ENR 405 - Lecture 1posted-1

ENGINEERING
ECONOMY
Engineering Economic Decisions

Foundations of Engineering
Economy
Factors: Effect of Time and Interest
on Money
1
L-1
Engineering Economy
Description: Annual cost comparison;
Economic analysis for Present value analysis;
engineering decision Rate of return;
making;
Depreciation and taxes;
The finance function in
Multiple alternatives;
an industrial enterprise,
time value of money; Mathematical models for
equipment replacement;
Basic interest formulas;
Decision analysis;
Concepts of cost
2
engineering.
L-1
Why Engineering Economy is Important to
Engineers
v  Engineers design and create
v  Designing involves economic decisions
v  Engineers must be able to incorporate economic
analysis into their crea;ve efforts
© 2012 by McGraw-Hill, New York, N.Y All

Rights Reserved
v  O>en engineers must select and implement from
mul;ple alterna;ves
v  Understanding and applying ;me value of money,
economic equivalence, and cost es;ma;on are vital
for engineers
v  A proper economic analysis for selec;on and
execu;on is a fundamental task of engineering
1-3
Chapter Opening Story 1 - Bose
Corporation
•  Dr. Amar Bose, a graduate of electrical engineering,
an MIT professor, and Chairman of Bose
Corpora;on.
•  He invented a direc;onal home speaker system that
reproduces the concert experience.
•  He formed Bose Corpora;on in 1964 and became
the world’s No.1 speaker maker.
•  He became the 288th wealthiest American in 2002 by
Forbes magazine.
L-1
Opening Story 2: Google
5
A Little Google History
•  1995
•  Developed in dorm room by Larry Page and Sergey Brin,
graduate students at Stanford University
•  Nicknamed BackRub (reflecting great taste… J)
•  1998
•  Raised $25 million to set up Google, Inc.
•  Ran 100,000 queries a day out of a garage in Menlo Park
•  2005
•  Over 4,000 employees worldwide
•  Over 8 billion pages indexed
•  Estimated market value over $100 billion
•  As of today, the value of Google is likely to be in the
hundreds of billions range
6
Engineering Economics
Overview
•  Rational Decision-Making Process
•  Economic Decisions
•  Predicting Future
•  Role of Engineers in Business
•  Large-scale engineering projects
•  Types of strategic engineering economic
decisions
7
L-1
Rational Decision-Making
Process
1.  Recognize a decision problem The image cannot be displayed. Your computer may not have enough memory to open the image, or the image may have been corrupted. Restart
your computer, and then open the file again. If the red x still appears, you may have to delete the image and then insert it again.
2.  Define the goals or objec;ves

3.  Collect all the relevant
informa;on
4.  Iden;fy a set of feasible
decision alterna;ves
5.  Select the decision criterion to
use
6.  Select the best alterna;ve
L-1
A Simple Illustrative Example: Car to
Lease – Saturn or Honda?
§  Recognize the decision •  Need to lease a car
problem
§  Collect all needed •  Gather technical and
(relevant) information financial data
§  Identify the set of feasible •  Select cars to consider
decision alternatives
§  Define the key objectives •  Wanted: small cash outlay,
and constraints safety, good performance,
aesthetics,…
§  Select the best possible •  Choice between Saturn and
and implementable Honda (or others)
decision alternative
•  Select a car (i.e., Honda, 9
Saturn or another brand)
L-1
Financial Data Required to Make an Economic
Decision
10
L-1
Engineering Economic
Decisions
Manufacturing Profit
Planning Investment
11
Marketing
L-1
Predicting the Future
•  Es;ma;ng a Required
investment
•  Forecas;ng a product
demand
•  Es;ma;ng a selling price
•  Es;ma;ng a
manufacturing cost
•  Es;ma;ng a product life
and the profitability of
con;nuing produc;on 12
L-1
Role of Engineers in Business
Create & Design

•  Engineering Projects
Analyze Evaluate Evaluate

•  Produc;on Methods •  Expected •  Impact on
•  Engineering Safety Profitability Financial Statements
•  Environmental Impacts •  Timing of •  Firm’s Market Value
•  Market Assessment Cash Flows •  Stock Price
•  Degree of
Financial Risk
13
L-1
Accounting Vs. Accounting
Evalua3ng past performance Evalua3ng and predic3ng future events
Accoun3ng Engineering Economy

Past Future
Present 14
L-1
Two Factors in Engineering
Economic Decisions
EMR 301 – ENGINEERING ECONOMY

Objec;ves, available resources, ;me
and uncertainty are the key defining
aspects of all engineering economic
decisions
The factors of ;me and uncertainty are the
defining aspects of any engineering 15
economic decisions L-1

A Large-Scale Engineering Project
•  Requires a large sum of

investment
•  Takes a long ;me to see
the financial outcomes
•  Difficult to predict the
revenue and cost streams
•  Can be very risky
16
L-1
Types of Strategic Engineering
Economic Decisions in
Manufacturing Sector
q Service Improvement
q Equipment and Process Selec;on
q Equipment Replacement
q New Product and Product Expansion
q Cost Reduc;on
q Profit Maximiza;on
Engineers have to make decisions unders resource constraints,

and in presence of uncertainty. 17
L-1

U.S. Gross Domestic Products (GDP)
Manufacturing
(14%)
Service sector
(80%)
Healthcare (14%)
Agriculture (2%) 18
L-1
Industrial Employment
Industry 1993 1983-94 1994-2005

Employment National Projected
distribution Average Change
Manufacturing 12.6% -0.70% -7.2%
Services 30.5% 60.0% 39.0%
Retail trade 16.7% 31.1% 13.0%
Financial 8.0% 26.8% 6.3%

19
Source: Bureau of Economic Analysis/Bureau of Labor Sta3s3cs
L-1
Types of Strategic Engineering Economic
Decisions in Service Sector

q  Commercial Transporta;on
q  Logis;cs and Distribu;on
q  Healthcare Industry
q  Electronic Markets and Auc;ons
q  Financial Engineering
q  Retails
q  Hospitality and Entertainment
q  Customer Service and Maintenance
20
L-1
Service Improvement
n  How many more jeans would Levi need to sell to jus;fy the cost
of addi;onal robo;c tailors?
21
L-1
Example - Healthcare Delivery
Which plan is more
economically viable?

n  Tradi;onal Plan: Pa;ents
visit each service provider.
n  New Plan: Each service

provider visits pa;ents
: pa3ent
22
: service provider
L-1
Equipment & Process Selection
•  How do you choose between the Plas;c SMC and the Steel

sheet stock for an auto body panel?
•  The choice of material will dictate the manufacturing process
for an automo;ve body panel as well as manufacturing costs.
23
L-1
Which Material to Choose?

24
L-1
Equipment Replacement Problem
•  Now is the ;me to
replace the old machine?
•  If not, when is the right
;me to replace the old
equipment?
25
L-1
New Product and Product
Expansion
•  Shall we build or acquire
a new facility to meet the
increased demand?
•  Is it worth spending
money to market a new
product?
26
L-1
Example - MACH 3 Project
•  R&D investment: $750 million
•  Product promo;on through

adver;sing: $300 million
•  Priced to sell at 35% higher
than Sensor Excel (about $1.50 Gillette’s MACH3
extra per shave). Project
•  Ques;on 1: Would consumers
pay $1.50 extra for a shave
with greater smoothness and
less irrita;on?
•  Ques;on 2: What would
happen if the blade
consump;on dropped more
than 10% due to the longer
blade life of the new razor?
27
L-1
Cost Reduction
•  Should a company buy

equipment to perform an
opera;on now done
manually?
•  Should spend money now
in order to save more
money later?
28
L-1
Fundamental Principles of
Engineering Economics
•  Principle 1: A instant (nearby) dollar is worth more than a
distant dollar
•  Principle 2: All it counts is the differences among alterna=ves
•  Principle 3: Marginal revenue must exceed marginal cost
•  Principle 4: Addi=onal risk is not taken without the expected
addi=onal return
29
L-1
Principle 1: A nearby dollar is
worth more than a distant dollar

Today 6-month later
30
L-1
Principle 2: All it counts is the
differences among alternatives
Option Monthly Monthly Cash Monthly Salvage
Fuel Maintena outlay at payment Value at
Cost nce signing end of
year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant items in decision making

31
L-1
Principle 3: Marginal revenue must
exceed marginal cost
Marginal
cost
Manufacturing cost 1 unit
Marginal
Sales revenue 1 unit revenue
32
L-1
Principle 4: Additional risk is not
taken without the expected additional
return
Investment Class Potential Expected
Risk Return
Savings account Low/None 1.5%

(cash)
Bond (debt) Moderate 4.8%

Stock (equity) High 11.5%
33
L-1
Summary
•  The term engineering economic decision refers to all
investment decisions rela;ng to engineering projects.
•  The five main types of engineering economic decisions

are
•  (1) service improvement,
•  (2) equipment and process selec;on,
•  (3) equipment replacement,
•  (4) new product and product expansion, and
•  (5) cost reduc;on.
34
•  The factors of ;me and uncertainty are the defining
aspects of any investment project. L-1
Time Value of Money (TVM)
Description: TVM explains the change in the amount of money over time
for funds owed by or owned by a corporation (or individual)
•  Corporate investments are expected to earn a return

•  Investment involves money
•  Money has a ‘time value’
The time value of money is the most important concept in

engineering economy
35
L-1
Engineering Economy
•  Engineering Economy involves
•  Formulating
•  Estimating, and
•  Evaluating
expected economic outcomes of alternatives designed to accomplish a
defined purpose
•  Easy-to-use math techniques simplify the evaluation
•  Estimates of economic outcomes can be deterministic or stochastic in
nature
36
L-1
General Steps for Decision Making Processes
1.  Understand the problem – define objectives
2.  Collect relevant information
3.  Define the set of feasible alternatives
4.  Identify the criteria for decision making
5.  Evaluate the alternatives and apply sensitivity analysis
6.  Select the “best” alternative
7.  Implement the alternative and monitor results
37
L-1
Steps in an Engineering Economy Study
38
L-1
Ethics – Different Levels
Ø  Universal morals or ethics – Fundamental beliefs: stealing, lying,
harming or murdering another are wrong
Ø Personal morals or ethics – Beliefs that an individual has and maintains
over time; how a universal moral is interpreted and used by each
person
Ø  Professional or engineering ethics – Formal standard or code that
guides a person in work activities and decision making
39
L-1
Code of Ethics for Engineers
All disciplines have a formal code of ethics. National Society of Professional
Engineers (NSPE) maintains a code specifically for engineers; many
engineering professional societies have their own code
40
L-1
Interest and Interest Rate (borrower’s perspective
- paid)
•  Interest – the manifestation of the time value of money
•  Fee that one pays to use someone else’s money
•  Difference between an ending amount of money and a beginning amount of
money
Ø  Interest = amount owed now – principal(initial ampunt)

•  Interest rate – Interest paid over a time period expressed as a
percentage of principal
Time unit = interest period (if no interest period is stated, a
1 year interest rate is assumed
Ø  41
L-1
Interest and Interest Rate (borrower’s perspective
- paid)
•  Example 1
•  Example 2
42
L-1
Rate of Return – ROR / Retorn on
Investment -ROI (saver / lender /
investor’s perspective - earned)
q  Interest earned over a period of ;me is expressed as a
percentage of the original amount (principal)

interest accrued per time unit
Rate of return (%) = x 100%
original amount
v  Borrower’s perspective – interest rate paid 43
v  Lender’s or investor’s perspective – rate of return earned

L-1
Rate of Return – ROR / Retorn on Investment -
ROI (saver / lender / investor’s perspective -
earned)

•  Example 3
44
L-1
Interest paid Interest earned

Interest rate Rate of return 45
L-1
Commonly used Symbols
t = ;me, usually in periods such as years or
months
P = value or amount of money at a ;me t
designated as present or ;me 0
F = value or amount of money at some future
;me, such as at t = n periods in the future
A = series of consecu;ve, equal, end-of-period
amounts of money
n = number of interest periods; years, months
i = interest rate or rate of return per ;me period;
percent per year or month
46
L-1
INFLATION
•  Infla;on : Changing value of money that is forced upon a
country’s currency by infla;on.
Cost and revenue cash flow es;mates increase
over ;me.

Infla;on contributes:
•  A reduc;on in purchasing power
•  An increase in the CPI (consumer price index)
•  An increase in the cost of equipment and its maintenance
•  An increase in the cost salaried professionals and hourly
employees
•  A reduc;on in the real rate of return on personal savings and 47
corporate investments
L-1

Cash Flows: Terms
•  Cash Inflows – Revenues (R), receipts, incomes,
savings generated by projects and activities that flow in.
Plus sign used
•  Cash Outflows – Disbursements (D), costs, expenses,
taxes caused by projects and activities that flow out.
Minus sign used
•  Net Cash Flow (NCF) for each time period:

NCF = cash inflows – cash outflows = R – D
•  End-of-period assumption: 48
Funds flow at the end of a given interest period
L-1
Cash Flows: Estimating
ü  Point estimate – A single-value estimate of a cash flow element of an
alternative
Cash inflow: Income = $150,000 per month
ü  Range estimate – Min and max values that estimate the cash flow
Cash outflow: Cost is between $2.5 M and $3.2 M
Point estimates are commonly used; however, range estimates with
probabilities attached provide a better understanding of variability of
economic parameters used to make decisions
49
L-1
Cash Flow Diagrams
What a typical cash flow diagram might look like
Draw a time line Always assume end-of-period cash flows
Time
0 1 2 … … … n-1 n
One =me
period
F = $100
Show the cash flows (to approximate scale)
0 1 2 … … … n-1 n
Cash flows are shown as directed arrows: + (up) for inflow
P = $-80 50
- (down) for outflow
L-1
Cash Flow Diagram Example
Plot observed cash flows over last 8 years and estimated sale next
year for $150. Show present worth (P) arrow at present time, t = 0
51
L-1
Cash Flow Diagram
Example 4
52
L-1
Economic Equivalence
Definition: Combination of interest rate (rate of return) and time value of
money to determine different amounts of money at different points in
time that are economically equivalent
How it works: Use rate i and time t in upcoming relations to move money
(values of P, F and A) between time points t = 0, 1, …, n to make them
equivalent (not equal) at the rate i
53
L-1
Example of Equivalence
Different sums of money at different times may be equal in economic
value at a given rate
$110
Year
0 1
Rate of return = 10% per year
$100 now
$100 now is economically equivalent to $110 one year from now, if the
$100 is invested at a rate of 10% per year.
54
L-1
Simple and Compound Interest
•  Simple Interest
Interest is calculated using principal only
Interest = (principal)(number of periods)(interest rate)
I=P.n.i
Example: $100,000 lent for 3 years at simple i = 10% per

year. What is repayment after 3 years?
Interest = 100,000(3)(0.10) = $30,000

55
Total due = 100,000 + 30,000 = $130,000
L-1
Simple Interest
Example 5
56
L-1
•  Compound Interest
Interest is based on principal plus all accrued interest
That is, interest compounds over time
Interest = (principal + all accrued interest) (interest rate)
Interest for time period t is

j=t-1
It = ( P + Σ Ij ) (i)
57
j=1
L-1
Compound Interest Example
Example: $100,000 lent for 3 years at i = 10% per year compounded. What is
repayment after 3 years?
Interest, year 1: I1 = 100,000(0.10) = $10,000
Total due, year 1: T1 = 100,000 + 10,000 = $110,000
Interest, year 2: I2 = 110,000(0.10) = $11,000
Total due, year 2: T2 = 110,000 + 11,000 = $121,000
Interest, year 3: I3 = 121,000(0.10) = $12,100
Total due, year 3: T3 = 121,000 + 12,100 = $133,100
Compounded: $133,100 Simple: $130,000
Practical Solution for the amount due the stated time in the future
F = P. (1 + i) n
$133,100 = 100,000 (1.10)3 58
L-1
Compound Interest
Example 6
59
L-1
Minimum Attractive Rate of Return
v  MARR is a reasonable rate of
return (percent) established
for evaluating and selecting
alternatives
v  An investment is justified

Rights Reserved
economically if it is expected
to return at least the MARR
v  Also termed hurdle rate,
benchmark rate and cutoff rate
60
L-1
MARR Characteristics
•  MARR is established by the financial managers of the firm
•  MARR is fundamentally connected to the cost of capital
•  Both types of capital financing are used to determine the weighted
average cost of capital (WACC) and the MARR
•  MARR usually considers the risk inherent to a project
61
L-1
Types of Financing
In general, capital is developed in two ways;
•  Equity Financing –Funds either from retained earnings,

new stock issues, or owner’s infusion of money.
•  Debt Financing –Borrowed funds from outside sources

– loans, bonds, mortgages, venture capital pools, etc.
Interest is paid to the lender on these funds
For an economically justified project

62
ROR ≥ MARR > WACC(cost of capital)
L-1
Opportunity Cost
§ Defini;on: Largest rate of return of all projects not
accepted (forgone) due to a lack of capital funds
§  If no MARR is set, the ROR of the first project not undertaken
establishes the opportunity cost
§  the loss of poten;al gain from other alterna;ves when one

alterna;ve is chosen.

Example: Assume MARR = 10%. Project A, not funded due to lack
of funds, is projected to have RORA = 13%. Project B has RORB =
15% and is funded because it costs less than A
Opportunity cost is 13%, i.e., the opportunity to make an
addi;onal 13% is forgone by not funding project A
63
L-1
Rule of 72
§ A common ques;on most o>en asked by investors is:
how long will it take for my investment to double in value
§  Must have a known or assumed compund interest rate in
advance
§  Assume a rate of 13%/year to illustrate….
§ The Rule of 72’s for Interest

§ The approximate ;me for an investment to
double in value given the compound interest
rate is:
§ Es;mated ;me (n) = 72 / i
64
§ For i = 13% = 5.54 years
L-1
Rule of 72

§ The Rule of 72’s for Interest
§  Likewise one can es;mate the requied interest
rate for an investment to double in value over
;me as:
§  iapproximate = 72 / n
§  Assume we want an investment to double in say 3

years.
§  Es;mate i = rate would be : 72 / 3 = 24%
65
L-1
Chapter Summary
•  Engineering Economy fundamentals
v Time value of money
v Economic equivalence
v Introduction to capital funding and MARR
v Spreadsheet functions
•  Interest rate and rate of return
v Simple and compound interest
•  Cash flow estimation
v Cash flow diagrams
v End-of-period assumption
v Net cash flow
v Perspectives taken for cash flow estimation
•  Ethics
v Universal morals and personal morals
v Professional and engineering ethics (Code of Ethics) 66
L-1
ENGINEERING ECONOMY

Factors : How Time and Interest
Affect Money

67
L-1
Chapter 1
Foundations Of
Engineering Economy
Lecture slides to accompany
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-68
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-69
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-70
71
72
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-73
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-74
75

L-1
76
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-77
78
79
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-80
81
82
83
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-84
85
86

L-1
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-87
88
89
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-90
91
L-1
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-92
93
94
95
96
97
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-98
99
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-100
101
102
103
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-104
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-105
106
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-107
Example 15

L-1
108
Example 16

L-1
109
110
111
112
113
Chapter 1
Foundations Of
Engineering Economy
Engineering Economy

Rights Reserved
7th edition
Leland Blank
Anthony Tarquin
1-114
ENGINEERING ECONOMY
Combining Factors

115
L-1
LEARNING OUTCOMES
1.  Shifted uniform series

2.  Shifted series and single
cash flows
3.  Shifted gradients
116
L-1
117
118
Shifted Uniform Series
A shifted uniform series starts at a time other than period 1
The cash flow diagram below is an example of a shifted series
Series starts in period 2, not period 1
A = Given FA = ? Shifted series

usually
require the use of
0 1 2 3 4 5 multiple factors
PA = ?
Remember: When using P/A or A/P factor, PA is always one year ahead
of first A
119
When using F/A or A/F factor, FA is in same year as last A
L-1
120
121
122
Example Using P/A Factor: Shifted Uniform Series
The present worth of the cash flow shown below at i = 10% is:
(a) $25,304 (b) $29,562 (c) $34,462 (d) $37,908

P0 = ?
P1 = ? i = 10%
0 1 2 3 4 5 6
Actual year
0 1 2 3 4 5 Series year
A = $10,000
Solution: (1) Use P/A factor with n = 5 (for 5 arrows) to get P1 in year 1
(2) Use P/F factor with n = 1 to move P1 back for P0 in year 0
123
P0 = P1(P/F,10%,1) = A(P/A,10%,5)(P/F,10%,1) = 10,000(3.7908)(0.9091) = $34,462
Answer is (c) L-1
124
L-1
Example Using F/A Factor: Shifted Uniform Series
How much money would be available in year 10 if $8000 is deposited each

year in years 3 through 10 at an interest rate of 10% per year?
Cash flow diagram is:

i = 10%
FA = ?
Actual year
0 1 2 3 4 5 6 7 8 9 10
0 1 2 3 4 5 6 7 8
Series year
A = $8000
Solu=on: Re-number diagram to determine n = 8 (number of arrows)
FA = 8000(F/A,10%,8)
= 8000(11.4359)
= $91,487
125
L-1
Shifted Series and Random Single Amounts
For cash flows that include uniform series and randomly placed single amounts:
Uniform series procedures are applied to the series

amounts
Single amount formulas are applied to the one-3me cash flows
The resulting values are then combined per the problem statement
The following slides illustrate the procedure

126
L-1
Example: Series and Random Single Amounts
Find the present worth in year 0 for the cash flows
shown using an interest rate of 10% per year.
PT = ?
i = 10%
0 1 2 3 4 5 6 7 8 9 10
A = $5000
$2000
PT = ?
i = 10%
Actual year
0 1 2 3 4 5 6 7 8 9 10
0 1 2 3 4 5 6 7 8
Series year
A = $5000
$2000
Solution:
First, re-number cash flow diagram to get n for uniform series: n = 8

127
L-1
Example: Series and Random Single Amounts
PA
PT = ? i = 10%
0 1 2 3 4 5 6 7 8 9 10 Actual year
0 1 2 3 4 5 6 7 8
Series year
A = $5000 $2000
Use P/A to get PA in year 2: PA = 5000(P/A,10%,8) = 5000(5.3349) = $26,675
Move PA back to year 0 using P/F: P0 = 26,675(P/F,10%,2) = 26,675(0.8264) = $22

Move $2000 single amount back to year 0: P2000 = 2000(P/F,10%,8) = 2000(0.4665) = $933
Now, add P0 and P2000 to get PT: PT = 22,044 + 933 = $22,977
128
L-1
Example Worked a Different Way
(Using F/A instead of P/A for uniform series)
The same re-numbered diagram from the previous slide is used
PT = ? FA = ?
i = 10%
0 1 2 3 4 5 6 7 8 9 10
0 1 2 3 4 5 6 7 8
A = $5000
$2000
Solu=on: Use F/A to get FA in actual year 10: FA = 5000(F/A,10%,8) = 5000(11.4359) = $57,180
Move FA back to year 0 using P/F: P0 = 57,180(P/F,10%,10) = 57,180(0.3855) = $22,043
Move $2000 single amount back to year 0: P2000 = 2000(P/F,10%,8) = 2000(0.4665) = $933
Now, add two P values to get PT: PT = 22,043 + 933 = $22,976 Same as before
As shown, there are usually multiple ways to work equivalency problems 129
L-1
Example: Series and Random Amounts
Convert the cash flows shown below (black arrows) into
an equivalent annual worth A in years 1 through 8 (red arrows)
at i = 10% per year.
A=?
0 1 2 3 4 5 6 7 8 i = 10%
0 1 2 3 4 5
A = $3000
$1000
Approaches: 1. Convert all cash flows into P in year 0 and use A/P with n = 8
2. Find F in year 8 and use A/F with n = 8
Solution: Solve for F: F = 3000(F/A,10%,5) + 1000(F/P,10%,1)
= 3000(6.1051) + 1000(1.1000)
= $19,415
Find A: A = 19,415(A/F,10%,8)
= 19,415(0.08744) 130
= $1698
L-1
131
L-1
132
133
134
135
136
137
Shifted Arithmetic Gradients
The present worth of an aritmetic gradient will always be located two periods
the gradient starts
Shifted gradient begins at a time other than between periods 1 and 2
Present worth PG is located 2 periods before gradient starts
Must use multiple factors to find PT in actual year 0
To find equivalent A series, find PT at actual time 0 and apply (A/P,i,n)
138
L-1
Example: Shifted Arithmetic Gradient
John Deere expects the cost of a tractor part to increase by $5 per year
beginning 4 years from now. If the cost in years 1-3 is $60, determine the
present worth in year 0 of the cost through year 10 at an interest rate of 12%
per year. i = 12%
PT = ? Actual years
0 1 2 3 4 5 10
0 1 2 3 8 Gradient years
60 60 60
65
70
G=5 95
Solu=on: First find P2 for G = $5 and base amount ($60) in actual year 2
P2 = 60(P/A,12%,8) + 5(P/G,12%,8) = $370.41
Next, move P2 back to year 0

P0 = P2(P/F,12%,2) = $295.29
Next, find PA for the $60 amounts of years 1 and 2 PA = 60(P/A,12%,2) = $101.41
13
Finally, add P0 and PA to get PT in year 0 PT = P0 + PA = $396.70 9
3-139 L-1
140
L-1
141
142
Shifted Geometric Gradients
Shifted gradient begins at a time other than between periods 1 and 2
Equation yields Pg for all cash flows (base amount A1 is included)
Equation (i ≠ g): Pg = A 1{1 - [(1+g)/(1+i)]n/(i-g)}
For negative gradient, change signs on both g values
There are no tables for geometric gradient factors 14

3
L-1
Example: Shifted Geometric Gradient
Weirton Steel signed a 5-year contract to purchase water treatment chemicals
from a local distributor for $7000 per year. When the contract ends, the cost of
the chemicals is expected to increase by 12% per year for the next 8 years. If an
initial investment in storage tanks is $35,000, determine the equivalent present
worth in year 0 of all of the cash flows at i = 15% per year.
14
4
3-144 L-1
Example: Shifted Geometric Gradient
Gradient starts between actual years 5 and 6; these are gradient years 1 and 2.
Pg is located in gradient year 0, which is actual year 4
Pg = 7000{1-[(1+0.12)/(1+0.15)]9/(0.15-0.12)} = $49,401
Move Pg and other cash flows to year 0 to calculate PT

14
PT = 35,000 + 7000(P/A,15%,4) + 49,401(P/F,15%,4) = $83,232
5
1-145 L-1
Negative Shifted Gradients
For negative arithmetic gradients, change sign on G term from + to -

General equation for determining P: P = present worth of base amount - PG
Changed from + to -
For negative geometric gradients, change signs on both g values

Changed from + to -
Pg = A1{1-[(1-g)/(1+i)]n/(i+g)}
Changed from - to +
All other procedures are the same as for positive gradients 146
L-1
Example: Negative Shifted Arithmetic Gradient
For the cash flows shown, find the future worth in year 7 at i = 10% per year
F=?

PG = ? i = 10%
0 1 2 3 4 5 6 7
Actual years
0 1 2 3 4 5 6 Gradient years
450
500
550
600
650
700
G = $-50
Solu=on: Gradient G first occurs between actual years 2 and 3; these are gradient years 1 and 2
PG is located in gradient year 0 (actual year 1); base amount of $700 is in gradient years 1-6
PG = 700(P/A,10%,6) – 50(P/G,10%,6) = 700(4.3553) – 50(9.6842) = $2565
F = PG(F/P,10%,6) = 2565(1.7716) = $4544 147
L-1
Summary of Important Points
P for shifted uniform series is one period ahead of first A;

n is equal to number of A values
F for shifted uniform series is in same period as last A;

n is equal to number of A values
For gradients, first change equal to G or g occurs

between gradient years 1 and 2
For nega=ve arithme=c gradients, change sign on G from + to -
For negative geometric gradients, change sign on g from + to - 148
L-1
ENGINEERING ECONOMY

Nominal and Effective Interest
Rates

149
L-1
LEARNING OUTCOMES
1.  Understand interest rate statements
2.  Use formula for effective interest rates
3.  Determine interest rate for any time period
4.  Determine payment period (PP) and compounding
period (CP) for equivalence calculations
5.  Make calculations for single cash flows
6.  Make calculations for series and gradient cash flows
with PP>=CP
7.  Use interest rate formula for continuous compounding
8.  Make calculations for varying interest rates 4-15
0

ENR 405 - Lecture 1posted-1

Diunggah oleh

Informasi Dokumen

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

ENR 405 - Lecture 1posted-1

Diunggah oleh

Hak Cipta:

Format Tersedia

ENGINEERING

Engineering Economic Decisions

© 2012 by McGraw-Hill, New York, N.Y All

2. Deﬁne the goals or objec;ves

Analyze Evaluate Evaluate

Accoun3ng Engineering Economy

EMR 301 – ENGINEERING ECONOMY

economic decisions L-1

EMR 301 – ENGINEERING ECONOMY

Engineers have to make decisions unders resource constraints,

EMR 301 – ENGINEERING ECONOMY

Services 30.5% 60.0% 39.0%

Retail trade 16.7% 31.1% 13.0%

Financial 8.0% 26.8% 6.3%

EMR 301 – ENGINEERING ECONOMY

n New Plan: Each service

EMR 301 – ENGINEERING ECONOMY

EMR 301 – ENGINEERING ECONOMY

EMR 301 – ENGINEERING ECONOMY

EMR 301 – ENGINEERING ECONOMY

Today 6-month later

Buy $960 $550 $6,500 $350 $9,000

Lease $960 $550 $2,400 $550 0

Irrelevant items in decision making

Manufacturing cost 1 unit

Savings account Low/None 1.5%

Bond (debt) Moderate 4.8%

• The ﬁve main types of engineering economic decisions

• Corporate investments are expected to earn a return

The time value of money is the most important concept in

Ø Interest = amount owed now – principal(initial ampunt)

v Borrower’s perspective – interest rate paid 43

v Lender’s or investor’s perspective – rate of return earned

EMR 301 – ENGINEERING ECONOMY

EMR 301 – ENGINEERING ECONOMY

• Net Cash Flow (NCF) for each time period:

Draw a time line Always assume end-of-period cash flows

Example: $100,000 lent for 3 years at simple i = 10% per

Interest = 100,000(3)(0.10) = $30,000

Interest = (principal + all accrued interest) (interest rate)

Interest for time period t is

Compounded: $133,100 Simple: $130,000

© 2012 by McGraw-Hill, New York, N.Y All

• Equity Financing –Funds either from retained earnings,

• Debt Financing –Borrowed funds from outside sources

For an economically justified project

§ the loss of poten;al gain from other alterna;ves when one

§ The Rule of 72’s for Interest

§ Assume we want an investment to double in say 3

EMR 301 – ENGINEERING ECONOMY

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

EMR 301 – ENGINEERING ECONOMY

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All

Lecture slides to accompany

2.  Deﬁne the goals or objec;ves

n  New Plan: Each service

•  The ﬁve main types of engineering economic decisions

•  Corporate investments are expected to earn a return

Ø  Interest = amount owed now – principal(initial ampunt)

v  Borrower’s perspective – interest rate paid 43

v  Lender’s or investor’s perspective – rate of return earned

•  Net Cash Flow (NCF) for each time period:

•  Equity Financing –Funds either from retained earnings,

•  Debt Financing –Borrowed funds from outside sources

§  the loss of poten;al gain from other alterna;ves when one

§ The Rule of 72’s for Interest

§  Assume we want an investment to double in say 3

1.  Shifted uniform series