Chapter 1 Foundations of Engineering Economy

Solutions to Problems 1.1 1.2 1.3 1.# 1.' Time value of money means that there is a certain worth in having money and the worth changes as a function of time. Morale, goodwill, friendship, convenience, aesthetics, etc. (a) Evaluation criterion is the measure of value that is used to identify !est". (!) The primary evaluation criterion used in economic analysis is cost. $earest, tastiest, %uic&est, classiest, most scenic, etc (f the alternative that is actually the !est one is not even recognized as an alternative, it o!viously will not !e a!le to !e selected using any economic analysis tools. (n simple interest, the interest rate applies only to the principal, while compound interest generates interest on the principal and all accumulated interest. Minimum attractive rate of return is the lowest rate of return (interest rate) that a company or individual considers to !e high enough to induce them to invest their money. E%uity financing involves the use of the corporation,s or individual,s own funds for ma&ing investments, while de!t financing involves the use of !orrowed funds. -n e.ample of e%uity financing is the use of a corporation,s cash or an individual,s savings for ma&ing an investment. -n e.ample of de!t financing is a loan (secured or unsecured) or a mortgage. 0ate of return 1 (#'2/)))(133) 1 #.)'4 0ate of increase 1 5(2/ 6 22)2227(133) 1 31.+4 (nterest rate 1 (2*',33322,333,333)(133) 1 13.*'4 0ate of return 1 (2.32))(133) 1 3+.34
1

1.) 1.*

1.+

1./ 1.13 1.11 1.12

8hapter 1

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1.13 1.1#

=rofit 1 +(3.2+) 1 >2,2#3,333 = ? =(3.13) 1 1,)33,333 1.1= 1 1,)33,333 = 1 >1,#'#,'#' Earnings 1 '3,333,333(3.3') 1 >1*,'33,333 (a) E%uivalent future amount 1 13,333 ? 13,333(3.3+) 1 13,333(1 ? 3.3+) 1 >13,+33 (!) E%uivalent past amount@ = ? 3.3+= 1 13,333 1.3+= 1 13,333 = 1 >/2'/.2)

1.1' 1.1)

1.1*

E%uivalent cost now@ = ? 3.1= 1 1),333 1.1= 1 1),333 = 1 >1#,'#'.#' #3,333 ? #3,333(i) 1 '3,333 i 1 2'4 +3,333 ? +3,333(i) 1 133,333 i 1 2'4 A 1 2#3,333 ? 2#3,333(3.13)(3) 1 >312,333 8ompound amount in ' years 1 1,333,333(1 ? 3.3*)' 1 >1,#32,''2 Bimple amount in ' years 1 1,333,333 ? 1,333,333(3.3*')(') 1 >1,3*',333 8ompound interest is !etter !y >2*,''2

1.1+ 1.1/ 1.23 1.21

1.22

Bimple@ 1,333,333 1 '33,333 ? '33,333(i)(') i 1 234 per year simple 8ompound@ 1,333,333 1 '33,333(1 ? i)' (1 ? i)' 1 2.3333 (1 ? i) 1 (2.3333)3.2 i 1 1#.+*4

8hapter 1

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1.23

Bimple@ 2= 1 = ? =(3.3')(n) = 1 =(3.3')(n) n 1 23 years 8ompound@ 2= 1 =(1 ? 3.3')n (1 ? 3.3')n 1 2.3333 n 1 1#.2 years

1.2#

(a) Bimple@ 1,333,333 1 = ? =(3.1')(13) 2.'= 1 1,333,333 = 1 >'23,333 (!) 8ompound@ 1,333,333 1 =(1 ? 3.1')13 #.3#')= 1 1,333,333 = 1 >321,3#3

1.2'

=lan 1@ (nterest paid each year 1 #33,333(3.13) 1 >#3,333 Total paid 1 #3,333(3) ? #33,333 1 >'23,333 =lan 2@ Total due after 3 years 1 #33,333(1 ? 3.13)3 1 >'32,#33 Cifference paid 1 '32,#33 6 '23,333 1 >12,#33

1.2)

(a) Bimple interest total amount 1 1,*'3,333(3.3*')(') 1 >)'),2'3 8ompound interest total 1 total amount due after # years 6 amount !orrowed 1 1,*'3,333(1 ? 3.3+)# 6 1,*'3,333 1 2,3+3+') 6 1,*'3,333 1 >)33,+') (!) The company should !orrow 1 year from now for a savings of >)'),2'3 6 >)33,+') 1 >2',3/#

1.2* 1.2+

The sym!ols are A 1 DE = 1 >'3,333E i 1 1'4E n 1 3 (a) AF(i4,n,-,=) finds the future value, A (!) (00(firstGcell@lastGcell) finds the compound interest rate, i (c) =MT(i4,n,=,A) finds the e%ual periodic payment, (d) =F(i4,n,-,A) finds the present value, =
3

8hapter 1

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1.2/ 1.33 1.31

(a) A 1 DE i 1 *4E n 1 13E - 1 >2333E = 1 >/333 (!) - 1 DE i 1 114E n 1 23E = 1 >1#,333E A 1 3 (c) = 1 DE i 1 +4E n 1 1'E - 1 >1333E A 1 >+33 (a) =F 1 = (!) =MT 1 - (c) $=E0 1 n (d) (00 1 i

(e) AF 1 A

Aor !uilt;in E.cel functions, a parameter that does not apply can !e left !lan& when it is not an interior one. Aor e.ample, if there is no A involved when using the =MT function to solve a particular pro!lem, it can !e left !lan& !ecause it is an end function. Hhen the function involved is an interior one (li&e = in the =MT function), a comma must !e put in its position. (a) 0is&y (!) Bafe (c) Bafe (d) Bafe (e) 0is&y (a) E%uity (!) E%uity (c) E%uity (d) Ce!t (e) Ce!t <ighest to lowest rate of return is as follows@ 8redit card, !an& loan to new !usiness, corporate !ond, government !ond, interest on chec&ing account <ighest to lowest interest rate is as follows@ rate of return on ris&y investment, minimum attractive rate of return, cost of capital, rate of return on safe investment, interest on savings account, interest on chec&ing account. H-88 1 (3.2')(3.1+) ? (3.*')(3.13) 1 124 Therefore, M-00 1 124 Belect the last three proIects@ 12.#4, 1#4, and 1/4

1.32

1.33

1.3# 1.3'

1.3)

1.3* 1.3+

End of period convention means that the cash flows are assumed to have occurred at the end of the period in which they too& place. The following items are inflows@ salvage value, sales revenues, cost reductions The following items are outflows@ income ta.es, loan interest, re!ates to dealers, accounting services

8hapter 1

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1.3/

The cash flow diagram is@

A1 D
i 1 134 >/333 3 1 2 3 # >3333 >13,333 ' ) * +

1.#3

The cash flow diagram is@

=1D
i 1 1'4 3 1 2 3 # '

>#3,333

1.#1 1.#2

Time to dou!le 1 *22+ 1 / years Time to dou!le 1 *22/ 1 + years Time to %uadruple 1 (+)(2) 1 1) years

1.#3 1.##

# 1 *22i i 1 1+4 per year -ccount must dou!le in value five times to go from >)2,'33 to >2,333,333 in 23 years. Therefore, account must dou!le every 232' 1 # years. 0e%uired rate of return 1 *22# 1 1+4 per year

FE Re#ie$ Solutions 1.#' 1.#) -nswer is (c) 2= 1 = ? =(3.3')(n) n 1 23 -nswer is (d)

'

8hapter 1

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1.#* -mount now 1 13,333 ? 13,333(3.13) 1 >11,333 -nswer is (c) 1.#+ i 1 *22/ 1 + 4 -nswer is (!) 1.#/ -nswer is (c) 1.'3 Jet i 1 compound rate of increase@ 23' 1 1)3(1 ? i)' (1 ? i)' 1 23'21)3 (1 ? i) 1 (1.#)/)3.2 (1 ? i) 1 1.3*//' i 1 *.//'4 1 +.34 -nswer is (c)

8hapter 1

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E%tended E%ercise Solution

F&' 1. 3 1 2 >'33 >/333 A 1 5K56/333(1.3+) 6 '337 (1.3+)L 6 '337 (1.3+) ? (23336'33) 1 >613,/)3.)3 or A 1 6/333(A2=,+4,3) 6 '33(A2-,+4,3) ? 2333 2. - spreadsheet uses the AF function as shown in the formula !ar. A 1 >613,/)3.)1. 3 >'33 >2333 # >'33

8hapter 1

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3. A 1 5K56/333(1.3+) 6 3337 (1.3+)L 6 '337 (1.3+) ? (2333 61333) 1 >611,22*.33 8hange is 2.324. Jargest maintenance charge is in the last year and, therefore, no compound interest is accumulated !y it. #. The fastest method is to use the spreadsheet function@ AF(12.324,3,'33,/333) ? 2333 (t displays the answer@ A 1 >612,##'.#3 Case Study Solution There is no definitive answer to the case study e.ercises. The following are e.amples only. 1. The first four steps are@ Cefine o!Iective, information collection, alternative definition and estimates, and criteria for decision;ma&ing. M!Iective@ Belect the most economic alternative that also meets re%uirements such as production rate, %uality specifications, manufactura!ility for design specifications, etc. (nformation@ Each alternative must have estimates for life (li&ely 13 years), -M8 and other costs (e.g., training), first cost, any salvage value, and the M-00. The de!t versus e%uity capital %uestion must !e addressed, especially if more than >' million is needed. -lternatives@ Aor !oth - and N, some of the re%uired data to perform an analysis are@ = and B must !e estimated. -M8 e%ual to a!out +4 of = must !e verified. Training and other cost estimates (annual, periodic, one;time) must !e finaliOed. 8onfirm n 1 13 years for life of - and N. M-00 will pro!a!ly !e in the 1'4 to 1+4 per year range. 8riteria@ 8an use either present worth or annual worth to select !etween - and N.
8hapter 1 +

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2. 8onsider these and others li&e them@ Ce!t capital availa!ility and cost 8ompetition and siOe of mar&et share re%uired Employee safety of plastics used in processing 3. Hith the addition of 8, this is now a ma&e2!uy decision. Economic estimates needed are@ 8ost of lease arrangement or unit cost, whatever is %uoted. -mount and length of time the arrangement is availa!le. Bome non;economic factors may !e@ :uarantee of availa!le time as needed. 8ompati!ility with current e%uipment and designs. 0eadiness of the company to enter the mar&et now versus later.

8hapter 1

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