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ENGINEERING ECONOMY
Engineering economy is concerned with the financial analysis of engineering projects. Solution to answers one of two questions:
1) which of the choices considered is best from a financial point of view? (i.e., which equipment offers the required service at lowest cost?), or 2) what is the expected return on investment (ROI) in using this equipment?
Interest Calculations
The four variables in an engineering economy problem:
p = present worth f= future worth i = interest rate n= number of interest periods
Interest rate is the rent charged on the money lent for a defined period of time.
Engineering economy problems have traditionally been solved employing interest tables, and their use is generally instructive. Values for four different interest rates are tabulated in table 8-1.
Example 2: You paid me $595.50 today for a loan made three years ago. If the interest charged was 6 percent, how much was the original loan? F is known ($595.50) and the prior present value P is unknown P=F(PF,i,n)= 595.5 (PF,6,3) = 595.5 (0.840) = 500.22 = $500 Cash flow diagram for this problem is shown in this figure.
Another variable in engineering economy problems is equivalent annual amount. It represents a constant value (A). Example If I put $1000 in a bank that pays 6 percent interest, what equivalent annual amount can I withdraw from this account at the end of each of the next five years? A=P(AP,I,n)=$1000(AP,6,5)=$1000(0.237)=$237 Cash flow diagram shown in this figure.
Example:
Machines A and B perform equally well. Machine A initially costs $20.000 has estimated net annual operating expenses of $3000, and has an estimated salvage value at the end of a 10year economic life of $4000. Machine B will cost $25.000 initially, with annual operating expenses of $2000, and a salvage value at the end of a 15-year economic life of $5000. If your minimum acceptable rate of return (MARR) is 20 percent, which machine should you purchase?.
The typical annual cost method problem for machine service over a period of years. EAC=P(AP,I,n)+AOC-F(AF,I,n)
Payback Method
The alternative that returns the initial investment in the shortest time period is preferred.
Example.
Machine A Machine B Initial investment $ 10.000 $ 10.000 Net annual income 2.000 2.500 Machine A will pay back the original investment in five years, and Machine B in four years. If we employ the payback criterion, Machine B would be preferred.
The weakness payback period criterion is in what it fails to consider, return after payback. Another weakness is that it does not consider the time value of money during the economic life of equipment.
Value is specific to individuals. It depends on a persons relative needs for security, pleasure, peer approval, aspirations, etc.
If potential purchaser offers to purchase 1000 units of Product A, which could be produced next month for a unit price of $41, the order would not be accepted. Assume 70% normal capacity. The order 1000 unit of product A would bring the plant to 90 % capacity. Even though order will not produce profits in the traditional sense, it will help pay some of the overhead expenses of the plant; in fact, to the amount of 1000x$10 = $10.000. So we accept an offer.