ENGINEERING EcoNoMICS

~ conomic considerations play a

t' vital role in product and servrce
r:
''"development and in engineering
design decision making process.
597
598 CHAPTER 20 ENGINEERING Ec0Noi'l-11cs
As we explained in Chapter 3, economic factors always play important roles in engi-
neering design decision making. If you design a product that is too expensive to man-
ufacture, then it can not be sold at a price that consumers can ajfard and still be
profitable to your company. The fact is that companies design products and provide
services not only to make our lives better but also to make money! In this section, we
will discuss the basics of engineering economics. The information provided here not
only applies to engineering projects but can also be applied to financing a car or a
house or borrowing from or investing money in banks. Some of you may want to
apply the knowledge gained here to determine your student loan payments or your
credit card payments. Therefore, we advise you to develop a good understanding of
engineering economics; the information presented here could help you manage your
money more wisel.y.
) '", :'' _, -> _,
""' ,,-, . _, ,,.
Figure 20.1
A cash flow diaqram for borrowed
money and the monthly payments.
Cash flow diagrains are visual aids that show the flow of costs and revenues over a period of
rime. Cash flow diagrams show ivhen the cash flow occurs, the cash flow rnagnitude, and whether
the cash flow iS out ofyour pocket (cost) or into your pocket (revenue). It is an important visual tool
rhat shows rhe timing, the magnirude, and the direction of cash flo\-v. To shed more light on
the concept of the cash flo\.v diagram, imagine that you are interested in-purchasing a new car.
Being a first-year engineering student, you may not have too much money in your savings ac-
count at this rime; for the sake of this example, !er us say that you have $1200 to your name in
a savings account. The car that you are interested in buying costs $15,500; let us further assume
rhat including the sales tax and other fees, the total cost of the car would be $16,880. Assum-
ing you can afford to put do,.-vn $1000 as a down payment for your new shiny car, you ask your
bank for a loan. The bank decides to lend you the remainder, which is $15,880 at 80/o interest.
You will sign a contract that requires you to pay $315.91 every month for the next five years.
You \vill soon learn ho\v to calculate these monthly payments, but for now let us focus on how
to draw the cash Row diagram. The cash flow diagram for this activity is shown in Figure 20.1.
Note in Figure 20.1 the direction of the arrows representing the n1oney given to you by the
bank and rhe payments that you must make to the bank over the next five years {60 months).
$15,880
1 2 3 4
:
57 58 59
6
0
I I I
J
0
fiqure 10.i
20.2 SIMPLE A.ND CoMPollND INTEREST 599
Draw the cash flow diagram for an investment that includes purchasing a machine that costs
$50,000 with a maintenance and operating cost of $1000 per year. lt is expected that the ma-
chine will generate revenues of $15,000 per year for five years. The expected salvage value of
the machine at the end of five years is $8000. The cash flow diagram for the invesnnent is shown in Figure 20.2. Again, note the direc-
tions of arrows in the cash flow diagram. We have represented the initial cost of $50,000 and
the maintenance cost by arrows pointing down, while the revenue and the salvage value of the
machine are shown by arrows pointing up.
2
l
0
$\S,000
3
4
$1000
$8000
5
Tne cash now diagram
!or Example 10.\.
$50,000

Interest is rhe extra money in addition to the borrowed amount that one must pay fot the pur-
= =' " 0, ,.,,,_, '"""'f ,_. "'""" f< '"' ;,ooITTO '"'"''" < f"'
,,, ' "" '"' """-"" '"'""-' =' . fo< ""''' ""'"" 'fu '" '""' '"""" '""'
on the principle each year will not collect interest itself. Only the initial principal will collecr
interest. For example, if you deposit $100.00 in a bank at 6% simple interest, after six years
>"" "'" $ r" '" '""' ,cro"' "' '"'"" ""'" '"' ' "" off% fu


' '""''"' " <"" '""' '"' '""' ''""" """ '"' '"' r " '"' ""'"' ""''" ,.,, " """ "'
F P + (P)(i)(n) P(l + ni)
Compute the futute value of a $1500 deposit, after eight years, in an account that pays a simple
interest rate of7%. How much interest will be paid to this account?
You can determine tbe future value of the deposited amount using Equation (20. l), which
results in
F = P(l + ni) 1500[ l + s(o.07)] = $2340
And rhe tot>I interest to be paid to this account is
(P)(n)(i) = (1500)(8)(0.07) $840
600 CHAPTER 20 ENGINEERING ECONOMICS
3
TABLE 20.l The Effect of Compounding Interest
Balance at the Interest for Balance at the End
Beginning of the Year at of the Year, Including
the Year (do Ila.rs 6/o (dollars the Interest (dollars
Year and cents) and cents) and cents)
100.00 6.00 106.00
2 !06.00 6.36 112.36
3 112.36 6.74 119.IO
4 119.10 7.14 126.24
5 126.24 7.57 133.131
6 133.81 8.02 141.83
Simple interests are very rare these days! Almost all interest charged to borrow accounts or
interest earned on money deposited in a bank is com pured using compound interest. The con-
cept of co1npound interest is discussed next.
, : ; \ --: i
Under the compounding interest scheme, the interest paid on the initial principal \.vill also
collect interest. To better understand how the compound interest earned or paid on a principal
works, consider the following example. Imagine that you put $100.00 in a bank that pays you
6o/o interest compounding annually. At the end of the first year (or the beginning of the second
year) you "vill have $106.00 in your bank account. You have earned interest in the amount of
$6.00 during the first year. However, the interest earned during the second year is determined
by ($106.00)(0.06) = $6.36. Thar is because the $6.00 interest of the first year also collects
6/o interest, which is 36 cents itself. Thus, the total interest earned during the second year is
$6.36, and the total amount available in your account at the end of the second year is $112.36.
Computing the interest and the total amount for the third, fourth, fifth and the sixth year
in a similar fashion will lead to $141.83 in your account at the end of the sixth year. Refer to
Table 20. l for detailed calculations. Note the difference between $100.00 invested at 6o/o sim-
ple interest and 6o/o interest compounding annually for a duration of six years. For the simple
interest case, the total interest earned, after six years, is $36.00, whereas the total interest accu-
mulated under the annual compounding case is $41.83 for the same duration.
Now we will develop a general formula that you can use ro compute the future value F of any
present amount (principal) P, afrer n years collecting io/o interest compounding annually. T_he
cash flow diagram for this situation is sho\.vn in Figure 20.3. In order to demonstrate,
step, the con1poundingeffect of the interest each year, Table 20.2 has been developed. As
in Table 20.2, starting with the principal P, ar the end of rhe first year we will have P + Pi or
P(I + i). During the second year, the P(l + i) collects interest in an amount of P(l + i)i,
by adding the interest to the P(l + i) amount that we starred wirh in the second year,". ;evVlll/
have a total amount of P(l + i) + P(I + i)i. Factoring out the P(l + i) term, we will
figure Z0.3
The cash flow diaqram for future
worth of a deposit made in the
hank today.
p
20.3 fuTURE WoRTH OF A PRESENT AMouNT 601
F
)ne Relationship Value P and the Future Value F
Balance at the
Beginning of
Interest for
Balance at the End of the Year,
Year
the Year
the Year
Including the Interest
p
(P)(i)
P + (P)(i) = P(l + i)
2
P(l + i)
P(l + i)(i)
P(l + i) + P(l + i)(i) = P(l + i)
2
3
P(l + i)
2 P(l + i)
2
(i)
P(l +if+ P(l + i)
2
(i) = P(l + i)
3
4
P(l + i)
3 P(l + i)
3
(i)
P(l + i)
3
+ P(l + i)
3
(i) = P(l + i)
4
5
P(l + i)'
P(l + i)
4
(i)
P(l + i)
4
+ P(l + i)
4
(i) = P(l + i)
5
.........
. ...............
n
P(l + ;r
1 P(l + ;r
1
(i)
P(l + ;r
1
+ P(l + ;r
1
(i) = P(l + i)"
P(l + i)
2
dollars at rhe end of the second year. Now by following Table 20.2 you can see how
rhe interest earned and the total amount are computed for rhe third, fourth, fifth, ... , and the
nth year. Consequently, you can see that the relationship between rhe present worth P and
the future value F of an amount collecting i% interest compounding annually after n years is
given by
F= P(l + i)"
Compute the future value of a $1500 deposit made today, after eight years, in an accoum that
pays an imeresr rare of7% that compounds annually. How much interest will be paid to this
account?
The future value of the $1500 deposit is com pured by substituting in Equation (20.2) for
P, i, and n, which results in the an1ount that follo\vs:
F= P(l + i)" = 1500(1 + .07)
8
= $2577.27
The total interest earned during the eighr-year life of this account is determined by calculating
the difference benveen the future value and the present deposit value.
interest= $2577.27 - $1500 = 51077.27

.
.
IF<
;,;,_,,.,

602
I '
CHAPTER 20 ENGINEERlNG EcoNorvucs
lvfany financial institutions pay interest that con1pounds more than once a year. For ex-
ample, a bank may pay you an interest rare rhar compounds semiannually (rwice a year), or
quan:erly (four rimes a year), or monthly (12 periods a year). If the principal Pis deposited for
a duration of n years and the interest given is compounded m periods (or m times) per year,
then the future value F of rhe principal Pis determined from
(
j )""' F= P l + -
m
{20.3)
Compute the furure value of a $1500 deposit, after eight years, in an account rhar pays an
interest rate of 7/o that compounds monthly. How much interest will be paid to this
account?
To determine the future value of rhe $1500 deposit, we substitute in Equation (20.3) for
P, i, m and n. 1'he substitution results in the future value shown next.
(
0.07 )(8)(12)
F= 1500 1 + - =
12
0.07)
96
+ - = $2621.73
12
And the total inreresr is
interest= $2621.73 - $1500 = $1121.73
The results of Examples 20.2, 20.3, and 20.4 are compared and summarized in
rfable 20.3. Note the effects of simple interest, interest compounding annually, and interest
compounding monthly on the total future value of the $1500 deposit.
Comparison for Examples 20.Z,20:3, and WA
Future
Value
:Example Principal Duration (dollars
Number (dollars) Interest Rate (years) and cents)
Example 20.2 1500 70/o simple 8 2340.00
Example 20.3 1500 7/o compounding 8 2577.27
annually
Example 20.4 1500 7% compounding 8 2621.73
monthly
Interest
Earned
(dollars
arid cents) _
840.00
1077.27
1121.73. c

" """ '"'"" """"" '" " _,..,, ""'""" " '"'"'""'"'" """'"'" """ "''"' ,,,,,,,.
""" 00 '1, " ili oo.f of oo "" m" '" ko $f "6 <' '" oo"' -'""'" T6 j6.' 6
'"'"' ili ""' '"' ,, "'"" '"'" "" 6% '"'"'"" "'"'" '"'" ,, ""'"""" ,, ""
'"' " """ "" .fq" "'" ' ""'"" "' ""' '". "' """' '" '""fo""' ,, '" ol "' '"'
"""' '" """ "' " """' '"' - -'"" "" """' "''""" '"'""' "" ,,
"""'" ''' ff""" - Tf' mW'""'"'" fo- M """ ;,,,; "'' < """ "" off"
rive rate, iett' is given by
--
..Oo w """""" "" """' of """'""""'0$ ""'"' "" m" To ""' o 06""" ili<
"""""""'"' """ """"'"' '" '" = "'"' " "'"'"" """"" '" "' ""'""'
fo< 'F' fooof "" ""' of< fo foff'"'' """"" '"'""" C% """""'"'"of""""""' C% """
'" "'"'"' 6% ""''"""' C% """'""' "ol " '""" "" '" ' "" "'' ""'" '"'""'
< "'" oo'<"'""""' ,.,rodr, M <om< '"'""'" of ,,oocy " '"' m6 of ""' P', ''" ='
earned, and the effective interest rates for each case.
""'"" """'""'"" "' '"' """"' r """" """"""""'"' """"''"'" '"' "'"""" '"
"" r "'"'"' "" I '"" "" <==""" = " '"""" J ' '"" """ ""' "'"' '"""' ""
<"", Oo< "' ''' 0 ""' '""' .,o< "" """ of "'""'" '" ""'"' f<ro"'" r.,f
'""' ;o '""'' '"' '"" "' '"" """ '"" """ " """'" """'"'" '"' '""""'"'
example.
TheEffecto! ol cornpoundinqPeriods
Total
Nurober of
Total AJnount
Interest
Effective
Compounding
Compounding
after 1 Year
(dollars
Interest
Period
Periods
(dollars and cents)
and cents)
Rate
Annuany
l

6.00
6/o
( 006)'
Semiannually
2
100 l + 2 106.09
6.09
6.0910
4
( 006)
4
Quarterly
100 \ + 4 106.13
6.13
6.13%
( 006)"
1Aonthly
12
100 l + l2 \06.16
6.16
6.16%
365
( 006)"'
6.18q
1
o
100 l + 365 106.lB
6.lB
Daily
604 CHAPTER 20 ENGINEERING ECONOMICS
Determine the interest earned on $5000 deposited in a savings accounr, for 10 years, based on
one of rhe following quoted interest rates: 6<10 compounding annually, semiannually, quarterly,
monthly, and daily. The solution to this problem is presented in Table 20.5.
TABLE 20.5 The Solution of Example 20.5
Total Number of Total Future Amount Interest
Compounding Compounding Using Eq. (16.8) (dollars
Period Periods (dollars and cents) and cents)
Annually IO 5000(1 + 0.06)" = 8954.23 3954.23
Semiannually 20
( 006)
20
5000 1 + -
2
- = 9030.55 4030.55
Quarterly 40
( 006)'
5000 1 + -
4
- = 9070.09 4070.09
Monthly 120
( 0.06) '
20
5000 1 + U = 9096.98 4096.98
Daily 3650
( 006)
36
'
5000 1 + - = 9110.14
365
4110.14
Determine the effective interest rates corresponding to rhe nominal rates: (a) 7% compound-
ing monthly, (b) 16.5% compounding monthly, (c) 6% compounding semiannually, (d) 9%
compounding quarterly.
We can compute the i ~ f f for each case by substituting for i and min Equation (20.4).
(
)m ( 007)"
(a) i,ff = 1 + ~ - 1 = 1 + - 1 = 0.0722 or 7.22%
. ( 0.165)
12
(b)t&= 1+]2 !=0.!780orl7.80%
(c) i& = ( 1 +
0
~
6

2
1 = 0.0609 or 6.09%
(
0 09)
4
(d) i,ff = 1 + ~ I = 0.0930 or 9.30%
-
Figure 10.4
The cash-flow diagram for a
borrowed sum of money and its
equivalent series
20.6 PRESENT WORTH OF SERIES PAYMENT OR ANNUITY 605
Let us now consider the following situation. You would like to have $2000 available to you for
a down payment on a car '\Vhen you graduate from coJlege in, say, five years. How much money
do you need to put in a certificate of deposit (CD) with an interest rate of 6.5/o (compounding
annually) today? The relationship between the future and present value was developed earlier
and is given by Equation (20.2). Rearranging Equation (20.2), we have
F
P=---
(1 + i)"
and substituting in Equation (20.S) for the future value F, the interest rate i, and rhe period n,
we have
2000
P = -(
1
-+-
0
-.
0
-
65
-)' = $1459.76
This may be a relatively large sum to put aside all at once, especially for a first-year engineering
student. A :more realistic option would be to put aside some money each year. Then the ques-
tion becomes, how much money do you need to put aside every year for the next five years at
the given interest rate to have that $2000 available to you at the end of the fifrh year? To an-
swer this question, we need to develop the formula that deals with a series of payments or
ries of deposits. This situation is discussed next.
In this section, we \Vill first formulate the relationship between a present lump .sum, P, and
future unifOrm series pay1nents, A_, and then from that relationship we will develop the formula
that relates the unifurm series payments A to a future lump sum F This approach is much easier
to follow as you will see. To derive these relationships, let us first consider a situation where we
have borrowed some money, denoted by P, at an annual interest rate i from a bank, and we are
planning to pay the loan yearly, in equal amouni:s A, inn years, as shown in Figure 20.4.
p
1 2 3 4
JL n-3
n-2 n-1 n
0
I I
__i_ _j
A
606 CHAPTER 20 ENGINEERING ECONOMICS
To obtain the relationship be[V{een P and A, \Ve \Vil! treat each future payment separately
and relate each payment to its presenc equivalent value using Equation (20:5); add all
the resulting tenns together. This approach leads to the following relationship:
A
P=---+
(1 + i) (1
A A A A
+ + ... + +
+ i)
2
(1 + i)
3
(1 + i)''-
1
(1 + i)"
(20.6)
As you can see, Equation (20.6) is not very user-friendly, so 1,ve need to simplify it somehow.
\'Vhat if we were to multiply both sides of Equation (20.6) by the term (1 + i)? This oper"atiort ...
results in the following relationship:
A A A A A
P(l .) A+ + ---+ + ...!... +----
'
1
= (I + i) (I + i)
2
(1 + i)
3
' (I + i)"-
2
(I + i)"-
1
(20.7)
No1,v if 1,ve subtract Equation (20.6) from Equation (20.7), \Ve have
A A A
P(l + i) - P =A+ --- + --- + +
A A
(l+i) (l+i)
2
(l+i)
3
. + (1 + w-' + (1 + w-1
[ (1 i) + -(l_+_A_i)- 2 + (1 : i) 3 + .
. + +
A A ]
(! + i)"-
1
(! + i)"
Simplifying the right-hand side of Equation (20.8) leads to the following relationship:
A
P(l + i) - P = A - (! + i)"
And after simplifying the lefr-hand side of Equation (20.8), we have
P(i) =A((! + i)" - !)
(1 + i)"
No1,v if\ve divide both sides of Equation (20.8c) by i, we have
p = A[-'-(1_+--'-i)_" -_ 1]
i(l + i)"
(10.8)
(20.8b)
(10.Bc)
(10.9)
Equation (20.9) establishes the relationship between the present value of a lump sum Pand its
equivalent uniform series payments A. We can also rearrange Equation (20.9), to represent A
in terms of P directly, as given by the following formula:
A= P(i)(I + i)" = r[ (i)(I + i)" l
(l+i)'-1 (l+i)"-1
''''11
'.'....:1 ')
(10.10)
To develop a formula for computing the future worth of a series of uniform payments. we{,f,'s/:::
begin \Vith the relationship between the present worth and the future won:h, Equation
and then we substitute for Pin Equation (20.2) in terms of A, using Equation (20.9).
20.7 FuTURE Wo1nH oF SERIES PAYMENT 607
procedure is demonstrated, step-by-step, next. The relation between a present value and a
future value is given by Equation (20.2):
F = P(l + i)"
And the relationship between the present worth and a uniform series is given by Equatioo (20.9):
l
(l + i)" - 1 l
P= A I
. i( 1 + i)" J
Substituting into Equation (20.2) for Pin terms of A using Equation (20.9), we have
p
,.------------:
l(
l i)" 1\
F = P(l + i)" = A , - (1 + i)"
i(l + i)" J
Simplifying Equation (20.11) results in the direct relarionship between rhe furure worth F and
r:he uniform payments or deposits A, which follo"vs:
l
(l + i)" - 11
F= A .
l
And by rearranging Equation (20.12), we can obtain a formula for A in terms of future
"vorth F:
A = F[_(l ___ ll
l + i)" - J
Now that we have all the necessary tools, we turn our attention to the question we asked
earlier about how much money you need to put aside every year for the next five years to have
$2000 for the down payment of your car when you graduate. Recall that rhe interest rare is
65% compounding annually. The annual deposits are calculated from Equation (20.13),
\Vhich leads to the following amount:
A
= 2oool o.o65 - J = 6
(
$351.2
1 + 0.065)' - 1
Putting aside $351.26 in a bank every year for the next five years mav be more manageable rhan
depositing a lump sum of $1459.76 today, especially if you don'r currendy have access to thar
Ir is important to note thar Equations (20.9), (20.10), (20.12), and (20.13) apply to a
large a sum'.
siruation wherein rhe uniform series of payments or revenues occur annually. We\1, the next
question is, how do we handle situations where the payments are made monthly' For example,
a car or a house loan payments occur monthly. Lee us now modify our findings by considering
rhe relationship between present value P and uniform series payments or revenue A rhat occur
more than once a year at rhe same frequency as rhefrequency of compounding interest per yc.rr.
608 CHAPTER 20 ENGINEERING ECONOMICS
For rhis sin1ation, Equation (20.9) is modified to incorporate the of compounding
interest per year, m, in the following manner:
[(
i)"m j
I + - - 1
m
P-A
-
Note that in order to obtain Equation (20.14), we simply substituted in Equation (20.9) for i,
i/rn, and for n, nm. Equation (20.14) can be rearranged to solve for A in terms of P according to
Similarly, Equations (20.12) and (20.13) can be modified for situations \Vhere A occurs more
than once a year-at the same frequency as the compounding interest-leading to the
following relationship:

i ym)(")
']
+-
m
m
; F[ ('
m
,]
i )(m)(,,)
+-
m
Finally, when the frequency of uniform series is different from the frequency of com-
pounding interest, ieff must first be calculated to match the frequency of the uniform series.
Let us return to the question \Ve asked earlier about ho\v much money you need to put aside
for the next five years to have $2000 for the down payment on your car when you graduate.
Now consider rhe situation where you make your deposits every month, and the interest rate
is 6.So/o compounding monthly.
The deposits are calculated from Equation (20.17), \.vhich leads to the following:
l
r
0.065 l
2000 ( 0.06152)(12)(5) = $28.29
I !+-- -1
L J2
Putting aside $28.29 in the bank every month for the next five years is even more manageable
than depositing $351.26 in a bank every year for the next five years, and it is certainly more
manageable than depositing a lump sum of$1459.76 in the bank today!

j
20.8 SuMMARY oF ENGINEERING EcoNoM1cs ANAISSIS
609
Determine the monthly payments for a five-year, $10,000 loan at an interest rate of 8% com-
To calculate the monthly payments, we use Equation (20.15).
pounding monthly.
-
A - P ( i )""' - 10,000 ( o.08 )
60
- $202.76
l+- -1 1+-- -1
m 12
The engineering econornics formulas that we have developed so far are summarized ll1
Tables 20.6 and 20.7. The definitions of rhe terms in the formulas are given here:
P = present worth, or present cost-lump sum ($)
F =future worth, or future cost-lump sum($)

A = uniform series payment, or uniform series revenue ($)
i = nominal interest rate
idf = effective interest rate
n = number of years
m = number of interest compounding periods per year
The interest-time factors shown in the fourth column of Table 20.6 are used as shortcurs to
avoid writing long formulas when evaluating equivalent values of various cash How occurrences.
A. su!11mary offormulasfor Situations wllen i Compounds A.nnually
Uniform Series A Occurs Annually
To Find
Given
Use This Formula
Interest-Time Factor
F
p
f=P(l + i)"
(F/P, i, n) = (l + i)"
F
l
p
F
p = -------------
(PIF i. n) =(!+if
(1 + i)"
'(!+i)"-11
. '(!+i)"-11
p
A
P=A
(PIA,,, n) =
i(l + i)"
r (i)(i + i)" l
l (i)(l + i)" 1
A
p
A= pl
(AIP,i,n)= (i+i)"-l
( 1 + i)" - 1
I c1 + i)" - 11
I u + i)" - 11
F
A
F= A I
(FIA, i, n) = ----:-----
- i J
c '
A
F
A= pf (i) 1
f (i) l
(AIF in)=.---
L(l + i)"-1
'' L(l + 1)"- iJ
610 CHAPTER 20 ENGINEERING ECONOMICS
T.,BLE 20.7 A Summary of Formulas for Situations when i
Compounds m Times per Year and the Uniform
Series A Occurs at the Same Frequency
To Find Given Use This Formula

F
p
p
A
F
A
p
F
A
p
A
F

F=P(1
For exan1ple, \vhen evaluating 1:he series payment equivalence of a present principal, instead of
writing,
A = p[_(_i)(_l _+_i)_" l
(l+i)"-1
-...ve write A = P(AIP, i, n), where, of course,
. r(i)(l+i)"l
(A!P, i, n) =,(I+ i)" - I
In this example, the (AJP, i, n) term is called the interest-tirnefactor, and it reads A given


interest rate, for a duration of n years. It is used to find A, Yvhen the present principal value
given, by multiplying P by the value of the interest-time factor (A/P, i, n). As an example,
numerical values of interest-time factors for i = So/o are calculated and shown in Table
- _-., -_,--:- -_
TABLE 20.&_ The lnterestcTimeFac!ors for l= 8%
n (FIP, i, n) (PIF, i, n) (PIA, ;, n) (AIP, i, n) (FIA, i, n) (A!F, i, n)
1 1.08000000 0.92592593 0.92592593 1.08000000 l.00000000 1.00000000
2 1.16640000 0.85733882 1.78326475 0.56076923 2.08000000 0.48076923
3 1.25971200 0.79383224 2.57709699 0.38803351 3.24640000 0.3080335 l
4 1.36048896 0.73502985 3.31212684 0.30192080 4.506ll200 0.22192080
5 1.46932808 0.68058320 3.99271004 0.25045645 5.86660096 0.17045645
6 1.58687432 0.63016963 4.62287966 0.21631539 7.33592904 0.13631539
7 1.71382427 0.58349040 5.20637006 0.19207240 8.92280336 0.1!207240
8 1.85093021 0.54026888 5.74663894 0.17401476 10.63662763 0.09401476
9 1.99900463 0.50024897 6.24688791 0.16007971 12.48755784 0.08007971
10 2.15892500 0.46319349 6.71008140 0.14902949 14.48656247 0.06902949
11 2.33163900 0.42888286 7.13896426 0.14007634 16.64548746 0.06007634
12 2.51817012 0.3971l376 7.53607802 0.13269502 18.97712646 0.05269502
13 2.71962373 0.36769792 7.90377594 0.12652181 21.49529658 0.04652181
14 2.93719362 0.34046104 8.24423698 0.12129685 24.21492030 0.04129685
15 3.17216911 0.31524170 8.55947869 0.11682954 27.15211393 0.03682954
16 3.42594264 0.29189047 8.85136916 0.11297687 30.32428304 0.03297687
17 3.70001805 0.27026895 9.12163811 0.10962943 33.75022569 0.02962943
18 3.99601950 0.25024903 9.37188714 0.10670210 37.45024374 0.02670210
19 4.31570106 0.23171206 9.60359920 0.10412763 41.44626324 0.02412763
20 4.66095714 0.21454821 9.81814741 0.10185221 45.76196430 0.02185221
21 5.03383372 0.19865575 10.01680316 0.09983225 50.42292144 0.01983225
22 5.43654041 0.18394051 10.20074366 0.09803207 55.45675516 0.01803207
23 5.87146365 0.17031528 10.37105895 0.09642217 60.89329557 0.01642217
24 6.34118074 0.15769934 10.52875828 0.09497796 66.76475922 0.01497796
25 6.84847520 0.14601790 10.67477619 0.09367378 73.10593995 0.01367878
26 7.39635321 0.13520176 10.80997795 0.09250713 79.95441515 0.01250713
27 7.98806147 0.12518682 10.93516477 0.09144810 87.35076836 0.01144810
28 8.62710639 0.11591372 1 l.05107849 0.09048891 95.33882983 O.Ol048891
29 9.31727490 0.10732752 11.1584060 l 0.08961854 103.96593622 0.00961854
30 10.06265689 0.09937733 l l.25778334 0.08882743 113.28321111 0.00882743
31 10.86766944 0.09201605 11.34979939 0.08810728 123.34586800 0.00810728
32 11.73708300 0.08520005 11. 43499944 0.08745081 134.21353744 0.00745081
33 12.67604964 O.o?888893 11.51388837 0.08685163 145.95062044 0.00685163
34 13.69013361 0.07304531 11.58693367 0.08630411 158.62667007 0.00630411
35 14.78534429 0.06763454 11.65456822 0.08580326 172.31680368 0.00580326
36 15.96817184 0.06262458 11.71719279 0.08534467 187.10214797 0.00534467
37 17.24562558 0.05798572 11.77517851 0.08492440 203.07031981 0.00492440
38 18.62527563 0.05369048 11.82886899 0.08453894 220.3 l594540 0.00453894
39 20.11529768 0.04971341 11.87858240 0.08418513 238.94122103 0.00418513
40 21.72452150 0.04603093 11.92461333 0.08386016 259.05651871 0.00386016
41 23.46248322 0.04262123 11. 967234 57 0.08356149 280.78104021 0.00356149
42 25.33948187 0.03946411 12.00669867 0.08328684 304.24352342 0.00328684
43 27.36664042 0.03654084 12.04323951 0.08303414 329.58300530 0.00303414
44 29.55597166 0.03383411 12.07707362 0.08280152 356.94964572 0.00280152
Contiuued
612 CHAPTER 20 ENGINEERING EcoNo;\<ncs
TABLE 20.8
The Interest-Time factors for i = 8% (continued)
n (FIP, 4 n) (PIF, 4 n) (PIA, 4 n) (AIP, 4 n) (FIA, 4 n) (AIF, 4 n)
45 31.92044939 0.03132788 12. l 0840150 0.08258728 386.50561738 o.0025sns
46 34.47408534 0.02900730 12.13740880 0.08238991 418.42606677 0.00238991
47 37.23201217 0.02685861 12.16426741 0.08220799 452.90015211 0.00220799
48 40.21057314 0.02486908 12.18913649 0.08204027 490.13216428 0.00204027
49 43.42741899 0.02302693 12.21216341 0.08188557 530.34273742 0.00188557
50 46.90161251 0.02132123 12.23348464 0.08174286 573.77015642 0.00174286
Addirional values of interest-time factors for other interest rates can be created using
Excel. I(eep in mind that you can use those tables or orher similar tables found in the back of
most engineering economy text books to determine interest-rime factors for interest rates that
coinpound more frequendy than once a year. To do so, ho\.vever, you must first divide the
quoted no1ninal interest rate i by the number of compounding frequency m and use the re-
sulting nu1nber to pick the appropriate interest table to use. You must then multiply the num-
ber of years n by the number of co1npounding frequency rn and use the outcome of n times mas
the period when looking up interest-time factors. For example, if a problem st:ates an interest
rate of 18o/o compounding monthly for four years, you use the 1.5% interest table (18/12 =
1.5), and for the number of periods, you will use 48 (4 X 12 = 48).
I
i What is the equivalent present worth of the cash flow given in Figure 20.5? Put another way,
how much money do you need to deposit in the bank today in order to be able to make the
wirhdravvals shovvn? The interest rate is So/o compounding annually.
The present V'torth (PW) of the given cash Bovv is determined from
PW= lOOO(P!A, 8%, 4) + 3000(P!F, 8%, 5) + SOOO(PIF, 8%, 7)
$5000
$3000
$1000
0
2 3 4 5 6 7
PW='
Figure 10.5 The cash flow diagram for Example 10.9.
20,9 CHOOSING THE BEST AI-TERNATIVES-DECISJ_ON Iv1AKING 613
We can use Table 20.8 to look up the interest-time f.1.cror v-alues, which leads to
(PIA, 8%, 4) = 3.31212684
(P!F, 8%, 5) = 0,68058320
(PIP, 8%, 7) = 058349040
PW= (1000)(3.31212684) + (3000)(0,68058320) + (5000)(0,58349040)
PW= $8271,32
Therefore, if today, you put aside $8271.32 in an account that pays So/o interest, you can >vith-
draw $1000 in the next four years, and $3000 in five years, and $5000 in seven years.
Up to this point, we have been discussing general relationships that deal '-Vith rnoney, time, and
interest rates. Let us now consider the application of these relationships in an engineerlng set-
ting. Imagine that you are assigned the task of choosing which air-conditioning unit ro pur-
chase for your company. After an exhaustive search, you have narrowed your selection to rwo
alternatives, both of which have an anticipated 10 years of working life. Assuming an 8o/o in-
terest rate, find the best alternative. Addjtional information is given in Table 20.9. The cash-
flow diagrams for each alternative are shown in Figure 2D.6.
Here we will discuss three different methods that you can use to choose the best econom-
ical alternative from many opdons. The three methods are cominonly referred to as (1) pres-
ent worrh (P\V) or present cost analysis, (2) annual worth (AW) or annual cost analysis, and
(3) future worth (F\Xl) or future cost analysis. When these: tnethods are applied to a problem,
they all lead to the same conclusion. So in practice) you need only apply one of these 1nethods
to evaluate options; however, in order ro show you the details of these procedures, \Ve '\-vill ap-
ply all of rhese n1ethods to the preceding problem.
Present Viorth or Prtsent Cost With this approach you con1pute rhe total present
worth or the present cost of each alternative and then pick the alternative with the lo>vest pres-
ent cost or choose rhe alternative 'ith the highest present V>'orth or profit. To emp1oy rh[s
TABLE 208 Data to Be Used in Selection of an Air-Conditioning Unit
Criteria
Inirial cost
Salvage value afcer 10 years
Operating cost per year
Maintenance cost per ye:ar
Alternative A
$100,000
S!0,000
52500
$1000
Alternative B
$85,000
$5000
$3400
$1200
614 CHAPTER 20 ENGINEERING c o N o ~ u c s
$10,000
0 l 2 3 4 5 6 7 8 9 lO
$3500
$100,000
Alternative A
$5000
0 l 2 3 4 5 6 7 8 9 lO
'
$4600
$85,000
Alternative B
Figure 10.6 The cash-flow diagrams for the example problem_
method, you begin by calculating the equivalent present value of all cash flow. For the example
problem mentioned, the application of the present worth analysis leads to:
Alternative A:
PW= -100,000 - (2500 + IOOO)(PIA, 8%, 10) + 10,000(PIF, 8%, 10)
The interest-rime factors for i = 8o/o are given in Table 20.8.
PW= -100,000 - (2500 + 1000)(6.71008140) + (10,000)(0.46319349)
PW= -118,853.35
Alternative B:
PW= -85,000 - (3400 + 1200)(PIA, 8%, 10) + 5000(PIF, 8%, 10)
PW= -85,000 - (3400 + 1200)(6.71008140) + 5000(0.46319349)
PW= -113,550.40
Note that we have determined the equivalent present worth of all future cash flow, including
the yearly maintenance and operating costs and the salvage value of the air-conditioning unit.
ln the preceding analysis, the negative sign indicates cost, and because alternative B has a lower
present cost, we choose alternative B.
er ' :'' Using this approach, we compute the equivalent annual
worth or annual cost value of each alternative and then pick the alternative with the lowest an-
nual cost or select rhc alternative with the highest annual worth or revenue. Applying the an-
nual worth analysis to our example problem, we have
Alternative A:
AW= -(2500 + \000) - 100,ooo(AIP, 8%, \0) + \O,OOO(A/F, 8%, 10)
AW= -(2500 + 1000) - (100,000)(0.14902949) + (10,000)(0.06902949)
AW= -17,7\2.65
Alternative B:
AW= -(3400 + 1200) - 35,ooo(AIP, 8%, io) + 5ooo(AIF, 8%, 10)
AW= -(3400 + 1200) - 85,000(0.14902949) + 5000(0.06902949)
AW= -16,922.35
Note that using this method, we have determined the equivalent annual worth of all cash flow,
and because alternative B has a lower annual cost, we choose alternative B.
cr:c r \\rr:: :.::-.:: This approach is based on evaluating the future worth or
future cost of each alternative. Of course, you will then choose the alternative with the lowest
future case or pick the alternative with the highest future worth of profit. The future worth
analysis of our example problem follows.
Alternative A:
FW = + lo,ooo - ioo,ooo(FIP, so/a, io) - (2500 + 1ooo)(F/A, 8%, 10)
F\Y.f = +10,000 - (100,000)(2.15892500) - (2500 + 1000)(14.48656247)
F\Y.f = -256,595.46
Alternative B:
F\Y.f = +sooo -. 35,ooo(F/P, 8%. 10) - (3400 + \200)(F/A, 8%, 10)
F\Y.f = +5000 - (85,000)(2.1ss92soo) - (3400 + 1200)(14.48656247)
F\Y.f = -245,146.81
Because alternative B has a lower future cost, again we choose alternative B. Note that regard-
less of which method we decide to use, alternative B is economically the better option. More-
over, for each alternative, ail of the approaches discussed here are related to one another
through the interest-time relationships (factors). For example.
61-6 CHAPTER 20 ENGINEERING ECONOMICS
Alternative A:
PW= AW(P/A, 8%, IO)= (-17,712.65)(6.71008140)
-118,853.32
or
PW= FW(PIF, 8%, IO) = (-256,595.46)(0.46319349) - l I 8,853.34
Alternative 8:
PW= i\.W(P/A, 8%, 10) = (-16,922.35)(6.71008140) -I 13,550.40
or
PW= FW(PIF, 8%, 10) = (-245,I46.81)(0.46319349) = -113,550.40
Finally, it is worth noting that you can rake semester-long classes in engineering eco-
nomics. Some of you will eventually do so. You will learn more in depth about the principles
of money-rime relationships, including rate-of-return analysis, benefit-cost ratio analysis,
general price inflation, bonds, depreciation methods, evaluation of alternatives on an after-tax
basis, and risk and uncertainty in engineering economics. For now, our intent has been to
introduce you to engineering economics, but keep in mind that we have just scratched rhe sur-
face! We cannot resist but to end this section with definition of some of these important con-
cepts that you will learn more about them later.
States, counties, and cities issue bonds to raise money to pay for various projects, such as schools,
highways, convention centers, and stadiums. Corporations also issue bonds to raise money to
expand or to modernize their facilities. There are many different types of bonds, but basically,
they are loans that investors make to government or corporations in return for some gain. When
a bond is issued, it will have a maturity date (a year or less to 30 years or longer),parvalue(the
amount originally paid for the bond and the amount that will be repaid at maturity date), and
an interest rate (percentage of par value that is paid to bond holder at regular intervals).
Assets (such as machines, cars, and computers) lose their value over a period of time. For ex-
ample, a computer purchased today by a company for $2000 is not worth as much in three or
four years. COmpanies use this reduction in value of an asset against their before-tax
There are rules and guidelines that specify what can be depreciated, by how much, and over
what period of rime. Examples of depreciation methods include the Straight Line and .c.;, ''
Modified Accelerated Cost Recovery System (MACRS).
u
In engineering, the term life-cycle cost refers to the sum of all the costs that are a.ssoda,ted,
vith a structure, a service, or a product during irs life span. For example, if you are
a bridge or a highway, you need to consider the costs that are related -to the initial deliniiti?.!!>;;
and assessment, conceptual design, detailed design, planning, construction,
tenance and disposal of the project at the end of its life span.