THE INTERNATIONAL UNIVERSITY (IU) Course: Engineering Economy

Department of Industrial System Engineering

MIDTERM EXAMINATION

ENGINEERING ECONOMY Duration:

120 minutes
Head of Department of Industrial Lecturer: Student ID: Date:
& Systems Engineering March 21,
2013
Name:

Assoc Prof. Ho Thanh Phong Luu Van Thanh

INSTRUCTIONS:
1. This is an open book examination. No laptops, PDA.
2. Use of calculator is allowed; discussion and material transfer are strictly prohibited.
Total pages: 02 (including this page)

Question 1 (25p)
(a) (05p) Define uncertainty. What are some of the basic causes of uncertainty in engineering economy
studies.
Solution:
- (1p) Uncertainty refers to the variation of actual values that will occur in the future from the
estimated values developed at the time of the study associated with a project.
- (4p) Engineering economic analysis is prospective in that it deals with the analysis of the estimated
future consequences of alternative courses of action. Thus, uncertainty is inherently involved.
Some causes of uncertainty are:
 Rapid changes in the demand for products and services; inflation and price changes; changes in
technology; changes in regulatory requirements
 Competition in the world marketplace.
 Lack of an adequate costing base (data) for a new project.

(b) (05p) Mr. Abel, an operation manager classifies each of the following cost items as mostly fixed or
variable: raw material, direct labor, depreciation, factory overhead, insurance and clerical salaries
Solution:
Fixed Variable
Raw Materials X
Direct Labor X
Depreciation X X
Factory overhead X
Insurance X
Clerical Salaries X

(c) (10p) He collects some following information to analyze the current operation: The fixed cost is
$45,000 per month, and the variable cost is $56 per unit. The selling price per unit is p= $150 –

Midterm Exam 1
 THE INTERNATIONAL UNIVERSITY (IU) Course: Engineering Economy
Department of Industrial System Engineering

0.02D, where D represents demand in units sold per month. Maximum output of the plant is 4,000
units per month.
 Determine optimum demand for this product.
 What is the maximum profit per month?
 At what volumes do breakeven occur?
Solution:
(a) (2p) p = 150 - 0.02D; CF = $45,000; cv = $56/unit;
D* = (a-cv)/2b = 2,350 units/month
(b) (4p) Max. profit = Total Revenue - Total Cost = 150D - 0.02D2 - (45,000 + 56D) = $65,450
(c) (4p) Breakeven occurs when profit = 0 = -0.02D2 +94D - 45,000 = D2 - 4,700D + 2,250,000.
D’1= 541 units and D’2= 4,159 units

(d) (05p) Mr. Abel now wants to use learning curve to estimate important factor as unit selling price of a
new product. Pertinent data are as follows:
- Direct labor rate: $15.00 per hour.
- Raw material: $375 per 100 units.
- Factory overhead: 125% of direct labor.
- Packing costs: 75% of direct labor.
- Desired profit:20% of total manufacturing cost.
Past experience has shown that an 80% learning curve applies to the labor required for producing these
items. The time to complete the first item has been estimated to be 1.76 hours.
Use the estimated time to complete the 50th item as your standard time for the purpose of estimating the
unit selling price.
Solution:
(1p) The estimate of direct labor hours is based on the time to produce the 50th unit. K = 1.76
hours, s=0.8, n = (log 0.80)/(log 2) = -0.322, Z50 = 1.76(50)-0.322 = 0.5 hours
(4p) for this table:

Factory Labor = ($15/hr)(0.5 hr/unit) = $7.50 / unit

Production Material = $375 / 100 units = $3.75 / unit
Factory Overhead = (1.25)($7.50 / unit) = $9.375 / unit
Packing Costs = (0.75)($7.50 / unit) = $5.625 / unit
Total Manufacturing Cost = $26.25 / unit
Desired Profit = (0.20)($26.25 / unit) = $5.25 / unit
Unit Selling Price = $31.50 / unit

Question 2 (15p)
The following figures give two cash-flows. Determine the value of P0, as a function of H, for these two
investment alternatives to be equivalent at an interest rate of i=15% per year.

Midterm Exam 2
 THE INTERNATIONAL UNIVERSITY (IU) Course: Engineering Economy
Department of Industrial System Engineering

Solution:
(7p) Left side: PL = 10(P/F, 15%, 1) + H(P/A, 15%, 12) (P/F, 15%, 4) + 0.7H (P/A, 15%, 6) (P/F,
15%, 7) = −10 (0.8696) + H(5.4206) (0.5718) + 0.7H (3.7845) (0.3759) = 4.0953H – 8.696
(5p) Right side: PR = −P0 + 2P0 (P/F, 15%, 10) = −P0 + 2P0 (0.2472) = −0.5056 P0
(3p) Set PR = PL: −0.5056 P0 = 4.0953H – 8.696; P0 = 17.199 – 8.1H

Question 3 (20p)
A small company purchased now for $23,000 will lose $1,200 each year the first four years. An additional
$8,000 invested in the company during the fourth year will result in a profit of $5,500 each year from the
fifth year through the fifteenth year. At the end of 15 years, the company can be sold for $33,000. The
MARR = 12% per year.
a. Draw a cash-flow diagram.
b. Calculate the FW, should this deal be undertaken?
c. Calculate the ERR when ε = 12%.

Solution:
(a) (07p) $33,000

0 1 2 3 4 $5,500

5 15
$1,200
$8,000

$23,000

(b) (6p) FW (12%) = − 23,000(F/P,12%,15) − 1,200(F/A,12%,4)(F/P,12%,11) −

8,000(F/P,12%,11) + 5,500 (F/A,12%,11) + 33,000 = − 23,000(5.4736) − 1,200(4.7793)(3.4785) −
8,000(3.4785) + 5,500 (20.6546) + 33,000 = −$27,070.25
(c) (07p) [−23,000 − 1,200(P/A,12%,4) − 8,000(P/F,12%,4)] (F/P,i'%,15) = 5,500(F/A,12%,11)
+33,000.
[23,000 + 1,200(3.0373) + 8,000(0.6355)] (F/P,i'%,15) = 5,500(20.6546) + 33,000
31,728.76 (1 + i')15 = 146,600.30; i' = ERR = 0.1074 or 10.74%

Question 4 (20p)
The winner of a state lottery received $12,000,000 in 2000. He wanted to donate this prize to a relief
organization. In 2004, he made a one-time donation of $3,500,000 for facilities expense, and decided to
provide $260,000 at the end of each year forever for their operating expenses and $X for capital
replacements at the end of every fifth year forever. The first operating expense was in 2005, and the first
capital replacement expense is in 2009.
If all money earns interest at 5%, what amount X would be available for capital replacement? (Hint: draw
a cash-flow diagram first.)
Solution:
- (7p) Cash flow construction

Midterm Exam 3
 THE INTERNATIONAL UNIVERSITY (IU) Course: Engineering Economy
Department of Industrial System Engineering

$12,000,000

$260,000
$3,500,000

- (2p) Amount at 2004: $12,000,000(1.05)4 − $3,500,000 = $14,586,075 – $3,500,000 = $11,086,075

- (7p) The next cash flow diagram:

$ 11,086,075

$ 260,000

- (4p) 11,086,075=260,000(P/A,5%,∞) + X(A/F,5%,5)(P/A,5%,∞)=260,000 (20) + 0.181X (20);

X = $1,625,988 every 5 years

Question 5 (20p)
You are a facilities engineer and consider mobile cranes to be critical equipment. The purchase of a new
medium-sized, truck-mounted crane is being evaluated. The economic estimates for two best alternatives
are shown in the following table. You have selected the longest useful life (9 year) for the study period and
would lease a crane for the final three years under alternative A.
On the basis of previous experience, the estimated annual leasing cost at that time will be $62,000 per
year and plus the annual expenses of &29,000 per year. The MARR is 15% per year.
Use the incremental investment analysis procedure to make your best selection, please.

Alternatives
A B
Capital investment &266,000 $340,000
Annual expenses $28,500 $19,000
Useful life (years) 6 9
Market value $22,000 $36,000
Solution:
(8p) Alternative A is the base alternative because it requires the least capital investment.
Year  (B − A) cash flow
0 -$340,000 -(-$266,000) = -$74,000
1 − 5 -19,000 - (-$28,500) = $9,500
6 -19,000 - (-$28,500 + $22,000) = - $12,500
7 − 8 -19,000 - (-$62,000-29,000) = $72,000
9 -19,000 + $36,000 - (-$91,000) = 108,000

Midterm Exam 4
 THE INTERNATIONAL UNIVERSITY (IU) Course: Engineering Economy
Department of Industrial System Engineering

(8p) PW(i′%) = 0 = −$74,000 + $9,500(P/A, i′%,5) − $12,500(P/F, i′%,6) + $72,000(P/A,

i′%,2)(P/F, i′%,6) + $108,000(P/F, i′%,9)
(4p) By trial and error, i′% = 22.5% > MARR. Therefore the incremental investment is justified
and Alternative B should be selected.

(Students can use any ERR, IRR, FW to answer the question)

GOOD LUCK

Midterm Exam 5