Foundation of Engineering Economy

8/12/2019 Foundation of Engineering Economy

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Foundation of Engineering Economy


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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


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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


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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 ofresults

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.


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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 youa 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


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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.


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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 originalamount (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.


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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.


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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.


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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


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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.


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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

FP

iPF

)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


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ni)1( Single payment compound amount factor

In Symbol:

F/P,i%,n

Read as F given P at i% in n interest periods

ni)1(

1

Single payment present worth factor

In symbol:

P/F,i%,nRead as P given F at i% in n interest periods.


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If HP borrows $1,000,000 from a different

source at 5% per year compound

interest, compute the total amount due after 3

years.


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R t f I t t


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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


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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.


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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.


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Example of positive

and negative cashflows.

A vertical

arrow pointing up indicates a positive cash

flow. Conversely, an arrow pointingdown indicates a negative cash flow.


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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. Identifythe 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


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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, plansexpenditures 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, usinga cost of capital estimate for

safety-related funds of 12% per year.


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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 3years from now. If the rate of

return is estimated to be 15.5% per year,

construct the cash flow diagram.

Foundation of Engineering Economy

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