Professional Documents
Culture Documents
CHAPTER I
FOUNDATIONS OF
ENGINEERING ECONOMY
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1. Foundations: Overview
1. Questions
2. Decision Making
3. Study Approach
4. Interest Rate
5. Equivalence
6. Simple and Compound Interest
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1. Foundations: Overview
7. Symbols
8. Spreadsheet Functions
9. Minimum Attractive Rate of Return
10. Cash Flows
11. Doubling Time
12. Spreadsheets
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CHAPTER I Section 1
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• Engineers “Design”
• Engineers must be concerned with the economic
aspects of designs and projects they recommend
and perform
• Analysis
• Design
• Synthesis
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Major Role of
Engineering
Economy
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The Question:
Do
Alt. 1 Which One do
Nothing
we accept?
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Do
Alt. 1 ………... Alt. j
Nothing
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• Example 1.3
• You borrow $10,000 for one full year
• Must pay back $10,700 at the end of one
year
• Interest Amount (I) = $10,700 - $10,000
• Interest Amount = $700 for the year
• Interest rate (i) = 700/$10,000 = 7%/Yr
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• Inflation impacts:
• Purchasing Power (reduces)
• Operating Costs (increases)
• Rate of Return on Investments
(reduces)
• Specifically covered in Chapter 14
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Equivalence
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1.5 EQUIVALENCE
• Example
• You travel at 68 miles per hour
• Equivalent to 110 kilometers per hour
• Thus:
• 68 mph is equivalent to 110 kph
• Using two measuring scales
• Miles and Kilometers
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1.5 EQUIVALENCE
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• Economic Equivalence
• Two sums of money at two different
points in time can be made economically
equivalent if:
• We consider an interest rate and,
• No. of time periods between the two
sums
Equality in terms of Economic Value
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T=0 t = 1 Yr
$21,800 paid
back here
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$20,000 is
received here
T=0 t = 1 Yr
$21,800 paid
back here
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• $20,000 now or
• $21,800 one year from now?
• The two sums are economically equivalent
but not numerically equal!
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• Simple Interest
• Calculated on the principal amount only
• Easy (simple) to calculate
• Simple Interest is:
(principal)(interest rate)(time)
$I = (P)(i)(n)
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• Example 1.7
• Borrow $1,000 for 3 years at 5% per year
• Let “P” = the principal sum
• i = the interest rate (5%/year)
• Let N = number of years (3)
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• Simple Interest
• DEFINITION
• I = P(i)(N)
• For Ex. 1.7:
• I = $1,000(0.05)(3) = $150.00
• Total Interest over 3 Years
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1 2 3
I1=$50.00
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• Year 2
P=$1,000
1 2 3
I1=$50.00 I2=$50.00
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1 2 3
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• Assume:
• P = $1,000
• i = 5% per year compounded annually (C.A.)
• N = 3 years
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P=$1,000
Owe at
Owe at tt =
= 33
years:
years:
1 2 3
$1,000 +
$1,000 + 50.00
50.00 +
+
I1=$50.00 52.50 +
52.50 + 55.13
55.13 ==
I2=$52.50 $1,157.63
$1,157.63
I3=$55.13
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1.6 Analysis
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1.7 P and F
0 1 2 … … n-1 n
t=n
$P
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1.7 P and F:
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…………
0 1 2 3 .. N-1 n
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1.8 Spreadsheets
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Introduction to Solution by
Computer
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1
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MARR - %
0%
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0
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• CASH INFLOWS
• Money flowing INTO the firm from outside
• Revenues, Savings, Salvage Values, etc.
• CASH OUTFLOWS
• Disbursements
• First costs of assets, labor, salaries, taxes
paid, utilities, rents, interest, etc.
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• END-OF-PERIOD Convention
ALL CASH
ALL CASH FLOWS
FLOWS ARE
ARE ASSUMED
ASSUMED TOTO OCCUR
OCCUR ATAT
THE END
THE END OF
OF AN
AN INTEREST
INTEREST PERIOD
PERIOD EVEN
EVEN IF
IF THE
THE
MONEY FLOWS
MONEY FLOWS AT
AT TIMES
TIMES WITHIN
WITHIN THE
THE
INTEREST PERIOD.
INTEREST PERIOD.
THIS IS
THIS IS FOR
FOR SIMPLIFICATION
SIMPLIFICATION PURPOSES
PURPOSES
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• “Now” is denoted as t = 0
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Positive CF at t = 1
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0
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A = +$1,100/yr
0 1 2 3 4 5
-$5,000
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P = +$5,000
0 1 2 3 4 5
A = -$1,100/yr
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•i approximate = 72/n
• Assume we want an investment to double in,
say, 3 years.
• Estimate i – rate would be: 72/3 = 24%
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Chapter Summary
• Engineering Economy:
• Application of economic factors and
criteria to evaluate alternatives
considering the time value of money
(interest and time)
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CHAPTER I - Summary
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Chapter Summary
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Chapter Summary
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Chapter Summary
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Chapter Summary
• Compounding of Interest
• The power of compounding is very
noticeable, especially over long periods of
time.
• Notion of computing interest on interest
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University. 13
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Chapter Summary
• The MARR
• The MARR is a reasonable rate of return
established as a hurdle rate to determine if an
alternative is economically viable.
• The MARR is always higher than a return
from a safe investment.
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Chapter Summary
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Chapter Summary
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