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Basics of engineering economics

Basics of engineering economics

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ECONOMICS

AUG 2016

WHO IS WHO?

Dr. Suganti Ramarad

School of Engineering (CE)

B1.15

Ext. 5098

Suganti.Ramarad@taylors.edu.my

WITH ME?

2 hours lecture per week

THURSDAY 2 to 4 PM

FRIDAY S1 8 to10 AM

FRIDAY S2 10 AM to 12 PM

FRIDAY S3 2.30 to 4.30 PM

holidays!

PREPARED BY SUGANTI RAMARAD

YOUR

HURDLES!

MY

YOUR

HURDLES!

RESPONSIBILITY!

30% continuous assessment

Overall =100%

70% final examination

1. The final examination mark must 50%

2. The overall assessment mark must 50%

ASSESS

MENT

MAR

K

(%)

Quiz

(Formativ

e)

NIL

Test 1

10

Test 2

10

Assignme

nt

10

Final

70

WEEK

1

10

11

12

13

14

PREPARED BY SUGANTI RAMARAD

MEASURE?

1. Explain the economics principles and concept

of time value of money.

2. Evaluate project proposals using economics

analysis techniques, such as Present Worth,

Future Worth, Annual Worth and Rate of Return

analysis.

3. Produce cost estimation and profitability

analysis report in Plant Design

PREPARED BY SUGANTI RAMARAD

ENGINEERING

ECONOMICS

AUG 2016

ABOUT?

Introduction to economics-based project calculations,

considerations & selections.

The time frame of Engineering Economics is primarily

the future.

In other words, its all about engineering decision

making in terms of dollar/ringgit for future investment!

PREPARED BY SUGANTI RAMARAD

LECTURE 1 - OBJECTIVES

Interest rates, simple and compound

interest

Economic equivalence

Cash flow

Minimum attractive rate of return

PREPARED BY SUGANTI RAMARAD

INTEREST RATE/RATE OF

RETURN

INTEREST RATE/RATE OF

RETURN

over a given time period is called the

time value of money

PREPARED BY SUGANTI RAMARAD

INTEREST RATE/RATE OF

RETURN

INTEREST RATE/RATE OF

RETURN

earne

d

Rate

of return (ROR)

(ROI)

PREPARED BY SUGANTI RAMARAD

CLASS ACTIVITY

ECONOMIC EQUIVALENCE

Different sums of money at different times

may be equal in economic value

RM106

one

0

1

year

year from

now

RM100

nownow is said to be equivalent to RM106

RM100

one year from now, if the RM100 is invested at

the interest rate of 6% per year.

INTEREST

= P(1+i)n

PREPARED BY SUGANTI RAMARAD

CLASS ACTIVITY

Company ABC loaned money to an engineering

staff member for purchasing a new phone. The

loan is for RM1000 for 3 years at 5% per year.

a) How much money will the engineer repay at the

end of 3 years based on simple interest?

b) How much money will the engineer repay at the

end of 3 years based on compound interest?

SOLUTION

a) Total interest for 3 years = RM1000(3)(0.05) = RM150

Total amount due after 3 years = RM1000+ RM150 = RM1150

b) METHOD 1

Year 1 interest = RM1000 (0.05) = RM50

Amount due after year 1 = RM1000+RM50 = RM1050

Year 2 interest = RM1050 (0.05) = RM52.50

Amount due after year 2 = RM1050+RM52.50 = RM1102.50

Year 3 interest = RM1102.05 (0.05) = RM55.13

Amount due after year 3 = RM1102.50+RM55.13 = RM1157.63

METHOD 2

Total amount due = RM1000(1+0.05)3 = RM1157.63

PREPARED BY SUGANTI RAMARAD

CASH FLOW

CASH

INFLOW

YEAR

1

UNKNOWN @

TO BE

DETERMINED

TIME 0 =

PRESENT

NET CASH

FLOW

CASH

Cash

inflows are the receipts, revenues, incomes, and savings generated

OUTFLOW

by project and business activity. A + sign indicates a cash inflow.

business activity. A sign indicates a cash outflow.

PREPARED BY SUGANTI RAMARAD

CLASS ACTIVITY

Each year Exxon-Mobil expends large amounts of funds for

mechanical safety features throughout its worldwide operations.

Carlo Ramos, a lead engineer, plans expenditures of $1 million now

and each of the next 4 years just for improvement of field-based

pressure-release valves. Construct the cash flow diagram to find

the equivalent value of these expenditure at the end of year 4,

using a cost capital estimates for safety-related funds of 12% per

year.

CLASS ACTIVITY

An electrical engineer wants to deposit an amount P now such that

she can withdraw an equal annual amount of A1 = RM2000 per year

for the first 5 years, starting 1 year after deposit, and a different

annual withdrawal of A2 = RM3000 per year for the following 3

years. How would the cash flow diagram appear if i = 8.5% per

year?

OF RETURN

Investors expect to earn a return on their

investment (commitment of funds) over time

We expect to see economic efficiencies greater

than 100%

A profitable investment should earn (return) funds

in excess of the investment amounts

Economic projects should earn a reasonable return,

which is termed:

MARR Minimum attractive rate of return

rate, but an established rate

by (financial) managers

expressed as a percent

value

projects should earn at a

rate equal to or greater than

the established MARR

MARRs are set based upon:

PREPARED BY SUGANTI RAMARAD

MARR

Equity Financing the firm uses funds either from retained

earnings, new stock issues, or owners infusion of money

Debt Financing the firm borrows funds from outside

sources

The cost of debt financing = the interest rate charged on the debt

(loan) amounts

cost of all sources of capital to the firm

A firms ROR > MARR > cost of capital

PREPARED BY SUGANTI RAMARAD

P = a present sum of money at a time designated

as t = 0

F = a future amount of money at some point in

time later than 0

A = a series of equal, end-of-period cash flows

n = the number of interest periods

i = the interest rate or rate of return per time

period, in percent

SUMMARY

DO YOU KNOW HOW TO CALCULATE

SIMPLE AND COMPOUND INTEREST?

DO YOU UNDERSTAND THE ECONOMIC

EQUIVALENCE?

CAN YOU BUILD A CASH FLOW?

CAN YOU EXPLAIN MARR?

PREPARED BY SUGANTI RAMARAD

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