Present values of future cash flows discounted at constant or varying interest rates are readily determined with spreadsheet computer programs that are also useful for solving many other engineering and financial problems. Therefore, several appendices of this book are designed to help readers utilize popular spreadsheet programs on PC and Macintosh computers. Constant interest rate tables with discrete and continuous compounding of cash flows with uniform, arithmetic and geometric gradients are given using American Society for Engineering Education symbols. Commissioners 1980 Standard Ordinary Mortality Tables with 4% Commutation Columns are given for females and males.

©Bernard Goldberg, 2007