Engineering Economy - Lecture - Intro, Lecture notes of Economics

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Engineering Economy

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Course Text Overview

• Level 1 This is How It All Starts

Chapter 1: Foundations of Engineering Economy

Chapter 2: Factors: How Time and Interest Affect Money

Chapter 3: Combining Factors

Chapter 4: Nominal and Effective Interest Rates

• Level 2 Tools for Evaluating Alternatives

Chapter 5: Present Worth Analysis

Chapter 6: Annual Worth Analysis

Chapter 7: Rate of Return Analysis: Single Alternative

Chapter 8: Rate of Return Analysis: Multiple Alternatives

Chapter 9: Benefit/Cost Analysis and Public Sector Economics

• Level 3 Making Decisions on Real-World Projects

Chapter 11: Replacement and Retentions Decisions

• Level 4 Rounding Out the Study

Chapter 14: Effects of Inflation

Chapter 17: After-Tax Economic Analysis

Chapter 18: Formalized Sensitivity Analysis and Expected Value

Decisions

Tentative Schedule

Chapter 1

Foundations

of

Engineering

Economy

Why Engineering Economy is Important to

Engineers

Decisions made by engineers, managers, corporation

presidents, and individuals are commonly the result of

choosing one alternative over another.

Decisions often reflect a person’s educated choice of how to

best invest funds (capital).

The amount of capital is usually restricted, just as the cash

available to an individual is usually limited. The decision of

how to invest capital will invariably change the future,

hopefully for the better; that is, it will be value adding.

Engineers play a major role in capital investment decisions

based on their analysis, synthesis, and design efforts.

The factors considered in making the decision are a

combination of economic and noneconomic factors.

Fundamentally, engineering economy involves

formulating, estimating, and evaluating the economic

outcomes when alternatives to accomplish a defined

purpose are available.

Time Value of Money

• An important concept in engineering

economy

• Money can “make” money if invested.
• The change in the amount of money

over a given time period is called the

time value of money.

The Big Picture

• Engineering economy is at the heart of making

decisions.

• These decisions involve the fundamental

elements of cash flows of money, time and

interest rates.

• Chapter 1 introduces the basic concepts and

terminology necessary for an engineer to

combine these three essential elements in

organized, mathematically correct ways to

solve problems that will lead to better

decisions.

Parameters and Cash Flows

Parameters

First cost (investment amounts)

Estimates of useful or project life

Estimated future cash flows (revenues and expenses

and salvage values)

Interest rate

Cash Flows

Estimate flows of money coming into the firm –

revenues, salvage values, etc. – positive cash flows--cash

inflows

Estimates of investment costs, operating costs, taxes

paid – negative cash flows -- cash outflows

The Cash Flow Diagram: CFD

Net Cash Flows

• A NET CASH FLOW is -

Cash Inflows – Cash Outflows

(for a given time period)

• We normally assume that all cash flows

occur:

At the END of a given time period

End-of-Period Assumption

Interest – Lending Example

Example 1.

• You borrow $10,000 for one full year
• Must pay back $10,700 at the end of one

year

• Interest Amount (I) = $10,700 - $10,
• Interest Amount = $700 for the year
• Interest rate (i) = 700/$10,000 = 7%/Yr

Interest Rate - Notation

Notation

I = the interest amount is $

i = the interest rate (%/interest period)

N = No. of interest periods (1 for this problem)

Interest – Borrowing

The interest rate (i) is 7% per year

The interest amount is $700 over one year

The $700 represents the return to the lender for the use

of funds for one year

7% is the interest rate charged to the borrower