Decision-Making PDF

Chapter 1 Decision-Making Over the next ten chapters, our course of study will improve your competency in financial decision-making. The book spans subjects in accounting, finance, and engineering economics; take a few moments to review Figure 1.1 illustrating the ”road ahead” before we forge ahead...

Chapter 1 Decision-Making Over the next ten chapters, our course of study will improve your competency in financial decision-making. The book spans subjects in accounting, finance, and engineering economics; take a few moments to review Figure 1.1 illustrating the ”road ahead” before we forge ahead! Decision Making Financial Statements Time Value of Money (TVM) Part I Applications of TVM Comparing Alternatives Intellectual Property Part II Concept Mapping Probability and Risk Capital Budgeting Part III Leadership Figure 1.1: The road ahead: Ten learning modules grouped in three parts. 1.1 Three tactical challenges Much has been written about the subject of accounting, finance, and engineering economics and there are many informative textbooks about these subjects. Three challenges with this abundance of information are that: • There are a wide variety of topics to introduce, explain, study, and learn that pertain to the everyday life of an engineering manager. 1 • Readers of this textbook have a wide variety of prior experiences with finance; some may have already taken an accounting class while others may be entirely new to the subject. • The purchase of several di↵erent specialized books (accounting, finance, and engineering economics) results in underutilization when, in practice, we find we only need pieces and parts of any one of these books when beginning in this field. Topic variety is a reference selection challenge. There are so many existing textbooks that we could draw upon – my personal experience, years of work, actually, is with the works of Meigs and Meigs[1], McManus[2], Powers[3], and Wickes[4] – but methodical navigation requires an abundance of time (months!) devoted to each. Later in this introductory chapter we provide some perspectives the reader can adopt to facilitate mastery of so many topics. It is an easy read, so let’s go! 1.2 Three perspectives It is unreasonable to expect that we could simply outline several dozen concepts and expect that, through laborious exercise, the student will somehow recognize the fundamental premise of this course of study. Let’s fix that now. If you don’t remember anything else, the abstraction is to understand a transaction concept map shown in Figure 1.2. Figure 1.2 illustrates a simple, fundamental representation of the daily activities of a typical business; the cycle illustrates the role of accounting, information, and decisions central to the management of business. This diagram is highly simplified (and adopts the so-called internal perspective, as we shall soon see), so, of course we could have said “products or services” that result from managerial decisions, but hopefully you get the idea. And lots of things are missing from the diagram (the roles of investors, boards, etc.), but, in this simplified diagram, we underscore that at the most fundamental level: • Managerial decisions drive the conversion or use of assets into products, that ... • if are appealing to a market need lead to customer transactions, that ... • produce revenue and data to be converted into information, that ... • must be organized and communicated to managers to support decisionmaking. Pause for several moments to compare the itemized list above with the diagram below. Where might “ethics” issues enter and be a problem? Now, with Figure 1.2 in mind, is the interconnected nature of activities clear? Can you visualize the activities associated with each step that managers must lead to make things happen? If everything is so ”interconnected” then how do we characterize the activities and outcomes in a simple, understandable way? Let’s distill the process into three steps: • Adopt a transaction-based view of the business and ways to capture and communicate transaction activity. • Understand the engineering managers’ view of asset (cash, equipment, 2 Management Decisions Products Customer Transactions Information Data Analyze the Transaction Measure, Categorize & Record Synthesize and Report Accounting Figure 1.2: Role of accounting to provide support for managerial decisionmaking. facilities) management. • Examine the decision-making required to support and direct changes in business activity. A primary objective of this chapter is to explore these three perspectives with a special emphasis on decision making. 1.2.1 Transaction-based perspective Let’s examine the most fundamental – and hopefully common – business activity: transactions! Figure 1.3 helps focus the discussion. You can talk Sn+1 Product or Service Customer Transactions Supplier Sn S3 $ $$$$$$$ S2 Market Industry Figure 1.3: Transaction-based view of businesses, industries, and markets. strategy, dream about products you that think consumers might need, and organize focus groups to determine what end-users say they want, but unless your business is profitable (the revenue is greater than expenses) and solvent 3 (you can pay bills as they become due), you will never realize those aspirations. Profitability and solvency critically require that customers have a preference for your product and are willing to enter into a transaction with your business in which a product or service is exchanged for payment (i.e., buyers, not talkers). Better yet, we look for a series of ongoing transactions where a preference (over other suppliers) for your product and perceived value (see Figure 1.4) results in a transaction where the market price is far in excess of the cost of production (more on that later). Very simply, then, the “reality” $1.50 $1.00 $0.80 Market Value Cost of Production Target Price Figure 1.4: Identifying value in a transaction. of your “day-to-day” business can be characterized by customer transactions. An ability to appropriately capture, analyze, understand, and communicate those transactions is the foundation to knowing your business. Ideally the information provides actionable items and drives a transaction-based perspective. Items critical to long-term success (again, profitability and solvency) correlate directly to the magnitude (number of), type (pay now or pay later), and value (market preference) of periodic business transactions. Given that accounting is an information management system related to the analysis, measurement, and synthesis of transaction information, it should come as no surprise that the chapter to follow discusses accounting in more detail and the production of financial statements. To focus on business transactions means, of course, there must be some business transactions to examine, and an implicit assumption is that we are dealing with an ongoing concern, one that has been under way for a period of time – say, three years – and can be anticipated to be in operation for sometime in the future (at least five years). Such an assumption is essential for financial statements to have meaning year-to-year. Aspects of the business other than transactions warrant attention, too. These include fund-raising for the startup, investing for business expansion, and deciding to replace equipment. All involve transactions and play into a vibrant business; these will be identified later as investment activities. For now, our assumption of a transaction-based perspective implies a more simplistic “operational” scope. 4 1.2.2 Engineering management viewpoint Many stakeholders have an interest in the activities of a business. Since this Field Guide hopes to address those activities most likely to touch engineering students embarking on new managerial careers, the present work adopts the managerial viewpoint, as distinct from a regulatory, audit, and (to some extent) shareholder viewpoint. Principal stakeholders and the central role of the accounting system are shown below. Note the central role accounting plays All Stakeholders Financial statements Bank & agency reports Accounting System Tax returns Management & data reports Engineering Management Leadership Figure 1.5: Engineering management served by an accounting system (concept adapted from Meigs and Meigs[1], p. 7). in communication with stakeholders! We’ll talk more in Chapter 2 about the critical role of accounting in communicating business results; further, we’ll dispel any misunderstanding that accounting is the same as bookkeeping (for fun, try an Internet search of the phrase “accounting versus bookkeeping” – a recent search yields over 750,000 hits on this subject). Section 2.3 on page 23 explains further. What is the impact of taking a managerial perspective? How does this matter to this course of study? What is gained? Lost? How do current events play into the context of solutions? Consider and discuss the following statements in your study group: • Taxes are important and demand attention, but in the current work we do not venture beyond a simple understanding of how decisions can be impacted (or influenced) by tax considerations. The reasoning is that a typical engineering manager relies on the corporate tax department to help frame and present tax issues as a “boundary condition” or a project input parameter, with the idea that managers are not customarily tax accountants themselves. This Field Guide is therefore “light” in the 5 treatment of tax accounting except to the extent that taxes pertain to capital investment decisions. Many types of taxes are important, just not right now. • Regulatory matters have a significant bearing on many facets of a modern business, but as with tax accounting, the regulatory and audit function is not explored very deeply in the chapters ahead. Separate from the subject of ethics (which will appear to some degree later on in some case studies), this Field Guide lacks depth in the description of the audit function. There is no question that regulatory issues play an important role in decision-making, but, for now, we’ll keep these issues on the periphery of our discussions. • Stockholders are quite central to much of managerial thinking, but for the topics, tools, and skills we wish to center on in this book, we relegate stockholders as an environmental variable. Not a good thing to do in a more complete context of financial management, but for the time being we frame our world as having to simply meet established goals and objectives set for us by the stockholders through executive management, keeping stockholders at an “arm’s reach.” Do you think this assumption really has much day-to-day impact on the life of an engineering manager? Another way to distinguish between perspectives is to consider that there are internal and external users of information created by an organization. External users are normally indirectly related (auditors, regulators, lawyers, the press, etc.) to business operations and they will have a legitimate need for reliable information about past and planned activities taking the form of regular financial statements, the prospect of and contingency for lawsuits, or the planned purchase or sale of major assets. Returning to the needs of shareholders – external users of information – as investors in a company (and part owners, however small that fraction of ownership may be!) they would need financial information to decide whether they would like to own a bigger part of the company (buy more stock) or if the a↵airs of the company have become too risky (new products outside the core competencies of the management) for their portfolio and it is time to sell their holdings. Regulatory users are external users, too, as they are monitors of the activities of the company with bearing on managerial decision-making, but the regulators are part of the external context of business operations and are not the managers of the company. Labor unions might also have an interest in the prevailing wages of company employees, even though they are not directly responsible for setting company wages. In comparison, internal users of financial information are those individuals directly responsible for the operations and management of the company. Whether it is sales sta↵, marketing managers, human resources, purchasing agents, supply chain managers, or product development leadership, all have a direct impact on the success of the organization and need reliable financial information to be able to make informed decisions contributing to the efficiency and e↵ectiveness of the organization. Accountant career paths are another way to observe the di↵erence between 6 internal and external reporting, too. Management accounting attends to understanding, analyzing, and reporting information to internal decision makers while financial accounting has an external stakeholder focus. For the present work, we assume that internal engineering management information needs dominate, thus we set and accept a fairly narrow view of many key stakeholders. Over time, though, managers in practice do have many occasions where the importance of external users takes center stage, and that is not to be trivialized. Here, it is enough to tackle the intertwined, interdisciplinary, multifaceted nature of engineering management by bounding and limiting the environment in which we operate and make decisions. 1.2.3 Emphasis on decision-making We noted at the end of the last section that an important role of engineering management is to make decisions; however, up to this point it has been assumed we know what “decision-making” really means! Decision-making is often confused and treated synonymously with problem solving and, to some extent, critical thinking skills. Does the di↵erence matter? Are we just playing with words? Or is there a structural di↵erence that can help guide development and learning specifically related to the financial a↵airs of an organization? This section briefly underscores managerial decision-making as the impetus for much of the information we collect, analyze, and communicate; further, we identify decision-making as just one part of the much larger problem-solving process. Daily living gives us many examples to observe the gap between “what should be” and “what is.” While this sets the stage for spotting a “problem” in many cases, absent any process for filtering problems by degree of severity, the domain of problems that confront us would be unbounded! It is therefore useful to narrow thinking (at least in the corporate world) around those important problems that motivate time and energy to investigate the situation in detail. Let’s clarify with a specific example illustrated in Figure 1.6. In this example we suggest that a corporate strategic advantage can be gained by creating intellectual capital though the development of product patents, but a problem may be that competitors might already have defensible claims. The process of identifying existing or similar patent claims requires only a simple search of the US Patent and Trademark Office (USTPO) database. Claims retrieved from a keyword search of the USTPO database can be compared against our idea for a patent claim we think is unique. In this situation, let us assume our idea is for a highly fragmented market with a high degree of competition between suppliers. We would want to check if there are patent claims similar to ours to avoid the problem of patent infringement. The problem-solving process involves an iterative search of the database, harvesting select information from the database to examine, and then using this information to decide if the product attributes we have in mind are unique. Absent any claims from the database we might consider “similar” to our own ideas, we then decide to proceed with our plans to launch a new product. If we 7 Idea for a patent claim Search USPTO database for a “patent claim” A match? No Yes Related? Yes Draft a new claim to test Modify the claim to test No Add claim to patent claims Figure 1.6: A perspective on the patent claim search decision-making process. are wrong, there is the probability of financial impact on operations through legal expenses, fines, and losses in divestment of a product line. While the idea for the product may have come from, say, marketing, the engineering manager plays a critical risk mitigation role on the management team. In this corporate growth problem, the choice of core competence to develop (intellectual capital), sources (and legitimacy) of data, the interpretation of that data, and the logic underpinning risk management involve a wide variety of factors contributing to problem definition and decision-making. We can’t say that one is more important than the other. Is it better to identify the “right” problem and make poor choices in solving it, or to optimize the solution to the wrong problem? This example is similar to many others one might confront in practice and emphasizes the subtle role decision-making plays in problem-solving: 1. The product launch problem is important and involves an engineering decision among options (in this case, regarding “freedom to operate” in a marketplace). 2. There is a large body of information available and we use analysis tools to identify and refine that subset of information to establish a choice of action. 3. The interdisciplinary nature of the problem (presumably involving lawyers, among other professionals) and an iterative solution helps refine the course of action. 4. Some risk of corporate financial exposure exists and decisions must be made about the probability of that risk. Problem definition and decision-making are intertwined; for many engineering managers, then, problems present themselves in a variety of ways and must be reduced to a tractable form, a problem-solving strategy crafted, and 8 decision-making undertaken to optimize corporate resources. Accountability follows decision-making and defines managerial success or failure. Leaders must be as good at identifying the right problems as they are good decisionmakers. While we attend to both issues in the course of study covered by this book, the abbreviated nature of this course does, however, place an emphasis on engineering decision-making. The successful financial decision-maker is one who embraces and finds delight in the problem-solving process, a person who has some comfort level with ambiguity and interdisciplinary activity. Many times the cause of the problem emerges when working through many iterations of the problem definition, in which there is a pattern to relevant changes. And it is most gratifying to find the outcome that explains all the facts. It’s sort of like a mystery novel! The reality is that such gratification is hard to come by, so we have to be content with success in the art of decision-making. We really do not understand the problem completely, yet still manage to make a decision that satisfies most of our criteria. Saundra Lipe and Sharon Beasley[5](page 37) emphasize the concept of decision-making: “decision making is a purposeful, goal-directed e↵ort applied in a systematic way to make a choice among alternatives. It is action to achieve a foreseen result, which is preceded by reflection and judgment to appraise the situation, and by a thoughtful, deliberate choice of what should be done.” Decision-making, then, is influenced by many factors – among them “perception” – but we suggest here that many of these skills can be acquired over time. Let’s summarize six aspects of decision-making: 1. Outcomes or required outputs must be established. 2. Within the context of an organization or project, the outcomes of required outputs must be prioritized. 3. A set of (actionable) alternatives must be identified or developed. 4. Each of the proposed alternatives must be examined with respect to objectives (and their priorities). 5. A tentative decision is an alternative that appears to provide all the objectives. 6. Decisive actions are taken, and additional actions are taken to prevent any adverse consequences, thus avoiding another round of problem analysis and decision making. And, it is easy say, for instance, in item 1 that “outputs must be established,” but how do we go about it? The start of a very long answer begins by looking at the context of decision-making, the topic of the next section. 1.3 Financial frame of reference Among the more frustrating responses to the student inquiry “How do I ...?” is the response “It depends.” This fails the test of didactic rigor learned over the students’ prior years of college engineering training yet is so common in 9 the practice of management that the credibility of models is undermined and, worse yet, the myth proliferated that much in management is decided simply as a matter of opinion. So, why bother, then, with learning models in the first place? Well, to some extent it does depend. The complexity of situations warrants full consideration of the context of the decision. This maturity in thinking comes about over time once you realize that there is not a oneto-one relationship between “models” and “problems” but that the manager integrates those models relevant to a problem. So, the choice of Present Worth (PW) or Equivalent Uniform Annual Cost (EUAC) models for a specific situation might give the appearance of entirely a personal preference for or familiarity with, certain models of analysis; indeed, the process of choosing masks significant experiential learning in which what was once a slow, deliberate, conscious process that over time has become a rapid, unconscious selection manifest in the intuition of the decision-maker. Over time, similar situations engaged over and over again prompt a response that seems like and is a professional opinion. There is no fault with that strategy, except that both Benner [6] and Quirk [7] would suggest that it becomes harder and harder for the expert to articulate an “if-then-else-do” methodology of decision-making that has largely become intuitive. Deliberate Rapid Metacognition Intuition Unconscious Conscious Figure 1.7: Development of expertise in decision-making. While we can acquire some skills through academic study and practice, there is often no substitute for experience in the field. There seems to be no substitute for college internships enabling juxtaposition of practice and theory for students to explore firsthand the context of decision making; context is the key to (a) framing the problem (narrowing scope), (b) prioritizing possible inputs and outputs, and finally (c) identifying actionable alternatives. Context is so very important, yet escapes those textbook problems designed to make them simple to solve. There is no simple remedy; even as recently as 2011, the workshop report by Koenig[8] on engineering education suggests that increasingly employers demand the type of thinking conveying a deep understanding of a problem domain and those relationships within it; pattern recognition and metacognitive skills are as important as quantitative skills. Wow! We can’t solve all that here, but Koenig’s line of thinking plays a key role in the way that we suggest students approach each of the problems at the end of each chapter. Though you can jump ahead to Section 1.6 for more 10 details, suffice it to say here that your individual e↵ort to supplement the solution to every problem by linking to a current article in the business press – and commenting in a meaningful way – will build competence in framing the context of problems. In particular, look beyond the obvious in the current press (an article from the Harvard Business Review, Wall Street Journal, or New York Times published within the last two weeks) and ask questions – indeed work to categorize problems, going beyond the numerical answer and exploring the possible context of the problem. This will make your answer unique (more time for the instructor to grade) but give you experience in shaping new contexts to problems. To be a bit more specific, many users of accounting information are decision-makers. In general, engineering managers and their mid-level counterparts are responsible for the day-to-day operations of a business. Three categories of activities cover most everything in the daily life of a business: (a) operating, (b) investing, and (c) financing activities; these activities are arranged in decreasing order of typical importance to an engineering manager. Management Decisions Financing Investments Information Products Customer Transactions Data Analyze the Transaction Operations Measure, Categorize & Record Synthesize and Report Accounting Figure 1.8: Operations, financing, and investing impact on simple day-to-day business activities. You may have noticed that Figure 1.8 looks much like Figure 1.2, except now expanded on the periphery to include three major activities that managers conduct to help organizations reach their performance goals: operations, financing, and investing activities. Below, we very briefly expand on the nature of these activities relevant to the daily activities of the corporation and for which the engineering manager must be familiar if asset allocation decisions are to be meaningful. Operating activities A transaction-based perspective was described in Section 1.2.1. In that context, identifying, categorizing, and communicating the results of transac11 tions are really some of the most fundamental tasks to be mastered as a manager. How will we know if we are profitable? Solvent? Reaching our goals? Did we properly record transactions when they occurred (accrual accounting), or simply at the time the payment of cash took place (cash accounting)? What are the needs of the internal stakeholders? External? Engineering managers must know how to communicate transaction information in a way that all stakeholders can understand. This is customarily done through the creation of financial statements, standardized reports about the analysis of business transactions. Paying workers, buying raw materials, paying taxes, subcontracting services, and selling products are all examples of operating activities. Investing activities Managers have an obligation to employ the assets of the company in the most productive way to assist the company reach its goals. Assets – most often in the form of cash or an equivalent – are provided to the management, who then must decide how they should be invested. Through investment decisions managers’ decision-making activity results in the conversion or reallocation of assets provided by investors or owners of the company into di↵erent forms of “capital” that drive the business: • Human capital: employees of the company who perform numerous purchasing, production, sales, and management activities. • Intellectual capital: the development of know-how, patents, copyrights, or other intellectual assets that shape organizational uniqueness and core competencies to enable survival in a competitive marketplace. • Financial capital: the cash needed for day-to-day materials and supplies, investments in new product development, reserves to solve operational problems, or investments in opportunities that arise unexpectedly. We often think of investing as acquiring assets, but this activity also involves understanding the life cycle of assets and when and how to dispose of them, too. Financing activities Finding the initial funding to start a company, securing additional funding to expand operations, or establishing lines of credit for future use are all forms of financing activities. Activities such as financing inventory may not be central to an engineering manager’s day-to-day concerns, but certainly the decision to introduce a new product in the market in which new inventory is purchased by a third party and bought back over time will impact profitability. Suppose corporate management decided to “free up cash” by selling the land and building holding product X assembly operations and then lease the building back over 15 years. Would this impact your willingness to upgrade (unrecoverable) improvement to the production line? Financing activities are often (dare I say!) of secondary concern to the engineering manager, but most certainly do impact the framework of decision-making. Generally, we distinguish financing activities as those involving long-term assets, liabilities, and equity issues such as the issuance or redemption of stocks 12 and bonds. Engineering managers would not normally become intimately involved with, say, the issuance of preferred stock, but to have even a pedestrian understanding of the implications enables one to sit at the boardroom table and to follow such discussions. Be curious A well-known research paper by Stuart and Robert Dreyfus [9] on the training of pilots reveals much about how we deal with the context of ambiguous situations, particularly as it relates to decision-making under pressure. Relevant here is the conclusion that while an expert can try to explain a stepby-step methodology for the novice to emulate on the path to development of expertise, there evidently is no substitute for practice and experiential learning. The approach is “study what I have said, then go out and try it on your own.” Concept understanding takes time and e↵ort. We can talk about the difference between, say, an income statement and a cash flow statement, but the two will always be confused unless some ”hands-on” activity is part of learning. The problems at the end of the chapter should help with that e↵ort. In this section we have implied the engineering manager must assume individual responsibility – embrace curiosity – of those other functions of the business, even if no direct responsibility is on the horizon. It is all part of the general context of decision-making. As shown in Figure 1.9, only iterative, self-directed learning can fill the void. Knowledge Critical Thinking Skills Problem Curiosity Figure 1.9: A cycle of learning leading to refinement of context for ambiguous problems in engineering. 1.4 Focus on financial decision-making Section 1.2 outlined three perspectives that are central to this overview: (a) a transaction-based view of business activity, (b) an engineering manager perspective of asset management, and (c) decision-making in support of changes in business activity. We now move forward to link these perspectives to the three major facets of financial decision-making: accounting, finance, and engineering economics. Consider the following statements describing each subject: 13 1. Accounting: The process of identifying, measuring, and communicating economic information to permit informed judgments and decisions. 2. Finance: The study of assets and the way in which organizations manage assets, resources, and risks over time to accomplish organizational objectives. 3. Engineering economics: Application of engineering or mathematical tools in the quantitative analysis of the economics of engineering alternatives. At the risk of over-generalizing, it can be suggested that our discussion of accounting will provide tools for developing the transaction-based perspective, finance will expand our thinking about asset management, and engineering economics will provide many ambiguous situations to explore that will sharpen decision-making skills. Recall that Figure 1.1 subdivided each subject area leading to a total of 12 critical “concept blocks” that we will expand upon in the chapters to follow. Accounting We often hear that accounting is the “language of business,” or an “information management system,” or even that it is “the communication tool for the health of a business.” While true in all cases and explored in great depth in, say, Meigs and Meigs[1] or Marshall[2], here we must narrow the scope a bit to fit within our strategic intent; that is, in short order, we need to do three things: 1. identify and categorize typical business transactions to produce data about operations, 2. analyze and classify data to produce financial statements about the business, and 3. interpret results by comparing statement summaries and ratios against corporate performance objectives and industry norms or trends. Consider this list as a basis for formulating engineering management questions. We produce data that are analyzed and classified to produce financial statements which can be used by decision-makers to draw conclusions about the health of the business and to take action as needed to meet corporate performance objectives. This important process turns out to be challenging for those students who have never been exposed to accounting before. Terms like ”accounting period” seem academic, yet are critical to knowledge about why adjusting entries discussed in Section 2.5.2 are important to, say, capital equipment depreciation. Most important is the ability to look beyond the data presented, and have a sharp eye to identify inconsistencies and ask perceptive questions. In contrast to the other major subject areas, our accounting focus is almost entirely centered around Chapter 2 and the preparation and interpretation of financial statements; this leaves a great deal to be desired, but much of the hands-on activity to collect and categorize data does not necessarily prepare the engineering manager for the task of knowing what the data mean. This is a compromise, but we have found that the scope of Chapter 2 is a great 14 way for the engineer without any prior business classes to be successful if that engineers enrolls in (the most basic, anyway) graduate accounting course. This is not a perfect solution, but a compromise we make that should be noted as we steam ahead. Finance There are di↵erent interpretations of “finance,” and one could say that some of what we have chosen to represent could have been under the heading “accounting” or “engineering economics.” With an asset management perspective, this course of study is separated into Chapter 3 on the time value of money and Chapter 4 on the applications of the time value of money. Once again, this narrow scope might call into question this being an adequate treatment of finance (especially as MBAs know it!) but we subdivide to create a somewhat “sterile” view of the characterization of assets prior to the section on engineering economics. Engineering Economics Most engineers understand the significance of converting units so that the calculations they make are based on equivalent units of measure. In accounting, finance, and engineering economics the same basic principle applies – calculations and comparisons must be made for situations where “equivalent” units of measure are in place, but the situation is slightly di↵erent because the basis of measures are time, risk, and the concept of the time value of money. Given that typical investment choices are made over long periods of time, we have to account for the fact that $10 today is simply worth more than $10 three years from now (under typical economic conditions). Risk, inflation, and the cost of money (interest rate) a↵ect estimated values. In this chapter, we describe the tools and techniques for converting time a series of cash or cash flows into a form that permits reasonable assessments of value and decisions to ensue. There is a standard set of formulas for which a complete understanding of the homework problems should leave the student comfortable with this subject. Previous work in developing an understanding of the basic concepts of the time value of money (TVM) is now applied in the context of decision-making; this chapter frames the basis of most contemporary methods for determining project profitability. To be successful, the student should be fluent in the use of the tables that provide normalized factors as a function of N and i, for single and uniform payments. It may seem peculiar that we have also interjected a discussion of Bonds in this chapter, but this is not only a classic use of TVM, but is sets a financial performance context against which the opportunity cost of pursuing project options can be measured. 15 1.5 The bottom line: Transactions We have only briefly looked at the foundations of business analysis, and recited a limited view of businesses at that! Still, this is a foundation for engineering managers who will be decision makers within their company. Let’s reiterate a previous position: 1. Managerial decisions drive the conversion of assets into goods and services, that ... 2. if appealing to a market need to lead to customer transactions, that ... 3. produce revenue and data to be converted into information, that ... 4. must be organized and communicated to managers to support decisionmaking. Study this very brief list. If you don’t remember anything else about the chapter, consider the significance of each and every item. Mastery of these steps can impact your career as an engineering manager. Connect each step to current events – search out examples in the press to underscore the relevance of failing to know impact on the business; manipulating transactions is at the root of most ethical lapses and fraud in business today. 1.6 Discussion problems Problem 1.1 Briefly explain the di↵erence between accounting, finance, and engineering economics. Try to put the concepts in your own (or your team’s) words and compare the concepts where appropriate. Problem 1.4 What is the purpose of financial statements? Would you want to produce them even if they were not required, say, for entity tax reporting? Problem 1.5 What are the two key financial objectives in the management of a company? How can a focus on these objectives create ethical dilemmas? Problem 1.2 What mechanisms are in place to guide the identification, measurement, categorization, and communication of information to stakeholders and users? Discuss di↵erences between users and stakeholders. Problem 1.6 Distinguish between accounting and bookkeeping – be brief and think in terms of, say, what the di↵erences in training would need to be for employment in those professions. Problem 1.3 Among your colleagues in class, identify a term or phrase italicized in this chapter that you think is the most significant from your reading. Absent team consensus, then just provide your perspective. Problem 1.7 Which of the three components of Figure 1.2 might be a source of concern regarding “ethics”? 16 Problem 1.8 What are the major forms of a business? Why would there need to be any di↵erence between them? What are some advantages and disadvantages to each form? ambiguity. In what ways might an engineering manager di↵er in this regard? Problem 1.16 Why are most engineers likely to have experience with deterministic risk and not probabilistic risk? Problem 1.9 How would a company know that its product or service was preferred in the marketplace? What could a competitor do to erode this favorable position? Problem 1.17 Clarify the di↵erence between risk and regret. Problem 1.18 It was stated that the topic of tax accounting would not receive extensive treatment in this textbook. In what way could this be justified? What might be the impact on what can be learned from the text? Problem 1.10 This chapter placed emphasis on a “transaction-based perspective” related to customers. What would be di↵erent about a transaction involving an investor? What do we mean by transaction? Problem 1.19 Why is the concept of an ongoing concern important to the interpretation of financial statements? Problem 1.11 How might the market value of a firm di↵er from its intrinsic value? Problem 1.20 It is mentioned that for a “decision to be made” there must be more than one alternative under consideration and the possible outcomes must be of unequal value. What are the three general types of problem outcomes? Problem 1.12 With Figure 1.5 in mind, how could changes in government policies a↵ect accounting activities? Problem 1.13 It is claimed that problem definition and decision-making are intertwined. Explain. Problem 1.21 In the decision-making process, what are the ways in which context can impact outcomes? Problem 1.14 Managers must be problem-solvers but are not always decision-makers. Do you agree? Disagree? Provide an example that clarifies your position. Problem 1.22 Intuition in decision-making can expedite decision-making (versus cognitive domains that are slow and deliberate), but it can fail or mislead us, too. How can that be? Problem 1.15 Engineers are often accused of having a narrow view of problems, and are claimed to lack skills to deal with 17 Problem 1.23 We live in a global economy, and many di↵erent external activities have an impact on the business. On what basis would we narrow the scope of this book to de-emphasize tax law, currency exchange, inflation, and financial accounting for the engineering manager? Problem 1.24 You are in a meeting to decide on a new product development investment. The VP in charge of the meeting seems to be asking a lot of questions of the design engineers. And it also seems like the VP changes position on controversial issues, which is frustrating the engineers, too. If the VP just a curious person? Possibly incompetent? How might this behavior be helpful (rather than frustrating)? 18 References [1] R.F. Meigs and W.B. Meigs. Financial accounting. McGraw-Hill, 6th edition, 1989. [2] D.H. Marshall, W.W. McManus, and D.F. Viele. Accounting: What the numbers mean. McGraw-Hill, 7th edition, 2007. [3] B.E. Needles, M. Powers, and S.V. Crosson. Principles of accounting. Houghton Mi✏in, 10th edition, 2008. [4] W.G. Sullivan, E.M. Wicks, and C.P. Koelling. Engineering economy. Prentice Hall, 15th edition, 2011. [5] Saundra K. Lipe and Sharon Beasley. Critical thinking in nursing: A cognitive skills workbook. Lippincott Williams and Wilkins, 2004. [6] Patricia Benner. From novice to expert: Excellence and power in clinical nursing practice. Prentice Hall, 2004. [7] Mark Quirk. Intuition and metacognition in medical education: Keys to developing expertise. Springer Press, 2006. [8] Judith Koenig. Assessing 21st-century skills. National Academies, 2011. [9] Stuart E. Dreyfus and Robert L. Dreyfus. A five-stage model of the mental activities involved in directed skill acquisition. University of California Berkeley, 1980. 19 This page intentionally left blank