Ch1 why engecon_rev2

1. Engineering EconomyEngineering Economy
Foundations Of Engineering Economy (CH1)Foundations Of Engineering Economy (CH1)
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2. Why Engineering Economy is important?Why Engineering Economy is important?
Engineering Design involves economic decisions
Engineers must be able to incorporate economic
analysis into their creative efforts
Often engineers must select and implement from
multiple alternatives
Understanding and applying time value of money,
economic equivalence, and cost estimation are vital
for engineers
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3. Why Engineering Economy is important?Why Engineering Economy is important?
Your company is considering buying a
new cement mixer,
◦ what economic questions you will try to
answer?
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4. What is Engineering Economy?What is Engineering Economy?
Engineering Economy involves
◦ Formulating
◦ Estimating, and
◦ Evaluating
expected economic outcomes of alternatives
designed to accomplish a defined purpose
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5. Engineering Economy in Decision MakingEngineering Economy in Decision Making
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
8. monitor results
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6. Common TermsCommon Terms
t = time, usually in periods such as years or months
P = value or amount of money at a time t
designated as present or time 0
F = value or amount of money at some future
time, such as at t = n periods in the future
A = series of consecutive, equal, end-of-period
amounts of money
n = number of interest periods; years, months
i = interest rate or rate of return per time period;
percent per year or month
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7. Engineering Economy in Decision MakingEngineering Economy in Decision Making
Your company wants to decide to buy or to
rent a cement mixer? How can you decide
which decision to take?
Measures of worth:
◦ Capitalized cost, economic value added
◦ Present worth, future worth, annual worth,
◦ Payback period, Rate of Return,
Time value of money(TMV): The change in
the amount of money over a given time period.
TMV is the most important concept in
engineering economy
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8. Engineering Economic Study StepsEngineering Economic Study Steps
Decision
making
process
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9. Interest RateInterest Rate
It is 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
Interest = amount owed now – principal
Interest rate – Interest paid over a time period
expressed as a percentage of principal
Interest rate is Borrower’s perspective
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10. Rate of ReturnRate of Return
Lender’s or investor’s perspective – rate of return
earned
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11. Interest Rate ProblemInterest Rate Problem
Calculate the amount deposited 1 year ago to
have $1000 now at an interest rate of 5% per
year, then calculate the amount of interest
earned during this period.
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12. Simple Interest RatesSimple Interest Rates
Simple interest is calculated using the
principal only, ignoring any interest
accrued in preceding interest periods.
Interest = principal x (Number of
Periods) x interest rate
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13. Simple Interest Rate - ExampleSimple Interest Rate - Example
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14. Compound InterestCompound Interest
The interest accrued for each interest
period is calculated on the principal plus
the total amount of interest accumulated
in all previous periods.
Interest = (principal + all accrued
interest) x interest rate
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15. Compound InterestCompound Interest
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16. Cash Flow: BasicsCash Flow: Basics
 Cash flow are described as the inflows and outflows of
money.
 Every person or company has
◦ Inflows: cash receipts or revenue or income
◦ Outflows: Cash disbursement, costs
 Cash flow estimation can be inexact
 Cash Inflow Types: Operating cost reduction, asset salvage
value, receipt of loan principal, income tax savings,
construction cost savings.
 Cash Outflow types: operating cost, maintenance, loan
interest,
 Net Cash Flow (NCF) for each time period:
NCF = cash inflows – cash outflows
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17. How to construct Cash FlowHow to construct Cash Flow
Diagram (CFD)Diagram (CFD)
Timeline
Draw cash flows with approximate scale
0 1 2 … … … n - 1 n
One time
period
0 1 2 … … … n-1 n
Cash flows are shown as directed arrows: + (up) for inflow
- (down) for outflow
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18. Cash Flow Example 1Cash Flow Example 1
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19. Cash flow Diagram ApproachCash flow Diagram Approach
Start with tabular form to construct CFD for
complicated problems
Complicated problems best solved with a
table first
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20. Cash Flow Example2Cash Flow Example2
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21. Cash Flow Example2Cash Flow Example2
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22. Homework QuestionsHomework Questions
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