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Engineering Economics

CSE/EE-301
Introduction
General Overview
 Back Ground.
 Intro & Importance.
 Students attitude.
 Attendance policy
 Tests policy
 Sessional marks policy.
Course Outline
Textbook: Engineering Economy
Sixtth Edition
By Leland Blank
Anthony Tarquin
Reference Book:
Engg Economy by E. Paul DeGarmo
Chapters (tentative)
 Foundation of Engineering Economy
 Factors: How Time and Interest Affect Money
 Present Worth Analysis
 Annual Worth Analysis
 Rate of Return Analysis: Single Alternative
 Rate of Return Analysis: Multiple Alternatives
 Breakeven Analysis
 Effect of Inflation
 Depreciation Methods
 After-Tax Economic Analysis
Engineering
It is a profession in which a
knowledge of the mathematical
and natural sciences gained by
study, experience, and practice is
applied with judgment to develop
ways to utilize, economically, the
materials and forces of nature for
the benefit of mankind
Engineering Economy Definition
 Engineering economy involves formulating, estimating
and evaluating the economic outcomes when
alternatives to accomplish a defined purpose are
available.
 Engineering economy is a collection of mathematical
techniques that simplify economic comparison.
 A discipline that involves the systematic evaluation of
the cost and benefit of proposed technical projects.
Importance
 For Engineering Activities

 For Public Sector Projects and


Government Agencies

 For Individuals
Principles of Engineering Economy
 Develop the Alternatives
 Focus on the Differences
 Use a consistent viewpoint
 Use a common unit of measurement
 Consider all relevant criteria
 Make uncertainty explicit
 Revisit your decisions
Role of Engineering Economy in
Decision Making
 Techniques and Models of engineering economy
assists people in making decisions
 The time frame of engineering economy is primarily
the future
 Estimates involves the three essential element
 Cash Flows
 Time of occurrence
 Interest rates
 The actual value may differ from the estimated
value
Role of Engineering Economy
(Contd…)
 Sensitivity Analysis is performed during the
engineering economic study.
Sensitivity analysis is concerned with the
determination of the changes in decisions
on the basis of varying estimates.

 Engineering economy can be used to equally well


analyze outcomes of the past.
 Observed data are evaluated to determine if the
outcomes have met or not met a specified criterion,
such as the rate of return requirement.
Alternative Description
 Initially there are many alternatives, but only a few will
be feasible and actually evaluated.
 Alternatives are stand-alone options that involve a
word description and best estimates of parameters,
such as first cost, useful life, estimated annual
incomes and expenses, salvage value, an interest
rate, and possibly inflation and income tax effects.
 Estimates of annual expenses are usually lumped
together and called annual operating costs (AOC) or
maintenance and operation (M&O) costs.
Alternative Selection
 On the basis of Measure of Worth
 Considering non-economic Factors
 If only one alternative is defines, a second is often
present in the form of do-nothing alternative
 In economic analysis, financial units (dollars or
other currency) are generally used as a solid basis
for evaluation
 Taxes represent a significant negative
cash flow.
 A realistic economic analysis must
assess the impact of taxes.
 Called an AFTER-TAX cash flow analysis
 Not considering taxes is called a
BEFORE-TAX Cash Flow analysis.
Cash Flows
 Inflows (Revenues)
 Outflows (Costs)

 Without cash flow estimates over a stated


time period, no engineering economy
study can be conducted.
Time Value of Money
 The change in the amount of money over
a given time period is called the time value
of money; it is the most important concept
in engineering economy.

 Money makes money…. “If Invested”


Interest Rate and Rate of
Return4
 Interest is the difference between an ending
amount of money and the beginning amount
 If the difference is zero or negative, there is no
interest.
 There are always two perspectives to an amount of
interest

Interest paid

Interest earned
 Interest is paid when a person or organization
borrows money (obtained a loan) and repays a
larger amount.
 Interest is earned when a person or
organization saves, invests, or lent money
and obtains a return of larger amount.
 The computations and numerical values
are essentially the same for both
perspectives.
Interest Paid
 Interest = amount owed now – original amount

 When interest paid over a specific time unit is expressed as a %age of


the original amount (principal), the result is called interest rate.

interest per unit time


Interest rate (%) = X 100
original amount
 The time unit of the rate is called Interest period.
 The most common interest period used to state an interest rate is 1 year.
(but can be 6 months, 1 month and so on)
 Normally stated 8.5% means over an interest period of 1-year.
Notations
 Notation

I = the interest amount is $
 i = the interest rate (% / interest period)
 N = No. of interest periods (1 Normally)
Example 1.3
Given
You borrow $10,000 for one full year
Must pay back $10,700 at the end of one
year
Determine
Interest amount = ?
Interest rate paid = ?
Example 1.4
 FME plans to borrow Rs. 200,000 from a bank
for 1 year at 9% interest for new equipment

Compute the interest and the total amount due after 1
year.
Interest Earned
 Interest = total amount now – original amount

 Interest paid over a specific period of time is expressed


as a %age of the original amount and is called Rate of
Return (ROR). interest per unit time
Rate of Return (%) = X 100
original amount

 ROR is also called the Return on Investment (ROI).


Example 1.5
 Calculate the amount deposited 1 year
ago to have $1000 now at an interest rate
of 5% per year.
 Calculate the amount of interest earned
during the time period.
Quiz (5 Minutes)
 A person borrows Rs. 1000 from bank and must pay a
total of 1100 after one year.

 Calculate the amount of interest and interest rate.

Formulae for use in problem: Interest = amount owed now – original amount

interest per unit time


Interest rate (%) = X 100
original amount