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Water resources management is a key challenge that will become even more crucial in the years ahead. From a system-theoretic viewpoint, there is a need to develop rigorous design and analysis tools for control, fault diagnosis and security of water distribution networks. This work develops a mathematical framework suitable for fault diagnosis and security in water systems; in addition it investigates the problem of determining a suitable set of locations for sensor placement in large-scale drinking water distribution networks such that contaminant detection is optimized. This work contributes to the research by presenting a problem formulation were the state-space representation of the propagation and reaction dynamics is coupled with the impact dynamics describing the “damage” caused by a contamination of the water distribution network. We propose a solution methodology for the sensor-placement problem by considering several risk-objectives, and by utilizing various optimization and evolutionary computation techniques. To illustrate the methodology, we present results of a simplified and a real water distribution network.