Course of Engineering Economy

University of Coahuila
U.A. de C.
Faculty of Metallurgy
Engineering Economy course

M. Garcia & Dr. J. R. Cano
Email: ma_ga_i@yahoo.com
Presentation designed and written by:

M. Garcia
October 2018
Tentative Course Outline
 Introduction
 Equivalence and Compound Interest
 Present worth analysis
 Annual cash flow analysis
 Rate of return analysis
 Incremental rate of return analysis
 Rationing capital among competing projects
 Other analysis techniques (Future worth analysis, Benefit-Cost ratio analysis,
etc.)
 Depreciation
 Income taxes
 Inflation and deflation
Course Outline | Text Book & Objectives

 Text:
Newnan, Donald G., Eschenbach, Ted G., and Lavelle, Jerome P. (2004).
Engineering Economic Analysis, Ninth Edition, Oxford University Press, New
York, Oxford, 2004.
Newnan, Donald G. and Wheeler, Ed. Study Guide for Engineering Economic
Analysis, Ninth Edition, Oxford University Press, New York, Oxford, 2004.
 Course Description:
This course deals with economic analysis of engineering, in
particular, with the evaluation of projects in terms of time, costs and
worth. Topics include interest rates, time value of money, present
and future worth, economic evaluation of alternative decisions,
replacement analysis, inflation, taxes, and economic justification of
new technologies.
Introduction:
Definition of Engineering
Engineering is the profession in which knowledge
(math and natural sciences gained by study,
experience and practice) is applied with judgment
to develop ways to utilize, economically, the
materials and forces of nature for the benefit of
mankind.
Ingenieering economy
Introduction
 We can locate Engineering Economics among several related
disciplines. Firstly, it is needed to complete engineering itself; without an
economic background, most engineering problems are trivial.
 For example, the problem of air pollution could easily be solved by

giving everyone an electric car.
 It is only when we add the economic constraint that electric cars are
too expensive for most people that the real engineering begins.
Introduction:
Definition of Engineering
Engineering is the profession in which knowledge
(math and natural sciences gained by study,
experience and practice) is applied with judgment
to develop ways to utilize, economically, the
materials and forces of nature for the benefit of
mankind.
which is the economic engineering ?

Some definitions
 It deals with the concepts and techniques of analysis
useful in evaluating the worth of systems, products, and
services in relation to their costs
 Engineering economy is involved with the formulation,
estimation, and evaluation of economic outcomes when
alternatives to accomplish a defined purpose are
available.
 Engineering economy is involved with the application of
defined mathematical relationships that aid in the
comparison of economic alternatives
Sample questions
• Knowledge of Engineering Economy will have a significant
impact on you, personally.
– Make proper economic comparisons • In your every day life
(personal)
– To purchase or to lease a car
– What type of car to buy
– Should you invest in the stock market or pay your credit cards-
– Should you buy or rent a house
– What are graduate studies worth financially over my
professional career? • In your profession (Engineering and
Business decisions)
Sample questions continue

– What is the expected profit of a particular investment? –
Should you pursue a particular risky business venture or
invest your money in a money market account
– What type of process should you use
– When should you replace a particular machine?
– Should you buy or produce a particular sub-assembly?
Why Engineering Economy is Important to

Engineers
 Engineers design and create
 Designing 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
 A proper economic analysis for selection and
execution is a fundamental task of engineering
Chapter 1
Engineering Economic Decisions
 Rational Decision-
making Process
 The Engineer’s Role in
Business
 Types of Strategic
Engineering Economic
Decisions
 Fundamental Principles in
Engineering Economics
Bose Corporation
Engineering Economics
Overview
• Rational Decision-Making Process
• Economic Decisions
• Predicting Future
• Role of Engineers in Business
• Large-scale engineering projects
• Types of strategic engineering economic
decisions
Rational Decision-Making Process

1. Recognize a decision problem
2. Define the goals or objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision criterion to
use
6. Select the best alternative
Which Car to Lease?

Saturn vs. Honda
1. Recognize a decision problem  Need a car
2. Define the goals or objectives
3. Collect all the relevant  Want mechanical security
information  Gather technical as well as
4. Identify a set of feasible financial data
decision alternatives  Choose between Saturn
5. Select the decision criterion to and Honda
use  Want minimum total cash
6. Select the best alternative outlay
 Select Honda
Engineering Economic Decisions

Manufacturing Profit
Planning Investment
Marketing
Predicting the Future
 Estimating a Required
investment
 Forecasting a product
demand
 Estimating a selling price
 Estimating a
manufacturing cost
 Estimating a product life
Role of Engineers in Business

Create & Design
• Engineering Projects
Analyze Evaluate Evaluate
• Production Methods • Expected • Impact on

• Engineering Safety Profitability Financial Statements
• Environmental Impacts • Timing of • Firm’s Market Value
• Market Assessment Cash Flows • Stock Price
• Degree of
Financial Risk
Accounting Vs. Engineering Ecom.
Evaluating past performance Evaluating and predicting future events
Accounting Engineering Economy

Past Future
Present
Two Factors in Engineering Economic

Decisions
The factors of time and uncertainty

are the defining aspects of any
engineering economic decisions
A Large-Scale Engineering Project
 Requires a large sum of

investment
 Takes a long time to see
the financial outcomes
 Difficult to predict the
revenue and cost streams
(Remember Cash flow discussed
earlier)
Types of Strategic Engineering

Economic Decisions in Manufacturing
Sector
Service Improvement
Equipment and Process Selection
Equipment Replacement
New Product and Product Expansion
Cost Reduction
Service Improvement
 How many more jeans would Levi need to sell to justify
the cost of additional robotic tailors?
Equipment & Process Selection

How do you choose between the Plastic SMC
and the Steel sheet stock for an auto body
panel?
The choice of material will dictate the
manufacturing process for an automotive
body panel as well as manufacturing costs.
Equipment Replacement Problem
 Now is the time to replace

the old machine?
 If not, when is the right
time to replace the old
equipment?
New Product and Product Expansion
 Shall we build or acquire a

new facility to meet the
increased demand?
 Is it worth spending
money to market a new
product?
Example - MACH 3 Project

 R&D investment: $750 million
 Product promotion through
advertising: $300 million
 Priced to sell at 35% higher than
Sensor Excel (about $1.50 extra Gillette’s MACH3
per shave). Project
 Question 1: Would consumers
pay $1.50 extra for a shave with
greater smoothness and less
irritation?
 Question 2: What would happen
if the blade consumption
dropped more than 10% due to
the longer blade life of the new
razor?
Cost Reduction
 Should a company buy

equipment to perform an
operation now done
manually?
 Should spend money now
in order to save more
money later?
Types of Strategic Engineering Economic

Decisions in Service Sector
 Commercial Transportation
 Logistics and Distribution
 Healthcare Industry
 Electronic Markets and Auctions
 Financial Engineering
 Retails
 Hospitality and Entertainment
 Customer Service and Maintenance
U.S. Gross Domestic Products (GDP)

Manufacturing
(14%)
Service sector
(80%)
Healthcare (14%)
Agriculture (2%)
Industrial Employment
Industry 1993 1983-94 1994-2005
Employment National Projected
distribution Average Change
Manufacturing 12.6% -0.70% -7.2%
Services 30.5% 60.0% 39.0%
Retail trade 16.7% 31.1% 13.0%
Financial 8.0% 26.8% 6.3%
Source: Bureau of Economic Analysis/Bureau of Labor Statistics

Example - Healthcare Delivery

Which plan is more
economically viable?
 Traditional Plan: Patients

visit each service
provider.
 New Plan: Each service

provider visits patients
: patient
: service provider
Fundamental Principles of Engineering

Economics
Principle 1: A nearby dollar is worth more than
a distant dollar
Principle 2: All it counts is the differences
among alternatives
Principle 3: Marginal revenue must exceed
marginal cost
Principle 4: Additional risk is not taken
without the expected additional return
Principle 1: A nearby dollar is worth
more than a distant dollar
Today 6-month later
Principle 2: All it counts is the differences

among alternatives
Option Monthly Monthly Cash Monthly Salvage
Fuel Maintena outlay at payment Value at
Cost nce signing end of
year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant items in decision making
Principle 3: Marginal revenue must

exceed marginal cost
Marginal
cost
Manufacturing cost 1 unit
Marginal
Sales revenue 1 unit revenue
Principle 4: Additional risk is not taken

without the expected additional return
Investment Class Potential Expected

Risk Return
Savings account Low/None 1.5%

(cash)
Bond (debt) Moderate 4.8%

Stock (equity) High 11.5%
Summary
The term engineering economic decision
refers to all investment decisions relating to
engineering projects.
The five main types of engineering economic
decisions are (1) service improvement, (2)
equipment and process selection, (3)
equipment replacement, (4) new product and
product expansion, and (5) cost reduction.
The factors of time and uncertainty are the
defining aspects of any investment project.
Time Value of Money (TVM)

Description: TVM explains the change in the
amount of money over time for funds owed by
or owned by a corporation (or individual)
 Corporate investments are expected to earn a return

 Investment involves money
 Money has a ‘time value’
The time value of money is the most

important concept in engineering
economy
Engineering Economy
 Engineering Economy involves
 Formulating
 Estimating, and
 Evaluating
expected economic outcomes of alternatives
designed to accomplish a defined purpose
 Easy-to-use math techniques simplify the
evaluation
 Estimates of economic outcomes can be
deterministic or stochastic in nature
General Steps for Decision Making Processes
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 and monitor
results
Ethics – Different Levels

 Universal morals or ethics – Fundamental
beliefs: stealing, lying, harming or murdering
another are wrong
Personal morals or ethics – Beliefs that an
individual has and maintains over time; how a
universal moral is interpreted and used by
each person
 Professional or engineering ethics – Formal
standard or code that guides a person in work
activities and decision making
Code of Ethics for Engineers

All disciplines have a formal code of ethics. National Society of
Professional Engineers (NSPE) maintains a code specifically for
engineers; many engineering professional societies have their own code
Interest and Interest Rate

 Interest – 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
Types of Interest
Simple Interest
I = Pni
where:
P = principal $1,000
i = interest rate 0.12
n = number of years or periods 1
I= interest $120.00
Interest = amount owed now – principal
Interest = $1120 - $1000 =120
• Interest is due at the end of the time period. For

fractions of a time period, multiply the interest by
the fraction
Types of Interest
Compound Interest
The interest of the interest.

– A loan of $1,000 is made at an interest of 12% for 5
years. The interest is due at the end of each year
with the principal is due at the end of the fifth year.
The following table shows the resulting payment
schedule:
Cash flow of an loan
i =interest rate 12%

n=number of period 5
P=amount of money $ 1,000.00
Year Amount at start of year Interest at year end Owed amount at year end Paymet
1 $ 1,000.00 $ 120.00 $ 1,120.00 $ 1,120.00
2 $ 1,120.00 $ 134.40 $ 1,254.40 $ 1,254.40
3 $ 1,254.40 $ 150.53 $ 1,404.93 $ 1,404.93
4 $ 1,404.93 $ 168.59 $ 1,573.52 $ 1,573.52
5 $ 1,573.52 $ 188.82 $ 1,762.34 $ 1,762.34
Interest - Lending
• You borrow money (renting someone else's money)
• The lender expects a return on the money lent
• The return is measured by application of an interest
rate
•Example
• You borrow $10,000 for one full year

• Must pay back $10,700 at the end of one year
• Interest Amount (I) = $10,700 - $10,000
• Interest Amount = $700 for the year
• Interest rate (i) = 700/$10,000 = 7%/Yr Ingenieering economy
Rate of Return
 Interest earned over a period of time is expressed as a

percentage of the original amount (principal)
interest accrued per time unit
Rate of return (%) = x 100%
original amount
 Borrower’s perspective – interest rate paid

 Lender’s or investor’s perspective – rate of return earned
Interest paid Interest earned
Interest rate Rate of return

Commonly used Symbols

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 (usually
in years)
i = interest rate or rate of return per time period;
percent per year or month (usually one year)
Cash Flows: Terms

 Cash Inflows – Revenues (R), receipts,
incomes, savings generated by projects and
activities that flow in. Plus sign used
 Cash Outflows – Disbursements (D), costs,
expenses, taxes caused by projects and
activities that flow out. Minus sign used
 Net Cash Flow (NCF) for each time period:
NCF = cash inflows – cash outflows = R – D
 End-of-period assumption:
Funds flow at the end of a given interest period
Cash Flows: Estimating

 Point estimate – A single-value estimate of a
cash flow element of an alternative
Cash inflow: Income = $150,000 per month
 Range estimate – Min and max values that

estimate the cash flow
Cash outflow: Cost is between $2.5 M and $3.2 M
Point estimates are commonly used; however, range estimates
with probabilities attached provide a better understanding of
variability of economic parameters used to make decisions
Cash
What a typical cashFlow Diagrams
flow diagram might look like
Draw a time line Always assume end-of-period cash flows
Time
0 1 2 … … … n-1 n
One time
period
F = $100
Show the cash flows (to approximate scale)
0 1 2 … … … n-1 n
Cash flows are shown as directed arrows: + (up) for inflow
P = $-80
- (down) for outflow
Cash Flow Diagram Example

Plot observed cash flows over last 8 years and estimated sale next
year for $150. Show present worth (P) arrow at present time, t = 0
Economic Equivalence
Definition: Combination of interest rate (rate of
return) and time value of money to determine
different amounts of money at different points
in time that are economically equivalent
How it works: Use rate i and time t in upcoming

relations to move money (values of P, F and A)
between time points t = 0, 1, …, n to make
them equivalent (not equal) at the rate i
Example of Equivalence
Different sums of money at different times may
be equal in economic value at a given rate
$110
Year
0 1
Rate of return = 10% per year
$100 now
$100 now is economically equivalent to $110 one year from

now, if the $100 is invested at a rate of 10% per year.
Simple and Compound Interest
 Simple Interest
Interest is calculated using principal only
Interest = (principal)(number of periods)(interest rate)
I = Pni
Example: $100,000 lent for 3 years at simple i = 10%

per year. What is repayment after 3 years?
Interest = 100,000(3)(0.10) = $30,000
Total due = 100,000 + 30,000 = $130,000
Simple and Compound Interest

 Compound Interest
Interest is based on principal plus all accrued interest
That is, interest compounds over time
Interest = (principal + all accrued interest) (interest rate)
Interest for time period t is
Compound Interest Example

Example: $100,000 lent for 3 years at i = 10% per
year compounded. What is repayment after 3
years?
Interest, year 1: I1 = 100,000(0.10) = $10,000
Total due, year 1: T1 = 100,000 + 10,000 = $110,000
Interest, year 2: I2 = 110,000(0.10) = $11,000
Total due, year 2: T2 = 110,000 + 11,000 = $121,000
Interest, year 3: I3 = 121,000(0.10) = $12,100
Total due, year 3: T3 = 121,000 + 12,100 = $133,100
Compounded: $133,100 Simple: $130,000
Minimum Attractive Rate of Return

 MARR is a reasonable rate
of return (percent)
established for evaluating
and selecting alternatives
 An investment is justified
economically if it is
expected to return at least
the MARR
 Also termed hurdle rate,
benchmark rate and cutoff
rate
MARR Characteristics
 MARR is established by the financial
managers of the firm
 MARR is fundamentally connected to the cost
of capital
 Both types of capital financing are used to
determine the weighted average cost of capital
(WACC) and the MARR
 MARR usually considers the risk inherent to a
project
Types of Financing
 Equity Financing –Funds either from retained

earnings, new stock issues, or owner’s
infusion of money.
 Debt Financing –Borrowed funds from outside
sources – loans, bonds, mortgages, venture
capital pools, etc. Interest is paid to the lender
on these funds
For an economically justified project
ROR ≥ MARR > WACC
Opportunity Cost
 Definition: Largest rate of return of all projects not
accepted (forgone) due to a lack of capital funds
 If no MARR is set, the ROR of the first project not undertaken
establishes the opportunity cost
Example: Assume MARR = 10%. Project A, not

funded due to lack of funds, is projected to
have RORA = 13%. Project B has RORB = 15%
and is funded because it costs less than A
Opportunity cost is 13%, i.e., the opportunity to
make an additional 13% is forgone by not
funding project A
Introduction to Spreadsheet Functions

Excel financial functions
Present Value, P: = PV(i%,n,A,F)
Future Value, F: = FV(i%,n,A,P)
Equal, periodic value, A: = PMT(i%,n,P,F)
Number of periods, n: = NPER((i%,A,P,F)
Compound interest rate, i: = RATE(n,A,P,F)
Compound interest rate, i: = IRR(first_cell:last_cell)
Present value, any series, P: = NPV(i%,second_cell:last_cell) + first_cell
Example: Estimates are P = $5000 n = 5 years i = 5% per year

Find A in $ per year
Function and display: = PMT(5%, 5, 5000) displays A = $1154.87
Chapter Summary
 Engineering Economy fundamentals
 Time value of money
 Economic equivalence
 Introduction to capital funding and MARR
 Spreadsheet functions
 Interest rate and rate of return
 Simple and compound interest
 Cash flow estimation

 Cash flow diagrams
 End-of-period assumption
 Net cash flow
 Perspectives taken for cash flow estimation
 Ethics
 Universal morals and personal morals
 Professional and engineering ethics (Code of Ethics)
Engineering Economy
Chapter 4: The Time Value of Money

The objective of Chapter 4 is to

explain time value of money
calculations and to illustrate
economic equivalence.
Money has a time value.

Capital refers to wealth in the form of money
or property that can be used to produce more
wealth.
Engineering economy studies involve the
commitment of capital for extended periods of
time.
A dollar today is worth more than a dollar one
or more years from now (for several reasons).
Return to capital in the form of interest and

profit is an essential ingredient of
engineering economy studies.
Interest and profit pay the providers of capital for
forgoing its use during the time the capital is being
used.
Interest and profit are payments for the risk the
investor takes in letting another use his or her
capital.
Any project or venture must provide a sufficient
return to be financially attractive to the suppliers of
money or property.
Simple Interest: infrequently used
When the total interest earned or charged is linearly

proportional to the initial amount of the loan
(principal), the interest rate, and the number of
interest periods, the interest and interest rate are said
to be simple.
Computation of simple interest

The total interest, I, earned or paid may be computed
using the formula below.
P = principal amount lent or borrowed

N = number of interest periods (e.g., years)
i = interest rate per interest period
The total amount repaid at the end of N interest
periods is P + I.
If $5,000 were loaned for five years at a

simple interest rate of 7% per year, the
interest earned would be
So, the total amount repaid at the end

of five years would be the original
amount ($5,000) plus the interest
($1,750), or $6,750.
Compound interest reflects both the remaining principal

and any accumulated interest. For $1,000 at 10%…
(1) (2)=(1)x10% (3)=(1)+(2)

Amount owed Interest Amount owed
at beginning of amount for at end of
Period period period period
1 $1,000 $100 $1,100
2 $1,100 $110 $1,210

3 $1,210 $121 $1,331
Compound interest is commonly used in personal and

professional financial transactions.
Economic equivalence allows us to

compare alternatives on a common basis.
Each alternative can be reduced to an
equivalent basis dependent on
 interest rate,
 amount of money involved, and
 timing of monetary receipts or expenses.
Using these elements we can “move” cash
flows so that we can compare them at
particular points in time.
We need some tools to find economic

equivalence.
Notation used in formulas for compound interest
calculations.
 i = effective interest rate per interest period
 N = number of compounding (interest) periods
 P = present sum of money; equivalent value of one or
more cash flows at a reference point in time; the present
 F = future sum of money; equivalent value of one or
more cash flows at a reference point in time; the future
 A = end-of-period cash flows in a uniform series
continuing for a certain number of periods, starting at
the end of the first period and continuing through the
last
A cash flow diagram is an indispensable

tool for clarifying and visualizing a series
of cash flows.
Cash flow tables are essential to modeling

engineering economy problems in a
spreadsheet
We can apply compound interest formulas
to “move” cash flows along the cash flow

diagram.
Using the standard notation, we find that a

present amount, P, can grow into a future
amount, F, in N time periods at interest rate
i according to the formula below.
In a similar way we can find P given F by
It is common to use standard notation for

interest factors.
This is also known as the single payment

compound amount factor. The term on the
right is read “F given P at i% interest per
period for N interest periods.”
is called the single payment present worth

factor.
We can use these to find economically

equivalent values at different points in time.
$2,500 at time zero is equivalent to how much after six
years if the interest rate is 8% per year?
$3,000 at the end of year seven is equivalent to how

much today (time zero) if the interest rate is 6% per
year?
There are interest factors for a series of

end-of-period cash flows.
How much will you have in 40 years if you

save $3,000 each year and your account
earns 8% interest each year?
Finding the present amount from a series

of end-of-period cash flows.
How much would is needed today to provide

an annual amount of $50,000 each year for 20
years, at 9% interest each year?
Finding A when given F.
How much would you need to set aside each

year for 25 years, at 10% interest, to have
accumulated $1,000,000 at the end of the 25
years?
Finding A when given P.
If you had $500,000 today in an account

earning 10% each year, how much could you
withdraw each year for 25 years?
It can be challenging to solve for N or i.
We may know P, A, and i and want to find N.

We may know P, A, and N and want to find i.
These problems present special challenges
that are best handled on a spreadsheet.
Finding N
Acme borrowed $100,000 from a local bank, which
charges them an interest rate of 7% per year. If Acme
pays the bank $8,000 per year, now many years will it
take to pay off the loan?
So,
This can be solved by using the interest tables and

interpolation, but we generally resort to a computer
solution.
Finding i
Jill invested $1,000 each year for five years in a local
company and sold her interest after five years for
$8,000. What annual rate of return did Jill earn?
So,
Again, this can be solved using the interest tables

and interpolation, but we generally resort to a
computer solution.
There are specific spreadsheet functions

to find N and i.
The Excel function used to solve for N is
NPER(rate, pmt, pv), which will compute the
number of payments of magnitude pmt required to
pay off a present amount (pv) at a fixed interest
rate (rate).
One Excel function used to solve for i is
RATE(nper, pmt, pv, fv), which returns a fixed
interest rate for an annuity of pmt that lasts for nper
periods to either its present value (pv) or future value
(fv).
We need to be able to handle cash

flows that do not occur until some
time in the future.
Deferred annuities are uniform series that do
not begin until some time in the future.
If the annuity is deferred J periods then the
first payment (cash flow) begins at the end of
period J+1.
Finding the value at time 0 of a

deferred annuity is a two-step
process.
1. Use (P/A, i%, N-J) find the value of the
deferred annuity at the end of period J
(where there are N-J cash flows in the
annuity).
2. Use (P/F, i%, J) to find the value of the
deferred annuity at time zero.
Sometimes cash flows change by a

constant amount each period.
We can model these situations as a uniform
gradient of cash flows. The table below shows
such a gradient.
End of Period Cash Flows
1 0
2 G
3 2G
: :
N (N-1)G
It is easy to find the present value of a

uniform gradient series.
Similar to the other types of cash flows, there is a

formula (albeit quite complicated) we can use to find
the present value, and a set of factors developed for
interest tables.
We can also find A or F equivalent to

a uniform gradient series.
The annual equivalent of End of Year Cash Flows ($)

this series of cash flows can 1 2,000
be found by considering an
2 3,000
annuity portion of the cash
flows and a gradient 3 4,000
portion. 4 5,000
End of Year Annuity ($) Gradient ($)
1 2,000 0
2 2,000 1,000
3 2,000 2,000
4 2,000 3,000
Sometimes cash flows change by a

constant rate, ,each period--this is a
geometric gradient series.
This table presents a End of Year Cash Flows ($)

geometric gradient series. It
1 1,000
begins at the end of year 1
and has a rate of growth, , 2 1,200
of 20%. 3 1,440
4 1,728
We can find the present value of a

geometric series by using the appropriate
formula below.
Where is the initial cash flow in the series.

When interest rates vary with time

different procedures are necessary.
Interest rates often change with time (e.g., a

variable rate mortgage).
We often must resort to moving cash flows
one period at a time, reflecting the interest rate
for that single period.
The present equivalent of a cash flow occurring at

the end of period N can be computed with the
equation below, where ik is the interest rate for the
kth period.
If F4 = $2,500 and i1=8%, i2=10%, and i3=11%, then
Nominal and effective interest rates.

More often than not, the time between successive
compounding, or the interest period, is less than
one year (e.g., daily, monthly, quarterly).
The annual rate is known as a nominal rate.
A nominal rate of 12%, compounded monthly,
means an interest of 1% (12%/12) would accrue
each month, and the annual rate would be
effectively somewhat greater than 12%.
The more frequent the compounding the greater the
effective interest.
The effect of more frequent

compounding can be easily
determined.
Let r be the nominal, annual interest rate and M the
number of compounding periods per year. We can
find, i, the effective interest by using the formula
below.
Finding effective interest rates.
For an 18% nominal rate, compounded quarterly, the

effective interest is.
For a 7% nominal rate, compounded monthly, the

effective interest is.
Interest can be compounded

continuously.
Interest is typically compounded at the end of
discrete periods.
In most companies cash is always flowing,
and should be immediately put to use.
We can allow compounding to occur
continuously throughout the period.
The effect of this compared to discrete
compounding is small in most cases.
We can use the effective interest

formula to derive the interest factors.
As the number of compounding periods gets

larger (M gets larger), we find that
Continuous compounding interest

factors.
The other factors can be found from these.


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University of Coahuila

Engineering Economy course

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Tentative Course Outline

Course Outline | Text Book & Objectives

 For example, the problem of air pollution could easily be solved by

which is the economic engineering ?

Sample questions continue

Why Engineering Economy is Important to

Rational Decision-Making Process

Which Car to Lease?

Engineering Economic Decisions

Predicting the Future

Role of Engineers in Business

Analyze Evaluate Evaluate

• Production Methods • Expected • Impact on

Accounting Vs. Engineering Ecom.

Evaluating past performance Evaluating and predicting future events

Accounting Engineering Economy

Two Factors in Engineering Economic

The factors of time and uncertainty

A Large-Scale Engineering Project

 Requires a large sum of

Types of Strategic Engineering

Equipment & Process Selection

Equipment Replacement Problem

 Now is the time to replace

New Product and Product Expansion

 Shall we build or acquire a

Example - MACH 3 Project

 Should a company buy

Types of Strategic Engineering Economic

U.S. Gross Domestic Products (GDP)

Services 30.5% 60.0% 39.0%

Retail trade 16.7% 31.1% 13.0%

Financial 8.0% 26.8% 6.3%

Source: Bureau of Economic Analysis/Bureau of Labor Statistics

Example - Healthcare Delivery

 Traditional Plan: Patients

 New Plan: Each service

Fundamental Principles of Engineering

more than a distant dollar

Today 6-month later

Principle 2: All it counts is the differences

Buy $960 $550 $6,500 $350 $9,000

Lease $960 $550 $2,400 $550 0

Irrelevant items in decision making

Principle 3: Marginal revenue must

Manufacturing cost 1 unit

Principle 4: Additional risk is not taken

Investment Class Potential Expected

Savings account Low/None 1.5%

Bond (debt) Moderate 4.8%

Time Value of Money (TVM)

 Corporate investments are expected to earn a return

The time value of money is the most

General Steps for Decision Making Processes

1. Understand the problem – define objectives

Ethics – Different Levels

Code of Ethics for Engineers

Interest and Interest Rate

 Interest = amount owed now – principal

 Interest rate – Interest paid over a time period expressed

Interest = $1120 - $1000 =120