Welcome to : OPMT 7031

Engineering Economics

Judy Li

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 Introduction
Why – Engineering Economics
• Division managers/Project managers
• Make decisions on alternative projects
• Project feasibility studies – involve
economic/financial feasibility
• Evaluate the project’s financial/economic
viabilities
• Communicate effectively with financial
managers
• Personal financial/investment decisions

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 Introduction
What – Engineering Economics
• Investment decision related to an
engineering projects
• Costs/benefits analysis on capital
investments
• Select the alternatives make the most
economic/financial sense

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 Introduction
How – Principles of Engineering Economics
• Time value of money – Cost of capitals - Money
invested today has a cost (interest)
• Incremental cost and revenue – All that counts are
the differences among alternatives
• Economic analysis – Make investments that are
economically / financially justified – Add value to
the firm
• Trade – off between risk and reward - Additional
risk is not taken without the expected additional
return
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 Introduction
How – Mathematic Modeling
• When dealing with the complexities of reality, it
is advisable to use a model.
• A model is a simplification of reality that
captures information useful and appropriate for
a specific purpose.
• Engineering Economic models typically
represent a project through estimates of its
costs / benefits over time.
• Excel will be the main modeling tool for this
course.
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 Introduction
How – Mathematic Modeling
• Dealing with Uncertainty
▪ When constructing economic models, we must
estimate costs, make predictions – this creates
uncertainty.
▪ Sensitivity analysis is means of dealing with
uncertainty .
• Dealing with Risks
▪ Probability Analysis
▪ Simulation

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 Course Grades Breakdown

• Lab Exercises – 5% 10 Lab Exercise, 0.5 mark each

• Weekly Quizzes – 10% 10 Quizzes, equally weighted

• Midterm – 30% Feb 16th 8:30 – 10:30 AM

• Team Project – 15% March 23 – April 6th

• Final exam – 40% Final Exam week April 13 – 20th

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 OPMT 7030
Engineering Economics

Module 1 - Time Value of Money

Annuities & Perpetuities

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 Time Value of Money
• The idea that a dollar today is worth more than a
dollar in the future because the dollar received
today can earn interest.
• The present dollars and future dollars are not equal
in value because of the opportunity cost associated
with the delay in earning a return.
• Dollar amounts that occur at different points in
time cannot be added, subtracted, or compared
UNLESS interest has been taken into account.

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 Time Value of Money
• When we deal with large amounts of money, long
periods of time, or high interest rates, the change in
the value of a sum of money over time becomes
extremely significant.
• Because engineering projects requires the
investment of money, it is important that the time
value of the money used be properly reflected in
the evaluation of these projects.

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 Single Payment Compound Value

𝐹𝑉 = 𝑃𝑉(1 + 𝑖)𝑛
Example 1:
You invested $3000 in a bond 3 years ago. Your investment earns 5%
compounded annually. What would your $3000 investment worth today?

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 Single Payment - Present Value

𝐹𝑉
𝑃𝑉 =
(1 + 𝑖)𝑛
Example 2:
You would like to save up $10,000 for a well deserved vacation in 4 years. How
much should you deposit today if money earns 5% compounded annually?

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 Equal Payments
Compound Future Value

(1 + 𝑖)𝑛 − 1
𝐹𝑉 = 𝐴
𝑖

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Equal Payments-Compound Future Value
Example 3:
Sam is saving for his daughter’s post-secondary education in 10 years.
He has $10,600.02 in an RESP account and plan to add $3,000 at the end
of each year for the next ten years. How much money will his daughter
have in 10 years if Sam earns a return of 5% compounded annually?

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Equal Payments - Sinking Fund

(1 + 𝑖)𝑛 − 1
𝐴 = 𝐹𝑉/
𝑖

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 Equal Payments - Sinking Fund
Example 4:
Sam is saving for his daughter’s post-secondary education and he needs
to accumulate up to $55,000 in 10 years. He has $10,600.02 in an RESP
account now and plan to deposit an equal amount at the end of each year
for the next ten years. How much money will he need to deposit each year
for the next 10 years to achieve the goal if Sam earns a return of 5%
compounded annually?

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Equal Payments - Discounted Present Value

1 − (1 + 𝑖)−𝑛
𝑃𝑉 = 𝐴
𝑖

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Equal Payments - Capital Recovery

1 − (1 + 𝑖)−𝑛
𝐴 = 𝑃𝑉/
𝑖

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 Equal Payments - Capital Recovery

Example 5:
You take out a loan for $100, 000 at 10% compounded annually for the
purchase of a new machine for your bottling plant. This new machine will
result in savings at the end of each year. If you want to recover the cost of
the machine in 10 years, what do you need these annual savings to be?

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 Deferred Annuities
• A deferred annuity is an annuity that begins at
some point in the future.
• It is essential to draw a timeline when you are
working on questions that involve a deferred
annuity.
• Clearly indicate where the annuity begins and
where the annuity ends.
• 2 steps approach
= waiting period (no payment) + annuity

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 Deferred Annuities - Example
Example 6:
You plan to retire in 30 years. You expect you will need 25 annual payments
of $40,000 with the first payment in 31 years. How much money should you
set aside today for your retirement if interest is calculated at 10%
compounded annually?

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 Perpetuity
• A perpetuity is a special kind of annuity, one in which the
cash flows continue on forever.
• At first glance this may seem impossible but you only
withdraw the interest earned then the principal will be
untouched and there is no end to this.
𝑨 = 𝑷𝑽 ∗ 𝒊
Example 7A:
A wealthy BCIT alumna has decided to make an endowment to the school of
engineering to fund an annual scholarship for the best engineering economics
student. She will donate $20,000 and the funds will be invested at 10 %
compounded annually. How much will the annual scholarship be if the first
scholarship is in one year?

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 Deferred Perpetuity
A deferred perpetuity is a perpetuity that begins at some point in
the future.
Example 7B:
A wealthy BCIT alumna has decided to make an endowment to the school of
engineering to fund an annual scholarship for the best engineering
economics student. She will donate $20,000 and the funds will be invested at
10 % compounded annually. How much will the annual scholarship be if the
first scholarship is in 5 years?

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 Perpetuities - Capitalized Values
• The present value of an indefinitely long uniform
series of cash flows (perpetuity)
• The capitalized value captures all the future cash
flows into infinity and discounts them back to the
present value.
𝐴
𝑃𝑉 =
i

A - the annual payment which lasts to infinity

i - is the annual interest rate

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 Perpetuities - Capitalized Values
The capitalized value of perpetuity is the present value of an
indefinitely long uniform series of cash flows.
1 − (1 + 𝑖)−𝑛
𝑃𝑉 = 𝐴
𝑖

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 Capitalized Value – Example
Example 8A:
Rental Property
− Annual revenue = $50,000
− Annual Maint. costs = $12,500
− Interest Rate, i = 10% annually
What is the present worth of this property, if the building can
be used indefinitely with this annual maintenance cost?

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 Capitalized Value – Example
Example 8B:
Rental Property
− Annual revenue = $50,000
− Annual Maint. costs = $12,500
− Interest Rate, i = 10% annually
What is the present worth of this property, if the building can
only last 100 years?

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 Perpetuity - Example
Example 9A:
The city is considering building a by-pass for truck traffic around the
downtown commercial area. The by-pass will provide merchants and
shoppers with benefits that have an estimated value of $500,000 per year
and the maintenance costs will be $100,000 per year. If the by-pass is
properly maintained, it will provide benefits indefinitely. If the required
rate of return for the project is 10%, what is the capitalized value of the
by-pass (present value of benefits minus maintenance costs)?

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 Deferred Perpetuity - Example
Example 9B:
It takes 2 years to build the by-pass, and the benefits and maintenance costs
will start at the end of year 3. What is the capitalized value of the by-pass if
the required rate of return for the project is 10%?

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