UNIVERSITY OF CENTRAL FLORIDA CECE DEPARTMENT F.E. REVIEW COURSE “ENGINEERING ECONOMICS” REVIEW OUTLI DOUT PROF. BENJAMIN M. FRIESwromo=v avy jompes (io 9 = 4 o/4 uni0% eee umn ee wrede=d 9/d om quosoid Wr Wwasy a/¥ puns Bupuis 1 o lwiway=4 sh . Wa qunowy bode) punodwos ties aa wojun «a [wrawa=v bere 3 d/v || Aierosey i trey tan rede view ct b | | | WI WAY = Abe bie ie Wd yom vv ye bedte py) * 1 wad qwoseid « |@rwadasa w(Pe bh) = WY did) did aon | oe quowked ‘ ° e16u1s add = 4 dpe b) = (tats) d/4 qunowy ! punodwog eco SNIGNNOdWOD GOldad-40-GN3 HLIM SMO14 HSWD 3L3u9SIG YO4 SNOILW1SYcr CECE SECTION 1 GENERAL ‘A. CASH FLOW DIAGRAMS 1. Conventions a. The x-axis is marked offin ijl increments, one per period, up tothe duration or horizon of the Project. Year years b. Alldisbursement and receipts (__(Mo/1_ 0/4 _ ) are assumed to take place at the tid ofthe yearin which they occur year-end” convention). The exception is for any intial (purchase) cost which occurs at time t= 0 ash flow, cc. Twoormore monetary (cash) transfers in the same year are placed end-to-end, and these may be__ emi 4X % Expenses incurred before t= 0 are called * uN, Werke _*. Sunk costs are not relevant to the problem. €. Receipts are represented by arrows directed _uy wal Disbursements are represented by arrows directed nwa aval “The arrow length is proportional to the magnitude of the cash flow. 1. EXAMPLE PROBLEM ‘A mechanical device will cost $20,000 when purchased. Maintenance will cost $1,000 per year. The device will generate $5,000 each year for five (5) years after which the salvage value is expected to be $7,000. Draw the cash flow diagram and then simpli. eee Engineering EconomiesCr CECE Course 4 1K sx 48K 45K sk [aK Initial Cash Flow 20K ae aK yak aK Simplified Cash Flow Diagram mK EQUIVALENCE 4. Decision makers using engineering economics are concerned with the uli of a Project's cash flows and the total proftabilty of the Project. 2. Single Payment Factors (F/P and P/F) @. Future Worth (F/P) - Single Payment Compound Amount 1). Determination of the amount of money, F. after n years (oF periods) from a single present worth, P, with terest () compounded one time per year (or period). 2) F = P(1#i)" = P(FIP,i,n) d. Present Worth (P/F) - Single Payment Present Worth 1) The present worth, P, of a given__ {Huy amount, F, after n years at interest rate, /. 2) P = F(1+i)* = F(PIF,in) 3. Uniform Series Factors a. Present Worth _(P/A| 4) Determines the dguivalun Present Worth, P, of a uniform, equivalent series, A, of end-of-peried cash flows (Present worth in Year 0), 2 Fs Ramte pe - apiteirn ty ma+ey Engineering EconomiesUGE CECE - FE, Review Course 5 b. Capital Recovery (AIP) NIN) MAINE 1) Determines the equivalent, uniform series amount, A, given the _fyo/vit Wovta, ? (in Year 0). 2 a = priest 2A P (AIP, i,n) Cia! cc. Compound Amount (Fi 1) Determines the Future Worth, F, of unifonn, equivalent series, A, of end-of-period cash flows. 2) F = AQAA) po apisit=ty 7 d. Sinking Fund (AIF) & VOW WAM 1). Determines the uniform annual series, A, that is equivalent to a given future worth, F. 2) A = F(AIF,i,n) A « Fe (asiy 4 4. Unif thmetic Gradient ‘a. Uniform Arithmetic Gradient - P h (PIG) 4) Determines the equivalent Present Worth, P, in year 0, of an arithmetic gradient for n” years. = Gris, po opl(trit-t 9 sy 2) P (PIG, i, n) trast W477" pi ay 0g one Engineering EeonomiesUGE CECE - FE Review Course b. Uniform Arithmetic Gradient - Future Worth (F/G) 1) Determines the equivalent Future Worth, F, of an _avilliméti gradient, G, for "n" years. 2) F = G(FIG,/,n) Fo = @p terres _ 4) P ¢. Uniform Gradient - Uniform Series (Ai 1). Determines the equivalent, uniform annual series, A, for an arithmetic gradient for ‘n* years. 2) A = GIAIG,|,n) A- 6 How much should be put in an investment with a 10% effective annual rate today to have $10,000 in five (5) years? EXAMPLE PROBLEM Central Florida Moving and Storage wants to have enough money to purchase a new tractor-trailer in three (3) years. if the unit will cost $250,000, how much should the company set aside each year if the account eams 9% per year? soution: a = ¥(4tlr,ih)- FC Al AD oX6 0h) A= (24 Engineering EconomiesYor CECE C._NON-ANNUAL COMPOUNDING 1 An interest rate that is compounded more than “once" ina year is converted from the compound vewtivial rete toan annual __(LHAtVE rate as follows: 1 enced annual vate _) 2 (i) r- ravine red 11-4 oman pr vil | er ‘dda at After the interest rate is converted to an _ gyi be‘ problem ts Pee as any annual interest rate problem using the factor conversion formulas or the factor tables, ‘The interest rate must be in cussivy (not percentage) form. EXAMPLE PROBLEM Assavings and loan office offers @ 5.25% rate per annum compounded daily over 365 days per year. What is the effective annual rate? pe MON _ |= 0,064 36) D. COMPARISON OF ALTERNATIVES — eit Worth 4 Avil Werth ave react onmma | 1. Present Worth (PW) Method ‘a. When mutually exclusive altematives do the same job and have the _<.avil, lifetimes, compare them by converting each to its cash value today (PW). The *__out alternative will have the Lara Present Worth (PW) value b. EXAMPLE PROBLEM Investment °A" costs $10,000 today and pays back $11,500 two years from now. Investment “B" costs $10,000 today and pays back $5,500 each year for two years. If the interest rate is ‘5% for the comparison, which investment is superior? Investment “A” foe in) pw, = 10,000 + FFF, UM) 0.400 Pw, = ~(0)000 + (\\ 00 (el, 5,2) pe = Poh |S lnwehont 6 Anus hall be odietea ‘Engineering EconomiesUCE CECE - FE. Review Cours Investment “B” pw) = 10i000 + A (el4iin) oth pw, =~ 10,000 + 51500 (0/4, 2) pw, 4 fazr | 2. Annual Worth (AW) or Annual Cost Method a ‘The AW Method is used to evaluate alternatives that do the _ naa unre Apalyee 2) Brick Evaluation AWanex =P - ¢(A)P LM) 0.0806 AWencx =~ - 0d) | fa) 20) AWencx = | 3) Wood Evaluation AWtnoos = #0 (A]0, iN) 6.01226 . Woon = 20 - (19 #/P, 710) AWwcon *| AM > 4150, Anu» wed sould We alee Engineering EconomiesYor CECE 3. Capitalized Cost (CC) Method a, The Capitalized Cost (CC) Method is used to determine the present worth of an alternative that will ast* Cov eve * oris an *__wiyibiliy - iv * project (bridges, dams, railroads, etc.) that has repeating expenses each year. b. Compare alternatives by calculating the capitalized cost (Le., the amount of money needed to pay the __stay} - wp cost and to yield enough de to pay the anwual opin ting exc without touching the principle). The factor conversion for a project with no end is the limit of the P/A factor as the number of Periods, n, goes to infinity: i the nee ~ d. EXAMPLE PROBLEM What is the capitalized cost of @ public works project that will cost $25,000,000. now and will require $2,000,000 in maintenance annually? The effective interest rate is 12%. peo) Capitalized Cost = ~27,, 000,000 - 2,600,000 (e/a 1%) r Capitalized Cost = -241000,000 ~ 2,000,000 (aia, Capitalized Cost 4, Benefit-Cost Analysis 2. Used in municipal Juliet ——_—_) project evaluations where benefits and costs accrue td different segments of the communit b, The BIC Is calculated in one of the following manners: PW of Benefits AW of Benefits FW of Benefits Be ee = PWof Costs AW of Costs FWof Costs pict = B-C Tngineering EconomiesUCE CECE - FE Review Course 20 ©. Decision Guidelines Sy S ‘Accept the Project 2s “economically’, acceptable for the estimates = =O and discount rate applied L\0 40 The Projectis “not economically’ acceptable = d. EXAMPLE PROBLEM The initial cost of a proposed project is $40,000,000, the capitalized annual costis $12,000,000, the capitalized benefit is $49,000,000, and the residual value is $0. Should the project be undertaken? Benefit (B) = 44,000,000 Gost (c) = 412, 000, 000 + 12,000 1000 = 5% 000, CO Thus, B.-G = 44,000/000 ~7000, 000= ~%000, 000 Since _b-b 4 0 «the project __)uilld NOT be undertaken 5. Rate of Return (ROR) Method 2, The interest rate that will discount all cash flows to @ total _YiA) equal to the initial required pwabiauat The advantage of the ROR Method is that no knowledge of the interest rate is required. b. Procedure 1) Set up the problem as if you were calculating the _P V\) 2) Arbitrarily select a reasonable value for “_i_*. Calculate the PW. 3) Choose another value of (not too close to the original value) and again solve for the PW. 4) Continue iterating until you find the interest rate, i, that yields a_i) pf 2ayo c. EXAMPLE PROBLEM The HVAC Engineer for a company constructing one of the world’s tallest buildings has requested that $500,000 be spent now during construction on software and hardware to improve the efficiency of the environmental control systems. This is expected to save $10,000 per year for 10 years in eneray costs and $700,000 at the end of 10 years in equioment refurbishment costs. Find the Rate of Retum (ROR). Engineering EconomicsUCE CECE - FE. Roviow Course un 1) Step 4:_Draw th Fl am 2) Step 2:_ Write a PW Equation based on the Cash Flow Diagram = = 00,000 + 10,000 (e/a 0,10) + 200/000 (r,t) 1d) 3) Step 3: Assume an interest rate that will equate the RHS and LHS of the equation 5% aa Pr) 7 3.308 0+ ~ 660,000 + to,e00(wfird,id)* 200:t00 (VIF 15,10) yoortve => Rok= hight Wai 6 Ye | 4) Step 4:_ Assume er inter that will equate the RHS and LHS of the equation a) Assume an interest rate of | % Tp 0~-A00,060 + 10,000 (+] 41 "b118) + 00, 000 (Plt 10) 5) Fngineering EconomicsUCE CECE - FE. Review Course 2 6 Break-Even Analysis a. This type of analysis is used to calculate when the revenue is to the cost, or when one alternative is equal to another if both depend on the same aviable b. Methodology 1) Derive *__indepuadint equations for both alternatives with respect to the common variable, 2). Setting both equations equal to ont autor yields the value of the common variable. c. EXAMPLE PROBLEM How many kilometers must be driven per year for easing and buying a carto cost the same using an interest rate of 10%, a year end cost convention and the following data? @ Leasing Costs: $0.19/m @ Purchasing Costs: $6,000 purchase cost $1,000 salvage value Syear life $0.07/Km operating costs 1) Derive Equations for both Alternatives @) Leasing Costs = -019x b) Purchasing Costs o2to2il 6.702. ~ =.09% - yoo (|, 10,3) +1060 (alr 10,3) = 0.04 - 20.55 ©) Eauate the two equations wk puma ve. 8% 7 WA > tured = = 20 = 0.18 = —0.09% = 2 oe X= 587.4 [ Pree 0.95 ‘Engineering EconomicsUCE CECE - FE. Roview Course 43 E. DEPRECIATION 1. Straight-Line Depreciation a. The depreciation per year is equal to the cost minus the _ FirstYear =~ (ps1 Y4000)= #200 ‘Second Year (4.18 (4000-4 20 Pio Third Year (6 vay (aod 4, Book Value a. The Book Value (BV) is equal to the assumed value of the asset after ‘J years. The initial cost minus the sum of the ol pv ot WV ‘out to the j* year. ev = intial Ww - 2D) i i a rem Engineering EconomiesUCE CECE “4 b. EXAMPLE PROBLEM What is the value of the asset in the previous example problem after 3 years using the straight- line depreciation method and the ACRS depreciation method? Straiah YK Bv= 1000 - »(480)= 4246 ACRS Depreciation Book Vawe (vit vitl*10) 4000 - (400+ (420% \24b) = 44 F. INFLATION 4, To account for the effects of inflation, one must replace the _I 4d interest rate, “with the inflation-adjusted interest rate, i,. The infiation-adjusted interest rate is calculated as follows: [+44 (ie) i = “inflation-free" or “real” interest rate (decimal) f= inflation rate (decimal) yume: ( eft} gam G. MISCELLANEOUS EXAMPLE PROBLEMS 1. Iteosts $1,000 for hand tools and $1.50 labor per unit to manufacture a product. Another alternative iso manufacture the product by an automated process that costs $15,000, with a $0.50 per unit cost With an annual production rate of 6,000 units, how long wil it take to reach the break-even point? (2) 20 years (b) 2.8 yoars (0) 3.6 years (d) never 1) Derive Equations for both Alternatives 2) Alternative No 1: Hand Tools > -1005 - \.60x Englnearing EconorUCE CECE - FE Roview Course 5 b) Altemative No. 2: Automated Process = 15,000 - 0.5% ©) Equate the two cumulative cost equations and solve for "x" 1000 - 15x = 19000 -0.5x wH000 = x d) Time required to reach the break-even point pH 000 unite 2. What is the uninflated present worth of $2,000 in 2 years if the average inflation rate is 6% and the interest rate is 10%? 1 = (oa)s (.0d)+ (le) = Oley (ir 4.tuey 3. Itecosts $75 per year to maintain a cemetery plot. Ifthe interest rate is 6.0%, how much must be set aside to pay for maintenance on each plot without touching the principle? (2) $1,150 (©) $1,200 O $1,250 (a) $1,300 p= Ae Arp Engineering Eeonones16 4. Alloan of $10,000 is made today at an interest rate of 15%, and the first payment of $3,000 is ‘made 4 years later. The amount that is stil due on the loan efter the first payment is most nearly (a) $7,000 (b) $8,050 (©) $8,500 @)s14.90 sew ob Laan in Year t= eaymndith in Yor + ‘Amount due in 4 years f \ ‘Amount due in 4 years 006 (#1? \9 yt) - 3,000 Amount due in 4 years = 9, 999 [ 1.444)= 3000 Amount due in 4 years = 32490 - 2,000 Amount due in 4 years = wg, 440 5. A machine is purchased for $1,000 and has a useful life of 12 years. At the end of the 12 years, the salvage value is $130. By straight-line depreciation, whatis the book value of the machine at the end of eight years? (2) $290 () $333 ())saz0 (@) $580 Straightline Depreciation = 2 1000 = "20 Ie Straightline Depreciation = 72,5 | year s) Book Value (BV) = inttigh- 2D) = 1,000 ~ + (42-5) oe | 4-420 | Book Value (BV) ‘Engineering EconomicsMachine “A Intias Cost, $ 15,000 (for st 15 years) ‘Annus Operation Cost, $ 18,000 20,000 forthe next 70 years) Salvage Valve, 3 Estimated Life, Yet From a purely economic standpoint, which machine should the company select ifthe interest rate is 10%? Annual We is - in AW, = -100,000(4]#,10,28) ~ 29000 20 . hh . wesunne 20k For untive lL t #1015 )aLe, io, 25) * 24 200 (7 Fy We apply ic ‘eel ao 26¢ conn vin or Kite fo Vlas AWa = —t,000(es62) 20,000 + 4000 (nou) (oii02)+ 2% 006 (0.002) 4 2, p_-Vr> pals AW, =\~ 4 24,97% P-7? Hue Machine & suid be lected Enginearing Eeonomies