Foundation of Engineering Economy

WHAT IS ENGINEERING ECONOMY?

engineering economy is a collection of
techniques that simplify comparisons of
alternatives on an economic basis.
PERFORMING AN ENGINEERING ECONOMY
STUDY
Terms
Alternatives
Cash Flows
Alternative Selection
Evaluation Criteria
Intangible Factors
Time Value of Money
Principles of Engineering Economy
1. Develop an ALternatives
2. Focus on the Differences
3. Use a Consistent Viewpoint
4. Use a Common unit of Measure
5. Consider all Relevant Criteria
6. Make Uncertainty Explicit
7. Revisit your Decision
Engineering Economic Analysis Procedure
1. Problem Recognition, Definition, and
Evaluation
2. Development of the Feasible
Alternatives
3. Developing of the Cash Flow for each
alternatives
4. Selection of a criterion (or Criteria)
5. Analysis and Comparison of the alternatives
6. Selection of the preferred alternative
7. Performance monitoring and post evaluation of
results
Engineering Design Process
1. Problem need definiton
2. Problem/ need formulation and
Evaluation
3. Synthesis of possible solutions
(alternatives)
4. Analysis, optimization, and
evaluation
5. Specification of preferred
alternative
6. Communication.
Bad news-you just wrecked your car! You need another car immediately because you
have decided that walking, riding a bike, and taking a bus are not acceptable. An
automobile wholesalers offers you 2000 for the car as is also your insurance companys
claims adjuster estimates that there is 2000 in damages of your car. Because you have
collision insurance with a 1000 deductibility provision, the insurance company mails you
a check for 1000. the odometer reading on your wrecked car is 58000 miles

what should you do? Use the seven step procedure to analyze your situation.
Also identify which principles accompany each step.
Step 1: Define the problem
Step 2: Develop your alternatives

1. Sell the wrecked car for 2000to the wholesaler and spend this money, the 1000
insurance check, and all of your 7000 savings account on a newer car. The total amount
paid out of your savings account is 7000and the car will have 28000 miles of prior use.
2. Spend the 1000 insurance check and 1000 of savings to fix the car. The total amount
paid out of your savings is 1000, and the car will have 58000miles of prior use.
3. Spend the 1000 insurance check and 1000 of your savings to fix the car, then sell
the car 4500 pplus 5500 off additional savings to buy the newer car. The total
amount paid out of savings is 6500, and the car will have 28000 miles.
4. Give a car to a part time mechanic, who will repair it to 1100 (1000 insurance
and 100of your savings) but will take and additional month of repair time. You will
also have to rent a car for that time at 400/month (paid out of saving). The total
amount paid out of saving is 500and the car will have 58000 miles on the
odometer.
5. Same aas alternative 4, but you then sell the car for 4500, and use this money plus
5500 of additional savings to buy the newer car. The total amount paid out of savings
is 6000 and the newer car will be have 28000 miles of prior use.
INTEREST RATE, RATE OF RETURN, AND MARR
Interest is the manifestation of the time value
of money, and it essentially represents
rent paid for use of the money.
Interest = End amount - Original amount
When interest over a specific time unit is
expressed as a percentage of the original
amount (principal), the result is called the
interest rate or rate of return (ROR).
Interest accrued per unit time
Interest rate or Rate of Return = ----------------------------------------- x 100%
Original amount
The time unit of the interest rate is called the
interest period.
EXAMPLE
An employee at LaserKinetics.com borrows
$10,000 on May 1 and must repay
a total of $10,700 exactly 1 year later.
Determine the interest amount and the
interest rate paid.
a. Calculate the amount deposited 1 year ago
to have $1000 now at an interest
rate of 5% per year.
b. Calculate the amount of interest earned
during this time period.
EQUIVALENCE
In engineering economy, when considered
together, the time value of money
and the interest rate help develop the concept
of economic equivalence, which
means that different sums of money at
different times would be equal in economic
value.
Simple Interest
Simple interest is calculated using the principal only, ignoring any interest that
had been accrued in preceeding period.
I=Pni
F=P + I
F=P(1+ni)
I- ineterst
P-Principal or present worth
N-number of interest periods
i-rate of interest per interest period
F-accumulated amount or future worth
Ordinary Simple Interest is computed on the basis of 12 months of 30 days
each or 360 days a year.
1 interest period = 360 days
Exact Simple interest is based on the exact number of daysin a year, 365
days for ordinary yearand 366 daysfor a leap year.
1 interest period = 365 or 366 days
Problem
1. Determine the simple ordinary interest on P700 for
8months and 15 daysif the rate of interest is 15%
2. What will be the future worth of money after
14 months if the sum of P10000is invested
todayat a simple interest rate of 12% per year.
Compound Interest
The interest for an interest period is calculated on the principal plus total
amount of interest accumulated in previous periods.
compound interest means interest on top of
interest.
Interest = (principal + all accrued interest)(interest rate)
n
n
i
F
P
i P F
) 1 (
) 1 (

P-Principal or present worth
n-number of interest periods
i-rate of interest per interest period
F-accumulated amount or future worth
n
i) 1 (
Single payment compound amount factor
In Symbol:
F/P,i%,n
Read as F given P at i% in n interest periods
n
i) 1 (
1

Single payment present worth factor

In symbol:
P/F,i%,n
Read as P given F at i% in n interest periods.
If HP borrows $1,000,000 from a different
source at 5% per year compound
interest, compute the total amount due after 3
years.
Rate of Interest
Nominal rate of interest, r
the nominal rate of interest specifies the rate of interest and a number
of interest periods in one year.

i=r/m

where: i- rate interest per interest period
r-nominal interest rate
m-number of compounding periods per year
Effective rate of Interest
effective rate of interest is the actual or exact rate of interest on the
principal during one year.
Effective rate = (1+i)
m
-1
Find the nominal rate which if converted quarterlycould be used
instead of 12% compounded monthly. What is the
corresponding effective rate.
Find the amount at the end of two years and seven months if P1000
is invested at 8%compounded quarterly using simple interest for
anytime less than a year interest period.
Cash Flow Diagrams
A cash flow diagram is simply a graphical representation of cash flows drawn
on a time scale.
Cash flows are inflows and outflows of money.
A typical cash flow
time scale for 5 years.
Example of positive
and negative cash
flows.
A vertical
arrow pointing up indicates a positive cash
flow. Conversely, an arrow pointing
down indicates a negative cash flow.
A new college graduate has a job with Boeing
Aerospace. She plans to borrow
$10,000 now to help in buying a car. She has
arranged to repay the entire principal
plus 8% per year interest after 5 years. Identify
the engineering economy
symbols involved and their values for the total
owed after 5 years.
Construct the cash flow diagram.
Cash flow diagram on the viewpoint of the borrower
Each year Exxon-Mobil expends large amounts
of funds for mechanical safety
features throughout its worldwide operations.
Carla Ramos, a lead engineer for
Mexico and Central American operations, plans
expenditures of $1 million now
and each of the next 4 years just for the
improvement of field-based pressure release
valves. Construct the cash flow diagram to find
the equivalent value of
these expenditures at the end of year 4, using
a cost of capital estimate for
safety-related funds of 12% per year.
A father wants to deposit an unknown lump-
sum amount into an investment
opportunity 2 years from now that is large
enough to withdraw $4000 per year
for state university tuition for 5 years starting 3
years from now. If the rate of
return is estimated to be 15.5% per year,
construct the cash flow diagram.