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ENGR 390 Winter 2007 Section 1

Lecture 1

ENGR 390 – Sect. 001


• Meetings:
•T, R: 11:00 – 12:20

• Instructor:
•Prof. Sundar V. Atre
•Phone: 737-8272
•E-mail: sundar.atre@oregonstate.edu
•Office Hrs: T,R 1:00 – 3:00 p.m.

• Class website:
BLACKBOARD

Central Idea

Money has a time value


because it can earn more
money over time (earning
power).
Time value of money is
measured in terms of interest
rate.
Interest is the cost of money—
a cost to the borrower and an
earning to the lender

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Course Learning Objectives

1. Be able to perform economic


calculations involving the time value of
money using standard formulas and
tables.

2. Be able to compare alternatives using


net present worth, equivalent annual
worth, internal rate-of-return, and
benefit-cost analysis.

Course Learning Objectives


3. Be able to apply the principles listed in
(1) and (2) above in applications such
as economic life, replacement analysis,
benefit/cost analysis, breakeven
analysis, lease vs. buy and inflation.
4. Be able to apply depreciation and
income tax principles to the
comparison of alternatives using after
tax cash flows.

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Other Course Objectives


1. Prepare economic reports
following correct engineering
economy procedures.

2. Solve problems in a manner


expected on the Fundamentals
of Engineering exam.

3. Evaluate personal finance


choices.

Course Structure
• Grading: Percentage

• Weighting:
•Assignments 25%
•Exam 1 25%
•Exam 2 25%
•Final 25%

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Assignment Structure
• Format for each problem:
•Find (objective)
•Given (starting values)
•Diagram (cash flow)
•Soln. (steps to solve):
•Write equation in Table Factor Form
•Insert values
•Double underline answer and units

• Not graded if illegible!

Policies
• Assignments:
•Due at class (Thursday), all equal wt.
(%)
•No late work

• Exams:
• One 8.5” x 11” Notecard
•Closed text, etc.
• No make-up Midterms
•Add extra weight to Final
•No make-up Final

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Typical Decisions
• Cost reduction
(e.g., equipment, tooling, facility
layout)

• Plant expansion
(e.g., to increase capacity, sales)

• Equipment selection
• Lease or buy decisions
• Make or buy decisions
• Equipment replacement

Engineering Econ Process


Manufacturing Profit

Planning Investment

Marketing

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Lecture 1

Engineering Econ Process


• Identify alternative uses for limited
resources

• Obtain needed data (not this class)

• Analyze data to determine preferred


alternative:

•Screening decisions
(meets minimum acceptable?)

•Preference decisions
(Select from competing alternatives)

Lets Get Started…


• Paid $100,000 for a piece of
equipment - 3 years ago
• Don’t need it now
• Option 1 – Sell it for $50,000
• Option 2 – Lease it for $15,000
for 3 years. Sell it for
$10,000 at the end of
the lease.
Note:
Leases typically pay at the beginning of a time period.
Loans typically pay at the end of a time period.

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Cash Flow Diagrams


OPTION 1:
$50 k

N= 0 1 2 3 YRS

F3?
OPTION 2:
$15 k $15 k $15 k
$10 k

N= 0 1 2 3 YRS

F3?

The Question
• Under what conditions would I be
indifferent between Options 1 & 2?
• Indifferent means:
– Have the same amount of
money at same point in time.
– In this case, 3 years from now.
• Interest Rates…
– Annual
– Compounding annually

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Future Value in 3 years…

I% Option 1 Option 2
2.5% $53,844 $57,288
5.0% $57,881 $59,652
7.5% $62,115 $62,094
10% $66,550 $64,615
At what interest rate, am I indifferent
between the two options?
• At an interest rate just a little less than 7.5%

Questions?
• What about the $100,000?
•The $100 K is irrelevant - it is a sunk cost, and makes no
difference in the decision at this point in time.

• How do we select between the options?


•We need to know under which conditions we would be
economically indifferent - we have the same amount of
money at the same time - and then if the conditions are
better for one option, we will select that option.

• Any other factors?


•Since we need to account for the time value of money - we
need to know the interest rate and the compounding period.

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Option 1
50,000 now
i = 10% compounded annually

F1 = 50,000 + 50,000 (.10) = 55,000


F2 = 55,000 + 55,000 (.10)
= 50,000 (1 + .10)2 = 60,500
F3 = 60,500 + 60,500 (.10)
= 50,000 (1 + .10)3 = 66,550

Generalizing …
P = Present value beginning
of first period.
FN = Future value at end of N
periods in the future.
i = interest rate
FN = P (1 + i)N
= P (F/P,i,N)
(F/P,i,N) = (1+i)N

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Standard Factors Used to


Solve ECON Problems
( F | P, i, N) Î Find F Given P
( P | F, i, N) Î Find P Given F
( F | A, i, N) Î Find F Given A
( A | F, i, N) Î Find A Given F
( P | A, i, N) Î Find P Given A
( A | P, i, N) Î Find A Given P
( P | G, i, N) Î Find P Given G
( A | G, i, N) Î Find A Given G
( F | G, i, N) Î Find F Given G

Tables…

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Tables…

Future Given Present


† P is the present value at Time 0
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate

F?

0 1 2 3 N

F = P(F/P,i,N)

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Tables…

i=

F3 = 50
50,000(F|P,i,N)
000(F|P,i,N) = 50
50,000(F|P,10%,3)
000(F|P,10%,3) = 50
50,000(1.3310)
000(1.3310) = $66,550

Present Given Future


† P is the present value at Time 0
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

0 1 2 3 N

P?

P = F(P/F,i,N)

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Future Given Annual


† A is the equal annual value over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

F?

0 1 2 3 N

F = A(F/A,i,N)

†Note: cash flow A does not have to be annual, just periodic

Annual Given Future


† A is the equal annual value over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

0 1 2 3 N

A?

A = F(A/F,i,N)

† Note: cash flow A does not have to be annual, just periodic

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Present Given Annual


† A is an equal annual flow over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† P is the present value at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period

P?

0 1 2 3 N

P = A(P/A,i,N)

† Note: cash flow A does not have to be annual, just periodic

Annual Given Present


† A is the equivalent annual flow over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† P is the present value at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period

0 1 2 3 N

A?

A = P(A/P,i,N)

† Note: cash flow A does not have to be annual, just periodic

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Present Given Gradient


(Linear)
† G is the linear gradient over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 2)
† P is the present value of the flow at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period
P?

0 1 2 3 N

P = G(P/G,i,N)

† Note: cash flow is periodic, no flow at Time 1, flow of G at Time 2

Future Given Gradient


(Linear)
† G is the linear gradient over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 2)
† F is the future value of the flow at Time N
„ (N periods in the future)
† i is the effective interest rate for each period
F?

0 1 2 3 N

F = G(F/G,i,N)

† Note: cash flow is periodic, no flow at Time 1, flow of G at Time 2

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ENGR 390 Winter 2007 Section 1
Lecture 1

Annual Given Gradient


(Linear)
† G is the linear gradient over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 2)
† A is the annual equivalent of the gradient flow
„ (annual flow starts at Time 1, goes through Time N)
† i is the effective interest rate for each period

A?
0 1 2 3 N

A = G(A/G,i,N)

† Note: cash flow of G starts at Time 2, flow of A starts at Time 1

Standard Factors Used to


Solve ECON Problems
( F | P, i, N) Î Find F Given P
( P | F, i, N) Î Find P Given F
( F | A, i, N) Î Find F Given A
( A | F, i, N) Î Find A Given F
( P | A, i, N) Î Find P Given A
( A | P, i, N) Î Find A Given P
( P | G, i, N) Î Find P Given G
( A | G, i, N) Î Find A Given G
( F | G, i, N) Î Find F Given G

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