Engineering Economics Using Excel

Engineering Economics Using Excel 1
FIRST EDITION
Anirban Ganguly, MBA, PhD

School of Systems and Enterprise
Stevens Institute of Technology
Hoboken, NJ 07030
Ph. (201)-216-8719 ; Fax : (201)-216-5541
Email : Anirban.Ganguly@stevens.edu
ACKNOWLEDGEMENT
The author of the workbook wishes to sincerely thank Dr. John V. Farr, Associate
Dean, School of Systems & Enterprises for initially putting forth the idea of writing this
workbook. The workbook is a result of his constant guidance and motivation. Very
special thanks also go out to Dr. Kathryn D. Abel, Lecturer, School of Systems and
Enterprises, for the relentless encouragement that was extended by her during this
project.
In addition, writing this workbook could not have been possible without the efforts put
forward by two special individuals. It is only fair that their valuable contribution to this
project is acknowledged. Acknowledgement goes out to Ms. Anne Carrigy, Masters
Student, School of Systems and Enterprises and Prof. Howard Berline, Senior
Instructor, School of Systems and Enterprises for providing us with valuable inputs in
addition to compiling and correcting our notes, and in the process helping the workbook
to see the light of the day.
Last but definitely not the least, sincerely thanks goes out to Dr. Dinesh Verma, Dean,
School of Systems and Enterprises for permitting me to publish this workbook along
with being a constant source of inspiration and guidance.
Anirban Ganguly, MBA, PhD
Hoboken, NJ
(July 2009)
TABLE OF CONTENTS
CHAPTER 1: OVERVIEW OF MS EXCEL® .............................................................................................................. 5
1.1 INTRODUCTION ................................................................................................................................................... 5
1.2 EXCEL 2007 BASICS ..............................................................................................................................................6
1.2.1 Excel Ribbon ................................................................................................................................................6
1.2.2 Working with an Active Cell ........................................................................................................................ 7
1.2.3 Some useful built‐in functions of Excel, ..................................................................................................... 10
1.2.4 Graphing with Excel ..................................................................................................................................12
1.2.4.1 Line Graphs in Excel .......................................................................................................................................... 13
1.2.4.2 Scatter Diagrams with Excel ............................................................................................................................. 14
1.2.4.3 Drawing a Line / Scatter Diagram .................................................................................................................... 15
1.3 MANAGING YOUR WORKSHEET AND WORKBOOK ........................................................................................................ 16
CHAPTER 02: INTEREST RATES, TIME VALUE OF MONEY AND IRR .......................................................................17
2.1 INTRODUCTION .................................................................................................................................................17

2.2 USING SPREADSHEET FOR CALCULATING INTEREST RATES ............................................................................... 17
2.2.1 Periodic and Nominal Interest Rate .......................................................................................................... 18
2.2.2 Effective Annual Interest rate.................................................................................................................... 18
2.2.3 Changing between Interest rates .............................................................................................................. 19
2.3 USING SPREADSHEETS TO CALCULATE THE TIME VALUE OF MONEY ................................................................ 20
2.3.1 Determining Present Worth (NPV() Function) ........................................................................................... 22
2.3.2 Difference Between NPV() and PV() Functions .......................................................................................... 24
2.3.3 Calculating the Annual Worth (PMT() Function) ....................................................................................... 26
2.3.4 Calculating the Future Worth (FV() Function) ........................................................................................... 28
2.4 CALCULATING THE RATE OF RETURN FACTORS USING EXCEL ........................................................................... 30
2.5 DETERMINING THE INTERNAL RATE OF RETURN (IRR) ...................................................................................... 33
2.6 CONCLUSION .....................................................................................................................................................37
CHAPTER 03: DEPRECIATION AND SENSITIVITY ANALYSIS ..................................................................................38

3.1 INTRODUCTION .................................................................................................................................................38
3.2 DEPRECIATION ..................................................................................................................................................38
3.2.1 Straight Line (SLN) Method ....................................................................................................................... 39
3.2.2 Double declining balance (DDB) Depreciation Method ............................................................................. 40
3.2.2 Modified Accelerated Cost Recovery Systems (MACRS) Depreciation Method ......................................... 43
3.3 SENSITIVITY ANALYSIS .......................................................................................................................................47
3.3.1 Overview of Sensitivity Analysis ................................................................................................................ 47
3.3.2 Sensitivity Analysis Using Excel Spreadsheet Functions ............................................................................ 47
3.3.3 Relative Sensitivity Graph using Excel ....................................................................................................... 52
3.3.4 Determining the Sensitivity Ratio .............................................................................................................. 54
3.4 CONCLUSION .....................................................................................................................................................54
APPENDIX 1: ADDITIONAL TOPICS ON ENGINEERING ECONOMICS .....................................................................56

A 1 SOME ADDITIONAL FUNCTIONS OF TIME VALUE OF MONEY ............................................................................ 56
A 1.1 Interest Rate of an Annuity ....................................................................................................................... 56
A 1.2 Amount paid as Interest during a Period .................................................................................................. 57

A 1.3 Principal Payment for a Loan .................................................................................................................... 58
A 1.4 Determining the Number of periods of an Investment ............................................................................. 59
APPENDIX 2: LIST OF SELECTED TEXTBOOKS ON ENGINEERING ECONOMICS AND FINANCIAL APPLICATION OF
EXCEL ................................................................................................................................................................62
Chapter 1: Overview of MS Excel®

1.1 INTRODUCTION
Microsoft Excel® is electronic spreadsheet software that allows the user to organize and perform
mathematical functions on numerical data. The origin of the word ‘spreadsheet’ stemmed from
the word ‘spread’ in the sense if a newspaper or a magazine item spreads over two facing pages –
thereby combining the two pages as a single large page1. Spreadsheets in its earliest form were
comprised of paper grids that were used by accountants to present their book keeping
transactions, with columns for categories of expenditures across the top, invoices listed down the
left margin, and the amount of each payment in the cell where its row and column intersect,
which were, traditionally "spread" across facing pages of a bound ledger (book for keeping
accounting records) or on oversized sheets of paper ruled into rows and columns 1,2.
Microsoft Excel is typically comprised of organizational units called “workbooks”3. A standard

workbook contains worksheets that perform calculations, store and organize data, present
graphics and performs a plethora of mathematical and statistical functions. A worksheet in turn is
comprised of cells whose function is to store data or a formula that performs a calculation. Ever
since its inception in the eighties, Excel® has rapidly gained importance among the engineering
community because many engineering tasks can be solved easily and efficiently within the
framework of a spreadsheet. Excel® aids any engineer in solving complex problems right on
his/her computer, thereby saving a lot of time and effort in the process. Excel®, to engineers, is
now much more than just an electronic medium of organizing data. It has become a powerful
tool for solving high-level mathematical, statistical and financial problems, along with problem
optimization techniques, simulation and report generation among others.
The intent of this workbook is to acquaint the students with the commonly used features of
Excel® that are widely used in the domain of Engineering Economics. The sole purpose of
designing this workbook lies in the fact that spreadsheets are fast becoming the principal tools of
practicing engineering economy4. Currently, spreadsheets are used in almost all the real world
1
http://en.wikipedia.org/wiki/Spreadsheet
2
Larsen, Ronald W., Engineering with Excel, Prentice Hall (2008)
3
http://www.emagenit.com/microsoft-Excel-overview.htm
4
Eschenbach, Ted G., Engineering Economy: Applying Theory to Practice, Oxford (2003)
applications of engineering economy. Excel is extensively used in the domain of engineering

economics to construct table of cash flows, determine the time value of money and IRR,
calculating depreciation and after-tax cash flows and so on. Additionally, this workbook can
serve as a valuable companion to the practicing engineers while making a proper engineering
economic decision, facilitating in the process a more effective selection of a capital project. This
book is primarily based on Excel® 2007 as it is becoming more and more popular among the
academicians and practitioners alike. Furthermore, since all the financial functions discussed in
this book migrated from Excel 2003, the Excel 2003 users would not have any problems in using
the same Excel functions.
1.2 EXCEL 2007 BASICS

Before moving on to discussing the financial functions and the applications of Excel® in
engineering economics, it was thought worthwhile to dwell briefly on some of the basics of MS
Excel® 2007. The following subsections in the chapter will be devoted toward a discussion of
some of the fundamental aspects and functions of Excel along with screenshot examples of the
same.
1.2.1 Excel Ribbon

The Ribbon, which is a new feature in MS Office 2007 products, is a tool that is intended to
provide a convenient access to the most commonly used features of the program. The Ribbon
replaces menus and toolbars found in earlier versions of Excel (Excel 1997 – Excel 2003) and is
comprised of a strip of tabs that are located above the work area in Excel 2007. Clicking on each
tab subsequently displays a series of related functions. The default ribbon tab is the “Home” tab
that provides the user with basic formatting options. Additionally, the ribbon is ‘context
sensitive’ 2 and additional tabs appears in the ribbon when required. For example, when working
with graphs and charts, an additional tab called ‘chart tools’ appear on the ribbon which aids the
user in customizing the graph. However, as soon as the user clicks outside the graph / chart, the
additional tab disappears and reappears whenever the graph / chart is clicked. Exhibit 1 provides
the readers with a snapshot of the ribbon on Excel 2007.
Exhibit 1.1 Excel 2007 Ribbon
Excel 2007 Ribbon
In conclusion, it should be stated that if necessary, the ribbon can be minimized to show only the
major tabs. Right clicking the ribbon tab bar and selecting ‘Minimize the Ribbon’ would enable
minimization of the ribbon. Repeating the same procedure will result in the ribbon being
maximized again to show the entire contents.
1.2.2 Working with an Active Cell

Active Cell (also known as Current Cell) in Excel can be defined as the cell in Excel that is
selected using the mouse or the keyboard. The active cell is identified by a heavy border
surrounding it and all information, including mathematical and financial functions are entered
into the active cell. Exhibit 1.2 shows the example of an Active cell.
Exhibit 1.2 Active cell in Excel 2007
Active Cell
An Active Cell can contain any one of the following in them: a label, numbers and formulas.
Label can be defined as one or more text / alphanumeric characters and words. If the first
character entered in any active cell is not a number or a formula, Excel treats the cell as a Label
by default. Additionally, using [‘] before the first character can convert a number or even a
formula to a label. For example, any mathematical formula can be converted to a label by
inserting [‘] before the first character, which is the “=” sign. This feature is particularly useful
in situations where the applied mathematical or financial calculations are required to be shown as
a label. Furthermore, if the first character of any active cell is an ‘=’ sign, the cell automatically
treat the entry as a formula (or an equation) and tries to arrive at a solution based on the
referenced cells or worksheets. Finally, if a number is entered in any active cell, it is treated as a
numerical value and the inserted number is shown on the active cell. Exhibit 1.3 further clarifies
the above-discussed ideas.
Exhibit 1.3 Labels, Numbers and Formulas
The details of
the calculation
The result of
the calculation
The symbol [‘] used to
convert formula into labels
It should be mentioned here that whenever a formula is entered in an active cell, the characters
that are typed in are displayed to start with but as soon as the [Enter] key is pressed, Excel
reverts back to displaying the numerical result of the equation, and not the equation itself in the
cell. However, the formula that was entered in the active cell is still stored in the cell and the
Engineeering Econo
omics Using Excel 9
[F2] key can be used

d to view the entered form
mula in the active
a cell ass well as to perform
p any
subsequeent edits on it.
i Additionaally, it shouldd also be meentioned heree that the priimary advanntage
of formulas in Excel (apart from its ability too solve compplex problem
ms in a relativvely easier and
a
quicker fashion)
f u cell addreesses as variiables in the formulas5. Exhibit
is its ability to use E 1.4
illustrates this point.
Exhibit
E 1.4 Using
U cell adddresses as variables
v in a formula
Thee formula bar and

a the
resu
ult of the calcu
ulation
Exhibit 1.4
1 illustratess the idea off using cell addresses
a as variables
v in a formula. An
A elementaary
engineeriing economiic problem iss depicted inn the Exhibitt. Suppose ann investor paays a nominaal
rate of 100% and the number
n of coompoundingg periods avaailable to thee investor is 12. Thus, thhe
periodic rate for the investor
i in question
q willl amount to 10%
1 / 12 = 0.833%
0 per period.
p In
Exhibit 1.4,
1 this calcu
ulation is peerformed usinng cell referrences and adddresses. Thhe output cell D5
contains the formula B5/C5 as inndicated on the
t formula bar
b and the result
r is dispplayed in the
active cell D5. Thus, using cell addresses
a preevents the ussers from re--inputting the values in the
t
output ceell. This is paarticularly useful when working
w withh a large datta set.
Furtherm
more, the Exccel feature of cell addresssing can be particularly useful in caase of repetitiive
calculatioons. In casess of repetitivve calculationns, either keyyboard or thhe left mousee button can be
used to drag
d the sourrce range of cells
c to the destination
d b done using the
range of cellss. This can be
fill handlle feature in Excel. By using
u this feaature, a form
mula and cell addresses caan be copiedd into
a range of
o cells ratheer than beingg inserted inddividually. Additionally,
A , the fill handdle serves ass
5
Larsen, Ronald W., Engineering
E w Excel, Pre
with entice Hall (20
008)
Engineeering Econo
omics Using Excel 10
filling upp a series witth certain inccremental vaalues, both liinear as welll as non-lineear. This featture
can provee to be particcularly usefuul in time series analysiss and forecassting of finanncial data.
1.2.3 Some useful builtin

b fun
nctions of Excel
E 6,7
Microsofft Excel com

mes with a plethora of buuilt-in featurees that can be used to perrform many
mathemaatical and staatistical funcctions. The foocus of this section will be to highligght some of
them. Hoowever, thiss chapter willl not cover all
a of the buiilt-in financiial functions offered by
Excel. Thhe user's manual provideed with Exceel or one of the
t many sellf-help bookks should be
consultedd for a comp
plete list of thhe built in fiinancial (andd other) funcctions.
A functioon is a built-in formula inn Excel thatt has a name and argumeents in parenntheses. At thhe
time of itts inception, Excel starteed out with handling
h bussiness functioons only butt gradually
de many addditional functtions that aree useful to enngineers8. Foor example, the
transitionned to includ
sum and average of a particular set
s of data caan be easily calculated using
u the buillt-in Averagge()
and Sum
m() functions. Additionally, common statistical fuunctions likee Standard Deviation
D
(STDEV
V()) and Corrrelation (COR
RREL()) aloong with finaancial functiions like calcculating Pressent
Worth (N
NPV()) and Internal
I Ratee of Return (IRR()).
( In thhis section, the
t basic buiilt in function of
Excel will be briefly discussed, and
a the Finanncial functioons, especially the ones related
r to
engineeriing economiics, will be discussed
d in detail in the later chapteers.
The entirre set of buillt-in functionns in Excel 2007

2 is available in the Formulas
F tabb in the Exceel
2007 ribbbon. This is shown in Exxhibit 1.5.
Exhib
bit 1.5 Built-in functions of Excel 20007
6
Some off the text is ta
aken from http
p://www.fgcu.e
edu/support/o office2007/Exxcel/index.asp
p
7
Some off the text has been taken frrom: Farr, Joh
hn V., Simulaation for Comp plex Systemss and Enterpriises
(2008)
8
Larsen, Ronald W., Engineering
E w Excel, Pre
with entice Hall (20
008)
Clicking on the ‘Insert Function’ tab in the Formulas tab enables the user to choose and insert
any built-in functions of his / her choice. However, for the purpose of this tutorial, this
discussion will be restricted to discussing a few basic functions. The built-in functions that will
be discussed here will be the following:
• SUM: Adds all cells in the argument

• AVERAGE: Calculates the average of the cells in the argument
• MIN: Finds the minimum value
• MAX: Finds the maximum value
• COUNT: Finds the number of cells that contain a numerical value within a range of the
argument
• ABS: Returns the absolute value of any numerical expression
The SUM function in Excel was created to speed up the process of adding together many values
in a spreadsheet. By using the SUM function, the user can eliminate changing equations when
values change. Excel can sum values across both rows and column. Constants, cell references,
and other formulas can also be added to the SUM function if required. There is also a method to
sum up values in non-contiguous blocks without having to manually type in the formula. In order
to add together the values in the four corners of a data table, type in =SUM( then hold down the
control key (Ctrl) and left click the mouse (without letting up on the Ctrl key) on each of the four
corners. This will provide the user with the sum of the values located in the four corners of any
particular table.
The AVERAGE function in Excel aids the user to determine the average (mean) of a range of
data. The AVERAGE function has all of the capabilities and properties of the SUM function.
Averages can be performed down columns, across rows, an entire table, non-contiguous ranges
and cells, formulas, and constants. Just like in the SUM function, spaces and text have no affect
on the AVERAGE function. The AVERAGE function can also be accessed by clicking the
Insert Function button from the Formulas tab.
Other basic built-in functions of Excel comprises of MAX, MIN, COUNT and ABS. while
MAX and MIN calculates the maximum and minimum values from a range of values, COUNT
determines the number of cells in the data rage. Finally, ABS determines the absolute value of
any numerical expression. This is particularly useful when dealing with ratios.
As an endnote, it should be worthwhile to have a section devoted towards a brief discussion on

relative, absolute and mixed references. Addressing cells by just their column and row labels
(such as ‘A1’) is called relative referencing. When a formula contains relative referencing and it
is copied from one cell to another, Excel does not create an exact copy of the formula but rather
changes cell addresses relative to the row and column they are moved to. For example, if a
simple addition formula in cell C1 "= (A1+B1)" is copied to cell C2, the formula would change
to "=(A2+B2)" to reflect the new row. In order to prevent Excel from automatically making this
change, the user must perform absolute referencing which is accomplished by placing dollar
signs "$" within the cell addresses in the formula. Thus, using absolute referencing, the formula
in cell C1 of the previous example would now read "= ($A$1+$B$1)" if the value of cell C2
should be the sum of cells A1 and B1 instead of A2 and B2 (which is the Excel default through
relative referencing). With absolute referencing, the column and row of both cells are absolute
and does not change when copied. Finally, in situations where only a particular row or column is
fixed, mixed referencing can be used. For example, in the formula "=(A$1+$B2)", the row of
cell A1 is fixed and the column of cell B2 is fixed. Therefore, mixed referencing enables the user
to fix particular rows or column according to convenience. Finally, it should also be stated that
the value from a cell in another worksheet can also be used within the same workbook in a
formula. For example, the value of cell A1 in the current worksheet and cell A2 in the second
worksheet can be added using the format "sheetname!celladdress". The formula for this example
would be "=A1+Sheet2!A2" where the value of cell A1 in the current worksheet is added to the
value of cell A2 in the worksheet named "Sheet2". This will be a very handy tool to have while
performing an After tax analysis problem as data from multiple worksheets are often required to
be interlinked together in calculations as a part of the process to arrive at the after tax cash flow.
1.2.4 Graphing with Excel9

One of the highlight of MS Excel is its ability to generate graphs based of data sets and data
ranges. Charts allow the user to present information contained in the worksheet in a graphic
format. Excel offers many types of charts including Column, Line, Pie, Bar, Area, Scatter among
9
Some of the text is taken from http://office.microsoft.com/en-us/Excel/HA010548401033.aspx
Engineeering Econo
others. However,
H since the majorrity of engineering econoomics probleems concernns primarily
scatter pllots and line graphs, thiss section willl be restricteed toward thoose only. Onnce again, the
user's maanual provided with Excel or one of the many seelf-help bookks should be consulted foor
further reeferences.
The availlable charts on Excel 2007 are locateed under thee Insert Tab on
o the Excell Ribbon. Thhis is
shown inn Exhibit 1.6
6.
Exhibit 1.6 Locationn of availablle charts in Excel

E
1.2.4.1 Line
L Graph
hs in Excel
Line Chaarts in Excel are often ussed to plot vaariations in financial
f andd other enginneering data over
time. Additionally, th
hey can be used
u to forecast a value over
o a certainn time-period. This is
especiallyy true when making time value foreccasts of a caash flow and bonds. Simiilar to most
graphs, a line diagram
m consists of a horizontaal and a vertical axis witth the time on the x-axis and
the variabble on the y--axis. The linne graph is located
l undeer the ‘Insert’ tab on the Excel ribbonn as
shown inn Exhibit 1.7.
Engineeering Econo
Exh
hibit 1.7 Linne Graph in Excel 2007
As seen from
f Exhibitt 1.7, there are
a various forms
fo of line chart availaable under Exxcel 2007.
Additionnally, line diaagrams displlay lines throough a set off data points, with or witthout data
markers. The data serries in Line charts can be stacked. Finally, unlikke Scatter charts, Line chharts
can even be displayed with a 3-D
D visual effecct.
1.2.4.2 Scatter
S Diagrams with
h Excel
Scatter Diagrams
D aree one of the most
m widely used graphss in the domain of busineess and
engineeriing. Scatter charts
c repressents relationnship betweeen pairs of variables
v andd are commoonly
used for displaying and
a comparinng numeric values,
v such as scientificc, statistical, and engineeering
data. A scatter diagraam allows a convenient visual
v repressentation of a pair-wise relationship.
r .A
Scatter Diagram
D can be effectiveely used to diisplay workssheet data thhat includes pairs
p or grouuped
sets of vaalues, depictt correlationss between laarge sets of data
d and hencce compare them
t in the
process. The scatter diagram
d is loocated underr the ‘Insert’’ tab on the Excel
E ribbonn as shown inn
Exhibit 1.8.
1
Engineeering Econo
Exhib
bit 1.8 Scatter Diagram in Excel 20007
Scatter chharts can be displayed with

w or withoout lines to connect the data
d points, and
a connectiing
lines can be displayed with or wiithout data markers.
m A Scatter
S chart has two valuue axes, shoowing
one set of numerical data along the x-axis annd another along the y-axxis. It combines these vaalues
into singlle data pointts and displaays them in uneven
u intervvals, or clustters. Additioonally, the X-axis
X
of a Scattter chart can
n only displaay numeric data
d and the scaling
s optioon of the axis can be chaanged
if neededd in order to achieve greaater flexibiliity.
1.2.4.3 Drawing
D a Line
L / Scattter Diagram
m
This secttion of the ch
hapter will conclude
c withh a descriptiion of the steeps required to create a Line
L
/ Scatter diagram. Th
he steps are isted
i below,
1. Arrangge the data so that the x--values are inn the first row or columnn of your woorksheet, andd the
y-values are located in
i adjacent rows
r or coluumns.
2. Select the range off X and Y vaalues that haas to be plotteed.
3. Click on
o the Inserrt menu that forms a partt of the Exceel 2007 ribboon.
4. Select Scatter or Line
L from thhe list of avaailable chartss.
5. Under Chart sub--type, click the
t chart subb-type you want
w to use.
6. Click Next,
N and co
ontinue to coomplete the chart
c
7. Format the graph according to the requirements and convenience.
1.3 Managing Your Worksheet and Workbook

The final section of this chapter will be devoted towards a brief discussion that deals with the
basic elements of formatting and managing an Excel 2007 workbook. A properly formatted
worksheet not only allows the data to be more organized visually, but also aids the reader in
deciphering information more quickly. This section will deal with a few basic formatting
commands in Excel and provide a brief overview of their utility and functions. The basic
formatting functions that any Excel users must be aware of are the following:
Wrapping Texts in a Cell. Used to wrap a label when it is too large to fit into a particular cell.
For example, if the label for a cell is ‘Time Value of Money’, it may require more space that the
one allocated by default in the active cell. Thus, wrapping the text in this case would allow the
text to be displayed across multiple rows across the cell, thereby making it more visually
compliant. The ‘text wrapping’ command is located within the ‘alignment’ group, which in turn
is located under the ‘Home’ tab in the ribbon.
Formatting Numbers. The Number Group on the Home tab provided the user with a plethora of
numeric formats. The most commonly used format for engineering economics are general,
numbers, currency, accountancy and percentages. Additionally, this aids any user to specify the
number of significant digits to be displayed and rounds of the number to the desired decimal
places.
Merging and Centering Cells. One of the more useful features of Excel is that it allows the user
to merge a set of cells to accommodate a large text label. Once the cells are merged, they are
then treated as a single cell for further calculation. One very common use of merging cells is to
create a common heading for several columns in a Table10.
10
Chapter 02: Interest rates, Time Value

of Money and IRR
2.1 INTRODUCTION
This chapter of the workbook is devoted toward the use of spreadsheets in engineering
economics. Spreadsheets have become one of the principal tools in solving engineering
economics problems and decision-making. The major advantage of using Excel in engineering
economics lies in the fact that they not only they allow easy ‘what-if’ calculations under a variety
of decision-making situations, but they also provide more powerful annuity factors than their
tabulated counterpart, thereby considerably reducing the margin for error11 . Other advantages of
using spreadsheets include constructing a year-by-year cash flow table more easily, easier
calculation of time value of money and sensitivity analysis and a more comprehensive analysis
of depreciation of assets and after tax analysis. The subsequent sections of this chapter will cover
in detail some of the facets of engineering economics that can be accomplished using Excel
spreadsheets.
2.2 USING SPREADSHEET FOR CALCULATING INTEREST RATES

The most important factor in determining the time value of money can be attributed toward the
concept of interest rates. Interest rates govern the growth of money with time along with the
growth of the economy in general. The importance of interest is so profound that Albert Einstein
is quoted referring to it as “the most powerful force in the universe”. There are set of inter-
related interest rates that can be used to determine the time value of money. For example, a bank
might end up providing its customers with a periodic interest rate (interest charged per
compounding period – days, weeks, months, etc.) for a savings account but charge a different
rate for a car / house loan (for example, annual percentage rates). Additionally, a company might
decide to use effective interests while deciding to fund a project. Hence, a clear idea of interest
rate often forms a cornerstone of selection of projects based on engineering economic analysis.
In this context, it should be mentioned that a clear knowledge regarding the compounding period
is also very important in determining a financing decision for a project. For example, a certain
11
Eschenbach, Ted G., Engineering Economy: Applying Theory to Practice, Oxford (2003)
amount of money loaned from the bank is generally repaid by the borrower on a monthly basis.
On the other hand, most financial institutions use quarterly compounding for their savings
account. However, as the interest rates are interrelated, knowing one can result in determining
the others12. The Excel’s time value of money functions can be used to determine and
interchange the types of interest rates to handle a variety of options, including the ones stated
above.
2.2.1 Periodic and Nominal Interest Rate

The interest rate per compounding period is called a periodic interest rate (or periodic rate). It is
dependent upon the compounding period and is determined by dividing the interest rate by the
number of compounding periods.
Nominal rate of interest can be defined as the rate of interest before adjustment of inflation13. It
can also be stated as the periodic rate multiplied by the number of compounding periods.
Example 2.1:
If the Periodic rate for a financing opportunity is 1% compounded quarterly, then
the Nominal Rate will be, (Periodic rate * # compounding periods) = (1% * 4) = 4%.
On the other hand, if the Nominal Rate is 5% quarterly, then the Periodic rate is,
(Nominal rate / # compounding periods) = (5% / 4) = 1.25 %. This can be
achieved by using simple math functions in Excel
2.2.2 Effective Annual Interest rate

The effective annual interest rate (also called effective rate) can be defined as an investment
annual rate of interest when compounding occurs more often than once a year14. In other words,
it can be stated as the rate that produces the same end-of-year value with a single interest
payment as would be produced by more frequent periodic interest payments 12. Microsoft Excel
has a built-in financial function called “EFFECT ()” that incorporates this and calculates the
effective rate, given the nominal rate and the number of compounding periods, as shown in
Example 2.2 and Exhibit 2.1
12
13
http://en.wikipedia.org/wiki/Nominal_interest_rate
14
http://www.investopedia.com/terms/e/effectiveinterest.asp
Engineeering Econo
Examplee 2.2:
What is
s the Effecttive Annua
al Interest rate for a financing
f o
opportunit
ty that offe
ers
an interrest of 1.50
0 % compo
ounded mo
onthly?
Answerr:
Exhibit 2.1
2 Calculatinng Effectivee Rate using Excel
F6 * F7
2.2.3 Ch
hanging be
etween Interest rate
es
Microsofft Excel 2007
7 (and Excell 2003) has built-in
b funcctions which allow the usser to togglee
between the Nominal and the efffective annuaal interest raate. In other words,
w if thee user is provvided
with the effective ann
nual interestt rate, he / shhe can use Exxcel’s built-iin function to
t calculate the
t
nominal annual interest rate from
m the given data.
d The buiilt-in financiial functionss that can be used
is this sittuation are “EFFECT()”” and “NOM
MINAL()”. While
W Exam
mple 2.2 (andd Exhibit 2.1)
familiarizzed the readers with the “EFFECT(()” function, Example 2..3 (and Exhibbit 2.2) will do
so with regards to thee “NOMINA
AL()” built--in function.
Examplee 2.2:
What is the Nominal Annual Interest rate for a financing opportunity that offers
an Effective Annual Interest Rate of 19.56%?
Answer:
Exhibit 2.2 Calculating Nominal Rate using Excel
From Previous
Example
AN IMPORTANT NOTE TO THE EXCEL USERS:
The NOMINAL() built-in function should only be used to convert any Effective Annual Interest
Rate to the corresponding Nominal rate. It should not be used to determine the nominal rate
from the periodic rate. Users are advised to multiply the periodic rate by the number of
compounding periods in order to arrive at the nominal rate. Furthermore, the users are advised
to download the Excel “Analysis Toolpack” available as an “Add-in”, for successfully performing
a variety of statistical and financial analyses.
2.3 USING SPREADSHEETS TO CALCULATE THE TIME VALUE OF MONEY

The basic constitution of engineering economics is comprised of interest rates and time value of
money. Excel’s time-value-of-money functions allow the user to determine the effect of interest
Engineeering Econo
rates on money
m as it moves
m throuugh any speccified time-pperiod15. Thee functions arre available
under thee “Financial Functions” list (located in the Form
mula tab in thhe ribbon) as shown in
Exhibit 2.3.
2 this is also available in Excel 2003.
Exhiibit 2.3 Finaancial Functiions in Exceel
Excel’s built-in
b finan
ncial functionns aid an enggineering manager to unnderstand and calculate the
t
present worth,
w annuaal worth and future worthh of any capiital project thereby
t facilitating him/hher
to select a project in an more effeective and effficient mannner. Additionally, having a
comprehensive know
wledge aboutt determiningg time valuee of time throough the usee of spreadshheet
might subbstantially aid
a any enginneering manaager, amongg others, in making
m decissions regardiing
the worthh of a machin
nery / equipment after a certain timee period, the cost effectivveness of anny
particularr project and
d the potential future bennefit of any capital
c projeects. Additionnally, time value
v
of moneyy can be used
d to make deecisions regaarding a car or a house looan as well as
a repaying
15
Larsen,, Ronald W., Engineering
E w Excel, Prrentice Hall (2
with 2008)
education loans. The following sub-sections will discuss in further details the calculation of time
value of money using Excel’s financial functions.
2.3.1 Determining Present Worth (NPV() Function)

The Net Present Value (NPV) of an investment is the total value of each of the cash flows for the
investment represented in terms of today’s dollars16. In other words, NPV compares the value of
a dollar today to the value of that same dollar in the future, taking inflation and returns into
account17. NPV calculations make use of the discount rate as it will be shown later in this
section. If the NPV of a prospective project is positive, it should be accepted. However, if NPV
is negative, the project should be rejected.
The Net Present Value of capital projects can be calculated using the NPV() function in Excel.
Also, at this point of time it should be worthwhile to mention that although NPV is similar to the
PV function (present value) function which is also available in Excel (under financial functions),
unlike the variable NPV cash flow values, PV cash flows must be constant throughout the
investment18. This difference will be discussed in detail in the next sub-section of the chapter.
As stated earlier, the Net present value (NPV) of any project cash flow can be determined by
using the NPV() function. The syntax of the NPV() function is provided in equation 2.1.
, , , … . …………………….. (2.1)
Where rate = MARR or the discount factor and “value1, value2, ....” are 1 to 254 arguments
representing the payments and income. Example 2.3 provides the reader with a simple NPV
calculation using both the traditional PW formula as well as using spreadsheet application
(Exhibit 2.4).
16
http://www-personal.umich.edu/~kathrynd/UsingExcelsFinancialWizard.pdf
17
http://www.investopedia.com/terms/n/npv.asp
18
http://office.microsoft.com/en-us/Excel/HP052091991033.aspx

While determining the Net Present Value of an investment using the NPV() function in Excel,
careful attention must be paid to the initial investment (in year 0). The NPV function in Excel
does not calculate the net present value of the investment. Rather, the NPV function calculates
the present value of a series of different future cash flows that occur at fixed intervals. Hence, in
order to determine the NPV, the initial investment must be subtracted from the amount
that is arrived at by using the NPV() function. In other words, for determining NPV using
Excel, the final formula should be:
Net Present Value = NPV(rate, value year 1,….value year n) – Initial Investment year 0
Example 2.3
Calculate the Net Present Value of an investment which has an initial investment
of $1,000 with an annual cash inflow of $100 and a salvage value of $200. The
life of the project is 5 years and the MARR associated with the project is 10%
Answer:
1. Traditional Method
, , , ,
Hence,
$1000 $100 , 10%, 5 $200 , 10%, 5
Thus,
$1000 $100 3.7908 $200 0.6209
$ .
2. Spreadsheet Method:
Exhibit 2.4 Calculating NPV using Excel
The initial investment is

deducted from the NPV cash
flow as stated earlier
The salvage value of $200 is

added to the final year’s cash
flow ($100 + $200 = $300)
Thus, it can be seen from Exhibit 2.4 that the final value of NPV using the Excel financial NPV()
function comes out to be exactly the same as the one arrived at by using the traditional PW
equation. Thus, the PW equation can be replaced by the NPV () function in Excel in order to
felicitate more ease of calculation. This is especially true in case of very long periods of cash
flow.
2.3.2 Difference Between NPV() and PV() Functions

Although very similar in nature, the NPV and the PV functions in Excel have some basic
differences. Although both of them returns the present value of an investment, the PV() function
preferably should be used only if there is an uniform cash flow spanning over the given
time period. In addition, while determining the present worth of a project using the PV()
function, the uniform annual cash flows, are considered as cash inflows (and hence has a positive
sign) and hence have to be inserted with a negative sign in front of it. Equation 2.2 provides the
reader with the syntax of the PV() function in Excel.
, , , , … … … … … … … … … … … … 2.2
Where rate = MARR, nper = number of periods (in years, months, etc.), pmt = uniform annual
cash flow, fv = the cash balance you want to attain after the last payment is made and type =
numbers 0 & 1 that basically indicate when the payments are due (a value of 0 indicates a EOY
payment whereas a value of 1 indicated the payments being made at the beginning of year). At
this point in time, Example 2.3 will be revisited and the problem will be solved using the PV()
function in Excel . The solution is provided in Exhibit 2.5 along with Equation 2.2.
Exhibit 2.5 Solving Example 2.3 using the PV() Function
, , , ,
Note that the Cash Flows are

inserted as negative and so is
the salvage value
Important: Since there is no

Future Value, the place is
left blank
Important: Since there is no

Annual value, the place is
left blank
As can be seen from Exhibit 2.5, the same answer is arrived at by using the PV() function. Using
the NPV() function is simpler to use than its PV() counterpart and the students are advised to use
the NPV function for the sake of simplicity. However, the students are welcome to use the PV()
function to verify the answer they arrived at using NPV().
As an endnote, it should be mentioned that when using the PV() function in Excel, the user must
use blank spaces for the variables absent in the data set. This is shown in Exhibit 2.5. Ignoring
the blank spaces might lead to Excel interpreting the formula variables differently than intended,
thereby resulting in an incorrect value of NPV.
2.3.3 Calculating the Annual Worth (PMT() Function)

One of the most commonly used concepts in the domain of financial decision-making is the
concept of amortization. Whether it be applying for a loan in order to finance a financial
investment or the mortgage of an apartment, regular uniform payments often hold the key to a
proper analysis of any financial investment decision. Microsoft Excel provides the users with a
built-in financial function that aids in determining the uniform payments required over time. The
PMT() function in Excel can be used to determine the annual worth of a project based on a series
of uniform payments and a constant interest rate.
The syntax for the PMT() function in Excel is provided in Equation 2.3
, , , , … … … … … … … … 2.3
Where rate = MARR (interest rate), nper = number of periods, PV = initial investment, FV =
future value of the investment (optional) and Type = numbers 0 & 1 that’s basically indicates
when the payments are due (a value of 0 indicates a EOY payment whereas a value of 1
indicated the payments being made at the beginning of year). Example 2.4 provides the reader
with a simple Annual Worth calculation problem using both the traditional AW formula as well
as using the PMT() spreadsheet function (Exhibit 2.6).

While determining the Annual Worth of an investment using the PMT() function in Excel, careful
attention must be paid to the existing annuities. The PMT() function in Excel does not consider
the existing amortization values. Rather, the existing annuities must be added back to the PMT()
function in order to arrive at the correct AW value. Hence, in order to determine the AW, the
existing annuities must be added to the amount that is arrived at by using the PMT()
function. In other words, for determining AW using Excel, the final formula should be
Annual Worth = PMT(rate, nper, PV, FV, Type) + A (where A = Annuities)
This is indicated in Exhibit 2.6
Engineeering Econo
Examplee 2.4
Calcula
ate the Ann
nual Worth
h of a finan
ncial projecct that has
s an initiall investmen
nt of
$1,000 with an annual
a cash inflow off $300 and
d a salvag
ge value off $350. The
e life
of the project
p is 5 years and
d the MARR
R associatted with th
he project is
i 10%
Answer:
1. Tradittional Meth
hod
Hence,
Thus,
2. Spreadsheet Meth
hod
Exhibiit 2.6 Determ

mining the Annual
A Worthh using the PMT()
P functtion
The Existing
T
A
Annuities (A) arre
a
added back
Notee that the Iniitial Investme

ent
is in
nserted as po ositive and th
he
salvvage value iss negative
Impo ortant: Since

e there is no
Futuure Value, the place is
left blank
b
Impo ortant: Since

e there is no
Pressent Value, th
he place is
left blank
b
As can be seen from Exhibit 2.6, the same answer is arrived at by using the PMT() function.
Using the PMT() function is simpler than the traditional method and the students are advised to
use the PMT() function to calculate the annual worth of a financial investment decision. More
complicated examples related to the application of PMT() function are provided later in this
chapter. As an endnote, it should be mentioned that when using the PMT() function in Excel, the
user must use blank spaces for the variables absent in the data set. This is shown in Exhibit 2.6.
Ignoring the blank spaces might lead to Excel interpreting the formula variables differently than
intended, thereby resulting in an incorrect value of AW.
2.3.4 Calculating the Future Worth (FV() Function)

Future value of a project can be stated as the value of a cash flow stream at the end of a given
time-period. Microsoft Excel’s FV() function provides the user with easy calculations of a Future
Value when the given present value, the rate of interest and the number of compounding periods
are given. The syntax of Excel’s FV() function is given in equation 2.4 below.
, , , , … … … … … … … … … … … . 2.4
Where rate = interest rate, nper = number of periods (n), PMT = the annuities, PV = Initial
Investment and Type = numbers 0 & 1 that’s basically indicates when the payments are due (a
value of 0 indicates a EOY payment whereas a value of 1 indicated the payments being made at
the beginning of year). Example 2.5 provides the reader with a simple Future Worth calculation
problem using both the traditional FW formula as well as using the FV() spreadsheet function
(Exhibit 2.7).

While determining the Future Worth of an investment using the FV() function in Excel, it should
be noted that the FV() function in Excel does not consider the salvage value. Rather, the
salvage value must be added back to the FV() function in order to arrive at the correct FW
value. Hence, in order to determine the FW, the existing salvage value must be added to
the amount that is arrived at by using the FV() function. In other words, for determining FW
using Excel, the final formula should be
Future Worth = FV(rate, nper, PMT, PV, Type) + S (where S=Salvage Value)
This is indicated in Exhibit 2.7
Engineeering Econo
Examplee 2.5
Calcula
ate the Futu
ure Worth of a financial projecct that has an initial investmen
nt of
$1,000 with an annual
a cash inflow off $500 and
d a salvag
ge value off $700. The
e life
of the project
p is 5 years and
d the MARR
R associatted with th
he project is
i 10%.
Answer:
1. Tradittional Meth
hod
Hence,
Thus,
2. Spreadsheet Meth
hod
Exhib
bit 2.7 Deterrmining the Future Wortth using the FV() functioon
The Salv
vage
Value (S)) is
added baack
Note that the Initia

al Investmennt
serted as pos
is ins sitive and the
e
cash inflows are negative
n
FW
As can be seen from Exhibit 2.7, the same answer is arrived at by using the FV() function. As an
endnote, it should be mentioned that when using the FV() function in Excel, the user must use
blank spaces preceded and followed by commas(,) for the variables absent in the data set.
Ignoring the blank spaces might lead to Excel interpreting the formula variables differently than
intended, thereby resulting in an incorrect value of AW.
2.4 CALCULATING THE RATE OF RETURN FACTORS USING EXCEL

One of the most important components of time-value-of-money calculations is the rate of return
factors. The rate of return factors are used to move around a certain some of money over time,
either through spreading it over a given time period (the annuity factors) or to determine the
present worth of a future sum of money ( present worth factors). Although available as a part of
the Appendix of any standard engineering economics, this section of the workbook will discuss
in brief the mathematics behind the Present Worth, Annuity and the Future Worth factors.
Exhibit 2.8a and Exhibit 2.8b provide the reader with a Table showing the commonly used rate
of return factors, their mathematical formula and their Excel functions. The reason for dividing
the rate of return factors into two exhibits is that while Exhibit 2.8a takes care of the single and
annuities, Exhibit 2.8b provides information about the gradient series.
Exhibit 2.8a The Commonly Used rate of Return factors (without Gradients)
Name of Factor Factor Symbol Functional Format Factor Formula Excel Function
Present Worth Factors for Discounting
Single Payment P/F (P/F,i,N) 1 =PV(i,N,0,FV,0)

N
(1+i)
N
Uniform series (annuity) P/A (P/A,i,N) (1+i) -1 =PV(i,N,Pmt,0,0)
N
i(1+i)
Future Worth Factors for Compounding
N
Single Payment F/P (F/P,i,N) (1+i) =FV(i,N,0,PV,0)
N
Uniform Series (annuity) F/A (F/A,i,N) (1+i) -1 =FV(i,N,Pmt,0,0)
i
Annuity Factors for Uniform series
N
Capital Recovery A/P (A/P,i,N) i(1+i) =PMT(i,N,PV,0,0)
N
(1+i) -1
Sinking Fund A/F (A/F,i,N) i =PMT(i,N,0,FV,0)

N
(1+i) -1
Exhibit 2.8b Rate of Return factors with Gradients**
Name of Factor Factor Symbol Functional Format Factor Formula
Present Worth Factors with Gradient Series
Arithmetic Gradients P/G (P/G,i,N) (1+i)N - 1 N

2 N
i (1+i) i(1+i)N
1 – [(1 + G)/ (1 + i)]N

Geometric Gradients P/A1 (P/A1,i,G,N)
(1 - G)
Future Worth Factors with Gradients
Arithmetic Gradients F/G (F/G,i,N) (1+i)N - 1 N

i 2 i
Annuity Factors with Gradients
N N
Arithmetic Gradient A/G (A/G,i,N) i (1+i)N - 1
**AN IMPORTANT NOTE TO THE EXCEL USERS:
While determining the rate of return factors with Gradient series, it should be noted that
these functions are not built-in in Excel and therefore have to be calculated using the
mathematic formula provided in Exhibit 2.8b. Furthermore, most of these values are not
provided in the discrete factor tables available in the Appendix of most engineering
economics book. Therefore, when required to do so, the user must manually arrive at
the value using either a scientific calculator or the basic math functions available under
Excel.
Exhibits 2.8a and 2.8b depict the mathematical formulas that are associated with determining the
rate of return factors. Although the numerical value of most of these factors are available in any
standard engineering economics textbook, the students are advised to calculate the rate of return
factor values manually using the formula and subsequently cross check it with the corresponding
table value. This will provide the student with a clearer understanding of the rate of return factors
and its background. Excel’s built in basic math functions or any standard scientific calculator
should be sufficient to calculate these values.
2.5 DETERMINING THE INTERNAL RATE OF RETURN (IRR)

The final section of this chapter will devote its attention toward determining the Internal rate of
Return (IRR) using the built-in IRR() function available under Excel’s financial function.
Internal Rate of Return can be stated as the interest rate for which the present worth
(PW/NPV/PV) of a project is zero. Although the method of interpolation is commonly used to
determine the IRR, Excel’s built-in IRR() function can return the IRR value given the basic
financial data of a project like initial investment , annuities and salvage value. It should also be
noted here that the cash flows used to determine IRR, although not required to be even, must
occur at regular intervals, such as monthly or annually. The internal rate of return is the interest
rate received for an investment consisting of payments (negative values) and income (positive
values) that occur at regular periods19. The syntax for IRR() function in Excel is given in
Equation 2.5.
, … … … … … … … … … . 2.5
where values = the cash flows (including the initial investment and salvage value (if any))
associated with the project guess = a number that can be guessed as a close one to the final IRR
value. Example 2.6 provides the reader with a simple IRR calculation problem using both the
traditional interpolation method as well as using the IRR() spreadsheet function (Exhibit 2.9).
19
As stated earlier, the traditional method of determining the IRR of any investment involves the
use of interpolation. Interpolation is a commonly used mathematical technique that involves
constructing new data points within the range of a discrete set of known data points20. Hence,
since the value of IRR is the MARR for which the PW equals zero, the first task in determining
the IRR consists of determining an interest rate for which the value of the PW of the investment
is positive and another interest rate for which the value of PW of the investment is negative.
Thus, interpolating the two identified MARR values along with their corresponding values of
PW (one positive and the other negative) will provide the user with the interest rate for which the
investment will have a zero present worth, and hence the Internal Rate of Return. The commonly
used interpolation equation is shown as Equation 2.6.
……………………… (2.6)
where y1 and y2 are the interest rates and x1 and x2 are the PW corresponding to y1 and y2
respectively. And ‘y’ is the IRR value.
It should be noted here that the interpolated value of IRR must always lie within the two
determined interest rates, i.e., one that yields a positive value of PW and another that yields
a negative value of PW. This is evident from equation (6). It should also be noted that
providing the MARR value for any problem that solves for IRR is not mandatory, as the
value of MARR is not required to arrive at the value for IRR.
Now armed with the fundamentals of interpolation, let us try to solve Example 2.6 using the
traditional method, followed subsequently by solving the same problem using Excel’s IRR()
function. Equation (6) will be used as the interpolation equation while determine the IRR.
20
http://en.wikipedia.org/wiki/Interpolation
Example 2.6
Determine the IRR for an economic project that has an initial investment of
$1,500 and a periodic cash inflow of $500 for 5 years. The salvage value for the
project is $200, which is recovered at the end of the project’s life.
Answer
Interpolation Method
As stated earlier, in order to arrive at a meaningful interpolation process, it is required to

determine an interest rate for which the PW is positive and another interest rate for which it is
negative. Thus using a MARR (i) of 20%, the Present Worth of the project comes out to:
, , , ,
Hence,
$1500 $500 , 20%, 5 $200 , 20%, 5
Thus,
$1500 $500 2.9906 $200 0.4019
$ .
Additionally, using a MARR (i) of 25%, the Present Worth of the project comes out to,
, , , ,
Hence,
$1500 $500 , 25%, 5 $200 , 25%, 5
Thus,
$1500 $500 2.6893 $200 0.3277
$ .
Engineeering Econo
Now usinng the interp

polation equaation, the IR
RR amounts to:
t
Hence,
Excel Sp
preadsheet Method
M
hibit 2.9 Callculation of Internal Rate of Return using

Exh u Excel
Note that the

t initial
investment is entered as
a negative value
Note that the salvage

value is addedd to the
final year’s ca
ash flow
AN IMPORTANT NOTE
N TO THE
T EXCEL
L USERS:
While deetermining the Internal rate of Re eturn using Excel’s IRRR() function
n, the users are
advised to rememb ber that the initial invesstment is en
ntered as a negative number
n andd the
salvage value of the project iss added to the
t final yea ars cash flo
ow. This is indicated
i in
n
Exhibit 2.9
2
As seen from Exhibit 2.9, the same answer is arrived at by using the IRR() function. As an
endnote, it should be mentioned that the minor difference in the IRR values (22.29% vis-à-vis
22.17%) is due to the rounding off errors on the rate of return factors rather than mathematical
errors. Using the IRR() function can be a much less time consuming than its traditional
counterpart. In addition, the fact that the rate of return factors and the interpolation are
automatically incorporated by Excel makes it a much more convenient tool for calculating the
IRR for any engineering economic decisions.
2.6 CONCLUSION
The discussion on Internal Rate of Return (IRR) concludes the first part of the application of
spreadsheets in engineering economics. The rate of interest, time-value-of-money and the
Internal Rate of Return can be used to perform a plethora of engineering economic decisions,
namely from choosing among alternative capital projects and calculating the economic feasibility
of any financial decision to simple decisions like buying or leasing a car. Furthermore, these
functions can be used to estimate the cash flow of a project over a given period of time, which in
turn can indicate to any engineering manager the potential risk associated with the particular
project in question. However, the use of spreadsheets in engineering economics is not confined
to the boundaries of the topics discussed in this chapter. Excel spreadsheets can be used in many
other applications of engineering economics as discussed in Chapter 03.
Chapter 03: Depreciation and

Sensitivity Analysis
3.1 INTRODUCTION
The previous chapter (chapter 02) of the workbook was devoted toward a discussion of basic
engineering economics concepts along with spreadsheet applications of the same. However, the
domain of engineering economics is not confined to the concept of time value of money and
interest rates alone. Rather, these concepts form the basic infrastructure of engineering
economics, based on which a series of advanced topics has been generated over the years. This
chapter will venture into spreadsheet applications of some of the more advanced concepts of
engineering economics. This chapter will cover the application of spreadsheet for two very
important aspects of Engineering Economics – Depreciation and Sensitivity Analysis.
3.2 DEPRECIATION
Depreciation, in very simple terms, can be stated as the reduction in the value of an asset21. An
asset is any object of value, ranging from a car to any heavy machinery. In the context of
engineering economics, an asset is a piece of property whose value over its lifespan can be
evaluated or estimated. When an item is acquired for the first time, the value of the asset is
referred to as its cost22. However, the value of the asset starts to deteriorate over time and finally
reaches a stage where the item will completely lose its productive value. The value that an asset
retains after it has lost all of its productivity is referred to its ‘Salvage Value’. At any time,
between the purchase value and the salvage value, accountants estimate the value of an item
based on various factors including its original value, its lifetime, its usefulness (how the item is
being used, wear & tear, etc.) and so on. This is generally referred to as the ‘Book Value’ and
can be determined at any point of time in the asset’s useful life given the periodic depreciation
amount of the asset. Depreciation is a very important aspect of financial and strategic planning
and is extensively used in the industry for tax purposes as tax codes subject most capital
21
Blank, Leland T. and Anthony J. Tarquin, Engineering Economy (Sixth Edition), McGraw-Hill (2007)
22
Collections and Business functions in Excel, accessed from
http://www.functionx.com/Excel/Lesson11.htm
expenditures to depreciation. The amount of capital expenditure that may be deducted each year
may be computed by several depreciation methods. The IRS requires businesses to use a
depreciation system called Modified Accelerated Cost Recovery System (MACRS), which will be
discussed at length later in this chapter. However, the discussion of deprecation will not be
restricted to MACRS only, but will also cover two other depreciation methods, namely Straight
Line (SLN) Depreciation Method and Double Declining Balance (DDB) Depreciation Method
and the spreadsheet functions used to determine them.
3.2.1 Straight Line (SLN) Method

One of the simplest methods of depreciating any asset is the Straight Line (SLN) Depreciation
Method. The depreciation method derives its name from the fact that the book value of the asset,
following this method, depreciates linearly with time. In other words, in the case of SLN
Depreciation Method, the same percentage of an asset’s net value is simply deducted in each
year of an asset’s service life. The annual straight-line depreciation amount can be determined
using equation 3.1 given below.
… … … … … … . . 3.1
The straight-line depreciation amount can be determined by the =SLN() built-in financial
function available in Excel. The syntax of the =SLN() function is as follows,
, , … … … … … … … 3.2
where cost = initial cost of the asset, salvage = salvage value of the asset and life = useful life of
the asset. Example 3.1 provides the reader with a simple problem that determines the straight-
line depreciation of a depreciable asset.
Example 3.1
ABC Inc. purchased a machine for $100,000. The salvage value of the machine
after a useful life of 5 years is $20,000. Calculate the straight-line depreciation
for the machine including the depreciation amount and the book value. Illustrate
the answer in a tabular format.
Answer:
Engineeering Econo
The straight-line dep

preciation tabble is provided in Exhibiit 3.1
Exhibit 3.1
3 Straight Line
L Depreciiation using Excel
The cells are listted using

T
‘ffixed reference’ so that the
‘ffill’ function can
n be used
foor the rest of thee years.
3 shows thee depreciatioon for the asset in question. As seen,, the depreciiation amounnt is
Exhibit 3.1
calculateed using the Excel
E built in
i function ‘=
=SLN()’, whhich is nothiing but equattion 3.1. Thuus,
using Excel’s built in
n function prroves to be a very handyy tool in deteermining the straight-linee
depreciattion rate and
d subsequenttly, using firsst principles of mathemaatics, the yeaarly book value
of the deppreciable asset.
3.2.2 Do
ouble decllining bala
ance (DDB
B) Depreciiation Metthod
A more commonly
c used
u method of depreciattion is the Doouble Declinning Balancee (DDB)
Depreciaation Method
d which can be stated as the method of computinng depreciatiion in whichh the
k value of a capital assett is reduced by double thhe depreciatiion rate of thhe
written-ddown or book
straight line depreciaation methodd23. DDB is comprised
c of one of the methods undder acceleratted
23
http://ww
ww.businessd
dictionary.com
m/definition/double-declining-balance-d
depreciation.h
html
depreciation technique (Sum of Digits, MACRS, etc. being the others) and is a depreciation
method that is approved by the Internal Revenue Service (IRS) for tax purposes a plethora of
organizations. The ‘=DDB()’ function in Excel calculates double-declining balance depreciation
for an asset given its initial cost, the salvage value, useful economic life, the accounting period
for which depreciation is being calculated, and the factor at which the balance declines
(optional). The syntax of the =DDB() function in Excel is provided in equation 3.3.
, , , , … … … . . 3.3
Where cost = initial cost of the depreciable asset, salvage = salvage value of the asset, life =
useful economic life of the asset, period = the depreciation period (can be in years, months,
weeks, etc.) for which depreciation is being calculated and factor = factor at which the balance
declines (Excel sets this value to ‘2’ by default thus indicating a "double" declining balance).
Example 3.2 provides the readers with a simple problem that determines the DDB of a
depreciable asset.
Example 3.2
ABC Inc. purchased a machine for $100,000. The salvage value of the machine
after a useful life of 5 years if $20,000. Calculate the Double Declining Balance
(DDB) method of depreciation for the machine including the depreciation amount
and the book value. Illustrate the answer in a tabular format.
Answer:
The Double Declining Balance (DDB) depreciation table is provided in Exhibit 3.2
Engineeering Econo
Ex
xhibit 3.2 Double
D Declinning Balance Method Using Excel
The year forr which the

depreciationn is calculated
(1, 2… n)
The cells arre listed using

‘fixed refere ence’ so that the
‘fill’ function can be used
for the rest of the years.
The book value

v at year (n--
1) is the be
eginning value aat
year ’ n’.
The =DD
DB() in Exhibit 3.2 deterrmined the DDB
D rate forr the depreciiable asset inn question. It can
be seen from
f the exh
hibit that the year for whiich the depreeciation is caalculated hass to be
specificaally mentioneed (B12 in thhe DDB funcction for yeaar 1) in the =DDB
= functiion. In this
context, a relative refferencing off the cells woould prove too be fruitful as it can then convenienntly
use Exceel’s ‘drag-and
d-fill’ functiion. Finally, after the DD
DB depreciattion amount is determineed,
first princciples of maathematics caan be used too complete the rest of the table.
AN IMP
PORTANT NOTE
N TO THE
T EXCE
EL USERS:
A comm
mon convention when using do
ouble-decliining balan
nce deprec
ciation is to
o
t straight-line depre
switch to i time when straight depreciation
eciation at the point in
exceeds
s declining
g balance depreciatio
d DB function doesn't ma
on. The DD ake this swiitch,
but the VDB
V functio
on does. Th
he = VDB() function also is a veryy useful too
ol to determ
mine
the MAC
CRS rate fo
or any depre
eciable assset, which will
w be discu
ussed subse
equently.
3.2.2 Modified Accelerated Cost Recovery Systems (MACRS) Depreciation

Method
With the passing of the Tax Reform Act in 1986, the Modified Accelerated Cost Recovery
Systems (MACRS) method of depreciation was deemed the most acceptable format of
calculating depreciation of assets. The MACRS is the current method of accelerated asset
depreciation required by the United States income tax code and all assets are divided into classes
that dictate the number of years over which an asset's cost will be recovered24. The MACRS
depreciation rates can be determined using the’ =VDB’ function in Excel which stands for
‘Variable Declining Balance’ (hence, VDB) and returns an asset’s depreciation for the specified
period. It also includes, like MACRS technique, partial periods and the balance declining at the
rate specified for that particular period. The Excel =VDB function is defined as,
, , , , , , … 3.4
Where cost is initial cost of the asset, salvage is salvage value of the asset (MACRS assumes a
salvage value of 0), life is the useful life of the asset, start period is the starting period for the
depreciation, end period is the ending period for the depreciation, factor is the rate at which the
balance declines and no switch is a logical value specifying whether to switch to straight-line
depreciation when depreciation is greater than the declining balance calculation25.
According to Eschenbach & Lavelle26 the =VDB function in Excel can be used to calculate the
MACRS depreciation of an asset if the syntax of the equation is modified slightly. The modified
=VDB() function as stated by Eschenbach & Lavelle 26 is given in equation 3.5
, , , , . , . , , . . 3.5
Equation 3.5 is a slightly modified version of the standard =VDB() function as provided by
Excel. The =VDB() function can be used to calculate the MACRS depreciation if the following
modifications are made to the parent equation 26.
24
http://en.wikipedia.org/wiki/MACRS#MACRS
25
26
Eschenbach, ted G. and Jerome P. Lavelle, “MACRS Depreciation with a Spreadsheet Function: A
Teaching and Practice Note,” The Engineering Economist, Vol. 46, No. 2 (2001), pp. 153-161
• Salvage Value is considered to be zero since MACRS assumes no salvage value

• The life should consist of a recovery period of 3,5,7,10,15 or 20 years
• The ‘start period’ and the ‘end period’ arguments are from (year – 1.5) to (year – 0.5) as
MACRS uses a ½ year convention for the first year. Thus, the first year has 0 to 0.5
year's worth of depreciation, and the second year starts where the first year stops. When
writing the spreadsheet function either the first and last periods must be edited
individually, or start-period must be defined with a minimum of 0 and ‘end period’ with a
maximum of life (as defined in equation 3.5). For convenience, the students are advised
to use the MAX and the MIN function (as shown in equation 3.5) in order to avoid
editing the periods individually.
• The ‘factor’ in the equation should always be 2 for MACRS
It should be noted that in order to achieve a minimum value of 0 years, the MAX
function with one value of 0 is used. The MAX and the MIN functions are used to avoid
the inconvenience of entering the periods individually. For example, for any asset
having a useful life of 5 years (say), for year one, MAX (0, 1-1.5) = 0 which is the
desired result for the first period (the other value being 1-1.5 = -0.5). Similarly, the MIN
function with one value of life is used to achieve a maximum value of life. Again, say for
year 1, the MIN (1-0.5, 5) = 0.5, which is the desired result.
Armed with the basic ideas about using the =VDB() function to determine the MACRS of any
depreciable asset, the next stage will be to demonstrate the equation with an illustrative example.
At this time, Example 3.2 is revisited and the problem is solved using the modified =VDB()
equation (Equation 3.5).
Exhibit 3.3 illustrates the MACRS depreciation calculation using the Excel’s =VDB() function.
Engineeering Econo
Exhib
bit 3.3 Deterrmining MACRS Using Excel’s =VD
DB() Functioon
MACCRS considers
Salv
vage Value as ze
ero
The =VD
DB() in Exhibit 3.3 deterrmined the MACRS
M deppreciation am
mount for thee depreciablee
asset in question.
q It can
c be seen from
f the exhhibit that the year for which the depreeciation is
calculateed has to be specifically
s m
mentioned (ccell B12 in the
t VDB funnction for yeear 1) in the
=VDB fuunction. In th
his context, a relative refferencing off the cells woould prove too be fruitful as
one can then
t conveniiently use Exxcel’s ‘drag--and-fill’ funnction. Finallly, after the MACRS
depreciattion amount is determineed, first principles of maathematics caan be used too complete the
t
rest of thhe table. Add
ditionally, the depreciatioon amount (ccolumn D inn exhibit 3.3)) is the samee as
the initiaal cost multip
plied by the depreciation
d n rate for that particular year.
y As an additional
a
resource to the users,, the MACR
RS table is prrovided in Exxhibit 3.4. The
T depreciattion amountss in
column D of exhibit 3.3 can be crosschecked
c d by the readders using thee MACRS raates provideed in
exhibit 3.4. Howeverr, the readerss are advisedd to use the formula
f rathher than lookking up the
individuaal percentagees from Exhhibit 3.4.
Exhibit 3.4 MACRS Depreciation Rate Table (All values in percentages)
Recovery 3-Year 5-Year 7-Year 10-Year 15-Year 20-Year

Year Property Property Property Property Property Property
1 33.33 20.00 14.29 10.00 5.00 3.750
2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.81 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52 12.49 11.52 7.70 6.177
5 11.52 8.93 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55 5.90 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12 5.90 4.461
13 5.91 4.462
14 5.90 4.461
15 5.91 4.462
16 2.95 4.461
17 4.462
18 4.461
19 4.462
20 4.461
21 2.231
The discussion on MACRS depreciation using the modified =VDB() equation concludes the
discussion on the use of Excel to determine the depreciation of an asset. A clear concept of
depreciation is of utmost importance to any organization as well as to any engineering managers
responsible for selecting among capital projects. Furthermore, an in-depth knowledge about
depreciation considerably aids any organization in efficiently dealing with any after tax analysis.
3.3 SENSITIVITY ANALYSIS
3.3.1 Overview of Sensitivity Analysis

Sensitivity Analysis can be stated as the study of the effect of changes in the output of a model,
qualitatively or quantitatively, to different sources of variation in the model’s inputs
(parameters)27. In simple terms, a sensitivity analysis reveals how much the Figure of Merit
(generally, NPV or IRR) will vary in response to a variation in one or more input variables.
Sensitivity Analysis is usually performed as a series of iterations where the decision maker sets
different values of the inputs in order to assess the change in the behavior of the output. The
inputs that are varied to assess their sensitivity can be both economic (cost, revenue, etc.) or non-
economic (time, interest rate, etc.) in nature. By showing how the model behavior responds to
changes in parameter values, both economic as well as non-economic, sensitivity analysis can
prove to be a very useful technique in the area of decision making. Knowledge about the degree
of sensitivity of any input variables in a project can substantially aid any organization to make
more accurate decisions on the selection of any capital projects or financial investment. It also
helps the top management of any organization to assess (and thereby monitor) the relative
effectiveness of the set of inputs that govern the final economic decision for any particular
project.
3.3.2 Sensitivity Analysis Using Excel Spreadsheet Functions

The premise of any sensitivity analysis problem lies in the ‘what-if?’ concept of decision
making. Excel spreadsheets, through the use of the built-in function called ‘Table’ (or Data
Table in case of Excel 2007), incorporates the idea of ‘what-if?’ and thereby can be successfully
used to determine the impact of any input parameters to the final value of the output. The ‘Table’
function in Excel 2007 can be found under the ribbon titled ‘data’ and is shown in Exhibit 3.5.
27
Definition provided by the forum of sensitivity and uncertainty analysis. Accessed from http://sensitivity-
analysis.jrc.ec.europa.eu/default2.asp?page=sa
Engineeering Econo
Exxhibit 3.5 Daata Table in Excel

E 2007
Now thatt the readers are converssant with the location of the Data Tabble in excel 2007 (in casse of
Excel 2003, this is lo
ocated under the ‘Data’ drop
d down menu),
m the neet stage will be to solve a
simple prroblem on seensitivity analysis using the Table fuunction in Exxcel. Exampple 3.3 providdes
the readeers with a sim
mple problem
m on sensitivvity analysiss.
Examplee 3.2
ABC Incc. is plann

ning to inve
est in a fin
nancial projject that is
s worth $100,000. Th
he
project will yield annual
a rev
venue of $2
20,000 an
nd has a pllanning ho
orizon of 10
0
years. The
T MARR
R of the proj
oject is 20%
%. Determiine the imp
pact of (a) varying
v th
he
initial in
nvestment by -10% to
t 10% (at an increme
ent of 5%),, (b) the an
nnual reven
nue
from -10
0% to + 10
0% (at an in
ncrement of
o 5%) and
d the time horizon
h fro
om 8 – 12
years. Consider
C Present
P Wo
orth as the
e figure of merit
m (FOM
M)
Answer
In order to
t solve this problem, thhe Data Table function avvailable in MS
M Excel waas used. The
problem requires the readers to determine
d thee impact of the
t variabless on the Pressent Worth of
o the
investmeent decision. Thus, the first step in soolving the prroblem was to
t determinee the Presentt
Worth (P
PW) of the prroject basedd on the data provided in the problem
m statement, i.e., the initiial
investmeent, the MAR
RR, the annuual revenue and
a the plannning horizonn. This will serve
s as the base
b
case of thhe sensitivity
y analysis prroblem. Thiss can be donee by using thhe =PV() forrmula that was
w
Engineeering Econo
discussedd in details in
n chapter 2 of
o the text. Exhibit
E 3.5 shhows the Preesent Worthh (PW) of thee
base casee of the projeect.
Exhibit 3.5 Presennt Worth forr the Base Caase
Now thatt the base caase of the invvestment prooject has been determined, the next stage
s is to usse the
‘Data Taable’ function m the sensitivvity analysis on the threee inputs stateed in the
n to perform
problem,, namely, iniitial investmeent, the annuual revenue and
a the plannning horizonn. However,
certain im
mportant poiints must be strictly abidded by while constructingg the sensitivvity tables using
u
the ‘Dataa Table’ funcction of Exceel 2007. Althhough the reeaders are suuggested to refer
r to any
standard Excel manu
ual in order to gain furtheer knowledgge about Excel Data Tablles, there aree
some bassic points thaat are worthw t the studennts (as givenn in the following
while to enliist as an aid to
page):
• While constructing the sensitivity table, it is imperative that the base case
calculation is done at the beginning. The primary reason for this is that for a
successful implementation of the ‘Data Table’ function, the cells from the base
case solution should be relatively referred (as indicated by arrows in Exhibit 3.6
a, b and c).
• Additionally, while selecting the data range in the table function, the header rows
should not be included in the selection range under any circumstances. Including
the header row in the data range will result in Excel calculating the wrong values
for the output.
• The values of the input parameters (say, the values of initial cost from a range of
-10% to +10%) should be hardcoded (and not cell-referred / mathematically
calculated) while using the ‘Data Table’ function. Hence, the readers are strongly
advised to use the Excel function of ‘paste special’ – ‘values’ if they want to
transfer the data from any mathematically calculated source.
• Since the common convention is to arrange the data by columns, in the Data
Table window, the cell of the argument for which the sensitivity is studied should
be mentioned as a column input cell.
Exhibit 3.6 (a, b and c) shows the results of the sensitivity analysis using the ‘Data Table’
function. The tables are provided on the next page.
Engineeering Econo
Exh
hibit 3.6 Sennsitivity Anaalysis Using the
t Data Tabble Functionn
Ex
xhibit 3.6a. Sensitivity of
o Initial Invvestment (Coost) on PW
Exhibit 3..6b. Sensitivvity of Annuaal Revenue on

o PW
Engineeering Econo
Exhibit 3.66c. Sensitiviity of Planniing Horizon on PW
The data from exhibiit 3.6 indicattes to any deecision makeer the changees in the Pressent Worth with
w
respect too the changees in various input variabbles (initial cost,
c annual revenue andd planning
i this case). These valuees can be useed by the decision makeers to arrive at
horizon in a sensitivityy
ratios, whhich might serve
s as an inndicator of relative
r sensiitivity among the differeent input
variabless, as will be discussed
d latter.
Althoughh the PW vallues in Exhibbit 3.6 are acccurate, the students cann verify the values
v obtainned
using thee traditional method
m to determine sennsitivity. Addditionally, thhe data obtaiined from thhe
sensitivitty table can be
b represented graphicallly as a ‘Relaative Sensitiivity Graph, which will be
b
discussedd in the nextt section.
3.3.3 Re
elative Sen
nsitivity Graph
G usin
ng Excel
The relattive sensitiviity graph is considered
c a one of the most comm
as mon and usefu
ful diagrams for
displayinng the resultss of a sensitiivity analysiss in which more
m than onne variable iss examined288.
The grapphing ability of Excel as discussed inn Chapter 01 of the workkbook servess as a very usseful
tool in thhe constructio
on of the rellative sensitiivity graph. Excel’s
E ‘scattter plot’ funnctionally located
under thee ‘Insert’ ribbon in Excel 2007 (and ‘Insert’ mennu under Exccel 2003) is used
u to draw
wa
28
Lang, Hans
H J. and Donald
D N. Merrino, The Sele
ection Processs for Capital Projects, Joh
hn Wiley & So
ons
(1993)
Engineeering Econo
relative sensitivity
s grraph. Exhibit 3.7 shows a relative sensitivity graaph on two of
o the three
parameteers used in ex
xample 3.2 – the initial cost
c and the annual revenue – on thee figure of merit
m
(PW in thhis case).
Exh
hibit 3.7 Rellative Sensittivity Graph
As seen from
f Exhibitt 3.7, the deccision makerr can have a clear idea abbout the deggree of sensittivity
of any paarticular paraameter by loooking at thee slope of thee graph. The steeper the slope of anyy
sensitivity graph, the more sensitive that particular parameter. For example, from Exhibit 3.7, it
can be stated with a fair degree of certainty that the annual revenue is more sensitive than the
initial cost for the project described in example 3.2. Finally, the base case is the value that
corresponds to 0% in the graph (Exhibit 3.7).
3.3.4 Determining the Sensitivity Ratio

Tabular representation of sensitivity analysis is often used to supplement the graphical
representation, especially in situations involving a large number of input parameters. The
sensitivity ratio can be calculated from the tabular representation and is given by the expression
provided in Equation 3.6.
… … … . . 3.6
The percentage changes in the figure of merit as well as the parameter can be calculated using
basic mathematics. The sensitivity ratio provides the decision maker with an accurate
quantitative measure of the degree of sensitivity. The higher the value of the sensitivity ratio, the
more sensitive the particular parameter is to the output. Hence, the sensitivity ratio, in addition to
the relative sensitivity graph, can provide the decision maker with valuable insights in regard to
making strategic and financial decisions.
3.4 CONCLUSION
The discussion on depreciation and sensitivity analysis concludes this chapter on the application
of spreadsheets to solve advanced engineering economics problems. The knowledge on the use
of spreadsheet to solve basic engineering economic problems like the time value of money,
coupled with the knowledge of asset depreciation and sensitivity analysis, can go a long way in
assisting the engineering (and financial) manager to make more rational choices in regards to
project selection in his / her organization along with making sound investment decisions.
However, it should be clearly stated at this point that the topics covered in this workbook do not
holistically cover all nooks and crannies of engineering economics and the spreadsheet
application of the same. It rather focuses its attention toward providing the reader with
knowledge of the most widely used functions of engineering economics. Appendix 1 of the text
will cover, in brief, some of the additional topics of engineering economics. Furthermore, any
reader who wishes to gain more knowledge of engineering economics and the spreadsheet
applications in the various domains of financial management are welcome to refer to any
standard textbook on engineering economics and Excel applications. Appendix 2 of this text
provides the reader with a list of widely used textbooks on engineering economics and Excel for
further reference.
Appendix 1: Additional Topics on

Engineering Economics
A 1 SOME ADDITIONAL FUNCTIONS OF TIME VALUE OF MONEY
Although most of the important functions with respect to the interest rate and time value of
money was discussed in Chapter 02 of this workbook, it was thought worthwhile to have a brief
discussion on three more financial functions of Excel that deal with loan repayments and
amortization. Every organization borrows a certain amount of money from the venture capitalist
(or financial institutions) in order to finance their project, which they subsequently pay back over
a certain period of time, and at a certain rate of interest. As a result, having knowledge about the
interest rate and the principal payment associated with the borrowed capital will prove to be
helpful to any managerial decision maker in an organization. The following sub sections will
discuss three basic financial functions in Excel that are associated with borrowing capital funds
and subsequently repaying them.
A 1.1 Interest Rate of an Annuity

The interest rate for an annuity can be calculated using the Excel’s =Rate() function. The
=Rate() function returns the interest rate per period of an annuity29. The syntax of the =Rate()
function in Excel is provided in equation A1.
, , , , , ……………..
Where, nper = number of periods, pmt = annual payment amount, PV = present value, FV =
future value and Type = numbers 0 & 1 that indicates when the payments are due (a value of 0
indicates a EOY payment whereas a value of 1 indicate the payment is being made at the
beginning of year). Example A 1.1 provides the readers with a simple application of the =Rate()
function in Excel.
29
http://office.microsoft.com/en-us/excel/HP052092321033.aspx
Engineeering Econo
Examplee A 1.1
Mr. ABC
C wants to
o invest $2
20,000 and
d would lik
ke it to dou
uble within
n the next 5
years. What
W perio
odic interes
st rate doe
es Mr. ABC
C need to receive
r in order
o to ge
et his
money doubled within
w the given
g time period?
Answer
In order to
t solve this problem, we
w use the =R
Rate() functiion in Excel.. The rate funnction is
providedd in Equation
n A1. The soolution is givven below in Exhibit A1..
Exhiibit A1. Calcculation on Interest Rates
The Exp pected Amount

is treate
ed as the FV
The Initial Amo

ount is taken
as negative as it is
considered as a cash
outflow y Exceel
The e annual paymeent is

con nsidered as zero
o since
it is
s not mentionedd in the
prooblem
Thus, as seen from Exhibit

E A1, Mr.
M ABC hass to receive an
a annual innterest rate off 14.87% inn
order forr his money to
t double in 5 years.
A 1.2 Am
mount paiid as Interrest during
g a Period
d
The amouunt of intereest that is paiid on any loaan is an impoortant conceern to the borrrower. Exceel’s
=IPMT() function aiids any invesstor in assessing the inteerest that he/she has to paay on the am
mount
of moneyy loaned. Kn
nowing the periodic
p interrest rate prom
mpts any invvestor to arriive at decisioon
regardingg borrowing funds from any particullar venture capitalists.
c O the other hand,
On h any
financial institution can
c assess thhe interest raate to decide whether the loan is wortth providingg.
The syntaax for excel’’s =IPMT() is given in equation
e A2.
, , , , , ……………..
Where, rate= interest rate per period, per= is the period for which the interest is calculated,
nper = is the total number of payment periods in an annuity, PV = Present Worth, FV = Future
Worth and Type= is the number 0 or 1 and indicates when payments are due. If type is omitted, it
is assumed to be 0. Example A1.2 provides the reader with a simple example of the calculation
of Interest on Loans using Excel Spreadsheets.
Example A 1.2
An investor borrows $2,500 at an interest rate of 8% annually. Using equation

A2, determine the interest on borrowed capital that the investor has to pay for
year 1 and 2.
Answer
Interest for Year 1:
. , , , $ .
Interest for Year 2:
. , , , $ .
The =IPMT() function in Excel returns a negative value for the interest amount. The
rationale behind this negative value is that interest amount paid is considered as a cash
outflow.
A 1.3 Principal Payment for a Loan

Much like the amount of periodic interest to be paid on a loan, it is of vital importance to any
investor to know the periodic principal payment on the loan. Excel’s =PPMT() aids an investor
to determine the periodic principal repayment on the loan. The =PPMT() function in excel
returns the payment on the principal for a given period for an investment based on periodic,
constant payments and a constant interest rate30. The syntax of the =PPMT() function in excel is
provided in Equation A3.
, , , , , ………
Where, rate = interest rate per period, per = the period for which the interest is calculated, nper =
is the total number of payment periods in an annuity, PV = Present Worth, FV = Future Worth
and Type= is the number 0 or 1 and indicates when payments are due. If type is omitted, it is
assumed to be 0. At this point, example A1.2 is revisited and the principal payment is calculated
based on the problem data. Equation A3 is used to determine the principal payment on the loan
proceeds.
Principal for Year 1:
. , , , $ .
Principal for Year 2:
. , , , $ .
The =PPMT() function in Excel returns a negative value for the principal payment. The
rationale behind this negative value is that principal amount paid on the loan is
considered as a cash outflow.
A 1.4 Determining the Number of periods of an Investment

Excel’s =NPER() function can be used to calculate the number of periods of any investment of a
loan. the =NPER() function returns the number of periods for an investment based on periodic,
constant payments and a constant interest rate. The syntax of the function is given in Equation
A4.
, , , , ………..
30
http://office.microsoft.com/en-us/excel/HP052092181033.aspx
Engineeering Econo
Where, rate = interesst rate per peeriod, per = is

i the period for which thhe interest iss calculated,
nper = is the total num
mber of payyment periodds in an annuuity, PV = Prresent Worthh and Type=
= is
the numbber 0 or 1 an
nd indicates when
w paymeents are due. If type is om
mitted, it is assumed
a to be
b 0.
Example A1.3 provid
des the readeer with a sim
mple problem
m of calculating the numb
mber of periodds in
an investtment.
Examplee A 1.1
A friend
d of yours lends you $20,000. You end up
u paying $30,000
$ a an annual
at
interestt rate of 12
2% with a monthly payment off $120. Wh
hat is the number
n of
paymen
nts that arre required
d to pay offf the loan?
?
Answer
The num
mber of period
ds can be caalculated usinng equation A4. This is provided
p in Exhibit A2.
Exhib
bit A2. Calcuulation of paayment Periood
Hence, as seen from Exhibit A2, the number of periods required

r to pay
p off the looan is 27.33
months (approximateely 28 monthhs).
While using the =NPER() function in Excel, it should be noted that there are negative
signs imposed before the periodic payment rate and the amount of funds borrowed. The
rationale behind this negative value is that those are considered as a cash outflow.
Additionally, the interest rate is divided by 12 in order to convert the annual interest to a
monthly interest rate.
Appendix 2: List of Selected

Textbooks on Engineering
Economics and Financial
Application of Excel
NAME AUTHOR (S) PUBLISHER
Engineering Economic Analysis Donald G. Newman, Ted G. Oxford University
Eschenbach and Jerome P. Lavelle Press
Engineering Economy: Applying Theory Ted G. Eschenbach Oxford University

to Practice Press
Contemporary Engineering Economics Chan S. park Prentice Hall
Fundamentals of Engineering Chan S. park Prentice Hall

Economics
Shaum’s Outline of Engineering Jose A. Sepulveda, et al. McGraw-Hill

Economics Companies
Basic of Engineering Economy Leland T. Blank and Anthony J. McGraw-Hill

Tarquin Companies
Engineering Economy Leland T. Blank and Anthony J. McGraw-Hill

Tarquin Companies
The Selection Process for Capital Project Hans J. Lang & Donald N. Merino John Wiley & Sons
Engineering Economy Willian G. Sullivan, Elin M. Wicks and Prentice hall

C. Patrick Koelling
Engineering with Excel Ronald W. Larsen Prentice Hall
Business Analysis with Microsoft Excel Conrad Carlberg Que
Principals of Finance with Excel Simon Benninga Oxford University

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Engineering Economics Using Excel 1

Anirban Ganguly, MBA, PhD

project is acknowledged. Acknowledgement goes out to Ms. Anne Carrigy, Masters

to see the light of the day.

with being a constant source of inspiration and guidance.

Anirban Ganguly, MBA, PhD

2.1 INTRODUCTION .................................................................................................................................................17

CHAPTER 03: DEPRECIATION AND SENSITIVITY ANALYSIS ..................................................................................38

APPENDIX 1: ADDITIONAL TOPICS ON ENGINEERING ECONOMICS .....................................................................56

A 1.2 Amount paid as Interest during a Period .................................................................................................. 57

Chapter 1: Overview of MS Excel®

Microsoft Excel is typically comprised of organizational units called “workbooks”3. A standard

applications of engineering economy. Excel is extensively used in the domain of engineering

1.2 EXCEL 2007 BASICS

1.2.1 Excel Ribbon

Exhibit 1.1 Excel 2007 Ribbon

Excel 2007 Ribbon

1.2.2 Working with an Active Cell

Exhibit 1.2 Active cell in Excel 2007

Exhibit 1.3 Labels, Numbers and Formulas

[F2] key can be used

Thee formula bar and

1.2.3 Some useful built­in

Microsofft Excel com

The entirre set of buillt-in functionns in Excel 2007

• SUM: Adds all cells in the argument

As an endnote, it should be worthwhile to have a section devoted towards a brief discussion on

1.2.4 Graphing with Excel9

Exhibit 1.6 Locationn of availablle charts in Excel

Scatter chharts can be displayed with

7. Format the graph according to the requirements and convenience.

1.3 Managing Your Worksheet and Workbook

Chapter 02: Interest rates, Time Value

2.2 USING SPREADSHEET FOR CALCULATING INTEREST RATES

2.2.1 Periodic and Nominal Interest Rate

2.2.2 Effective Annual Interest rate

Exhibit 2.2 Calculating Nominal Rate using Excel

AN IMPORTANT NOTE TO THE EXCEL USERS:

2.3 USING SPREADSHEETS TO CALCULATE THE TIME VALUE OF MONEY

Exhiibit 2.3 Finaancial Functiions in Exceel

2.3.1 Determining Present Worth (NPV() Function)

AN IMPORTANT NOTE TO THE EXCEL USERS:

Exhibit 2.4 Calculating NPV using Excel

The initial investment is

The salvage value of $200 is

2.3.2 Difference Between NPV() and PV() Functions

Exhibit 2.5 Solving Example 2.3 using the PV() Function

Note that the Cash Flows are

Important: Since there is no

Important: Since there is no

2.3.3 Calculating the Annual Worth (PMT() Function)

AN IMPORTANT NOTE TO THE EXCEL USERS:

Exhibiit 2.6 Determ

Notee that the Iniitial Investme

Impo ortant: Since

Impo ortant: Since

2.3.4 Calculating the Future Worth (FV() Function)

AN IMPORTANT NOTE TO THE EXCEL USERS:

Note that the Initia

2.4 CALCULATING THE RATE OF RETURN FACTORS USING EXCEL

Present Worth Factors for Discounting

Single Payment P/F (P/F,i,N) 1 =PV(i,N,0,FV,0)

Future Worth Factors for Compounding

1.2.3 Some useful builtin