Engineering Economy Studies

Value & value creation

Consider value creation onto a task, activity, sub-process, process or project’s performance
• the regard that something is held to deserve; the importance, worth, or usefulness of something.
• "your support is of great value"

What is a ‘value’…there are so many hardous in creating/building or recognizing the term ‘value’
despite its necessity

It may be related with the terms: merit, worth, usefulness, practicality, advantage, desirability, benefit,
gain, profit, good, helpfulness, effectiveness, importance, significance

How to identify value from non value…?

You may think of a value when placing your mind at one side/part; either:
- a client engaging with a single project’s accomplishment;
- contractor engaging with a single project’s accomplishment;
- Consultant engaging with a single project’s accomplishment; or
- All these three parties engaging with a single project’s accomplishment.

12/14/2023 emastine 1
• Consider any government agency, department,
municipal, district council and other entities,

• How do either of these entities prioritize a project(s) for

accomplishment?
… give your experience….

• For any desirable ‘operational system’, if a responsible

person [may be an engineer] fails to plan, investigate,
evaluate, and later on, suggest and implement a
competing project/investment within his entity; this
would lead into loosing of the government money, what
are the consequences? .…....……….
12/14/2023 emastine 2
 Project accomplishment/investment
Divided into two major phases
(i) before project –an agreeable/acceptable and
prioritized project
(ii) A prioritized project put on implementation

The question is ‘how to create value in each and

in both of these two cases’

12/14/2023 emastine 3
 Creation of a meaningful value
Project and product
Inception Design Procure construc Close maint
ment tion out enanc
e
Prioritization
-List of possible issues, problems (e.g., if government Deal with Determine economic size
– problems that face societies, any creative project to few Determine competent contractor
change life style of the citizens etc.) projects Execute
- Arrive onto one problem – e.g. quality water -when you
problem – how many possible alternatives to solve have vital
this problem are available? few, scan
-Are they analyzed in a sufficient detail? So that it them
can give us appropriate alternative
-To be appropriately evaluated, they need to focus on
consequential issues on the long run – i.e. up to their
end of life
-we make comparison to prioritize one

-If it is a new project, we may proceed or abandon; We plan, design, procure

-if it is a problem, we look at the existing if any and c
construct and manage [ ]
compare with all other possible options after
scanning their long term consequential issues Do the work items in C above while
focusing the maintenance period
Ideas are generated with great thinking on each and all phases to create the value

12/14/2023 emastine 4
 Basic Principles of Economic Choice
• Any firm or agency formulate strategic mgt decisions that
guide capital budget operatives
• Capital budget determine physical parameters on which
such firm or agency would operate and prosper for years in
future
• Results of strategic mgt decisions implemented through
budget processes include: highways, rail, water distribution
systems, irrigation schemes, etc.
• Their implementation need technical judgment and
expertise of engineers/planners
• Plus, expertise should estimate & evaluate costs and
benefits to be expected from various courses of action –
[such service is called ‘engineering economic study’
12/14/2023 emastine 5
 Engineers/planners responsibility
• The practice of engineering involves many choices among
alternative designs, procedures, plans and methods
• You may compare rail way with waterway, for example,
with different course of actions i.e. with different
investment plans, duration etc.
H/w – foster understanding of the problem for long term
1: *water problem in Shinyanga, alternative investments – e.g. [1] build wells (how many types
available – must be analyzed and features understood), [2] allow supply by bowsers [3] harvest
from rain [4] gravity from the highest possible points and [5] tap supply system from certain
…
source(s) etc
2: *transport problem (of people and their luggage) from a remote area – Use Options: (1) a bus &
pickup, (2) lorry & hiace; (3) a bus with a career; (4) train; (v) basic/needed services to be
offered in the villages, (vi) others*

‘ten groups to outline the consequences of each of ten alternatives’ [use mind map
analysis]
12/14/2023 emastine 6
The practice of engineering involves many choices
among alternative designs/alternatives,
procedures, plans and methods.

In this case, there are various types and amounts of

investment alternatives with different prospective
receipts and disbursements;

‘whilst the question ‘will it pay?’ persists’.

12/14/2023 emastine 7
One experienced engineer broken this question into three in
number:
(i) why do this at all?
(ii) why do it now? and
(iii) why do it this way? Etc.

Why do it at all:
- should a proposed new activity/project be undertaken?
- should an existing activity/project be expanded?
- Or abandoned?
- should the existing standards or operating procedures be
modified?
‘It is not just a matter of jumping into a mere project, base
on scientific judgements’
12/14/2023 emastine 8
Why do it now?
- should we build now with excess capacity in advance of demand?
OR
- with only sufficient capacity to satisfy the demand immediately in
prospect?
- are the costs of capital and other business conditions favourable to a
present development?
Why do it this way?
-this choice among alternative ways of doing the same thing is
common to all types of engineering activity.
This course deals with certain principles and techniques that secure
rational answer to questions of this type.
• It discusses how we may judge whether certain alternative will
prove to be economic in the long run as compared to other
possible alternatives.
• 12/14/2023
Such judgments should not beemastine
based on unsupported hunch, it calls
9
for an ‘economy study’
• An economy study may be defined as a
comparison between alternatives in which the
differences between the alternatives are
expressed so far as practicable in money terms.

• Where technical considerations are involved,

or are somehow involved, such comparisons
may be called an engineering economy study
(EES). The EES deals with the evaluation of
proposed investments

12/14/2023 emastine 10
 Fundamental principles of EES

Several principles for EE exist; four of them are

outlined here:
• Decisions are among alternatives: it is
desirable that alternatives are clearly defined
[i.e. scope issues] and that the merits of all
appropriate alternatives be evaluated; and
that there must be more than one alternative
to be compared with.
• Avoid a poor/bad alternative to be compared with worse alternative; or each of them is not clearly
described

12/14/2023 emastine 11
• The need to consider consequences: decisions should be based on
the expected consequences of the various alternatives; all such
consequences will occur in the future.

• The critical issue of consequences to whom – before establishing

evaluation studies, it is essential to decide whose view point is
adopted; it’s the enterprise, the one concerned would be an
owner.

• Commensurability – in comparing alternatives, it is desirable to

make consequences commensurable with one another in so far as
practicable. i.e. consequences should be expressed in numbers and
the same units should apply to all the numbers. Money units at
different times should somehow reflect the time value of money.

12/14/2023 emastine 12
 Interest and interest rate

• As previously stated, problems of EES determines what

is economical in the long run, that is, over a
considerable period of time; thus, it is necessary to
recognize the time value of money; because of
existence of interest in which ‘a shilling now worth
more than the prospective of a shilling next year or at
some later date’.

• Interest may be defined as money paid for the use of

borrowed money. Or, is a return retainable by the
productive investment of capital.
12/14/2023 emastine 13
 Interest rate

• Is the ration between the interest chargeable or

payable at the end of a period of time, usually a year
or less, and the money owed at the beginning of that
period. For example, if X is an amount of money
available, this is charged an Y amount at the end of
the year, its interest rate is Y/X%.

• The interest may be frequently payable more often

than once a year, for example, on monthly, quarterly
or semiannually; however, the interest per annum is
usually what is meant when an interest rate is stated.
12/14/2023 emastine 14
 Economy studies and comparisons

Exercise:
- differentiate between the simple and the compound interest and
rates?
- can you try some computations that differentiate the two cases?

• The economy study involves the use of formula that are represented
in abbreviations or symbols.
• Various symbols are chosen so that each one is an initial of the key
word associated with the most common meaning of the symbol. Thus,
• i - applies to interest;
• n - applies to number of periods;
• P - applies to present worth;
• F - applies to future worth and
• A - applies to annual payment or annuity.

12/14/2023 emastine 15
• The fundamental interest formula that
expresses the relationships between F, P and A
in terms of i and n can be shown.

• Development of formula for single payments

(F/P, P/F)
• If P is invested at an interest i, the interest for
the first year is iP, and the total amount at the
end of the first year F1 is P + iP. F1 = P(1 + i)

12/14/2023 emastine 16
• At the end of the second year, interest at this time
is i (P + iP), = iP(1 + i). the Future amount F, at this
time = P(1 +i) + iP(1 + i). This is equal to P + Pi + iP
+ P i2 = P(i2 + 2i +1), factorizing, F2 = P(1 + i) 2

• Continuing with this arrangements,

• The end of the third year, F3 = P(1 + i) 3
• Thus, the end of nth year Fn = P(1 + i) n

12/14/2023 emastine 17
• Hence; Fn = P(1 + i) n = (i)
• This is designated as F = P(F/P, i, n) which is the
formula for compound amount, F obtainable in n
years from a principal P.
• If expressing P in terms of F, i, and n
P = F[1/(1 + i)n] …..(ii)
This is designated as P = F(P/F, i, n)
• P may be thought of as the principal that will give a
required amount F in n years, in other words P is
the present worth of a payment of F, n years hence.

12/14/2023 emastine 18
• The expression (1 + i) n is called single payment
compound amount factor (F/P), its reciprocal
1/ (1 + i) n is called single payment present
worth factor (P/F)

• Below is the diagram for relationship between

P and F

12/14/2023 emastine 19
 F

0 1 2 3 4 n-1 n

Figure 1a: P equivalent to F

12/14/2023 emastine 20
 F
Cash- in

0 1 2 3 4 n-1 n

Cash out

Figure 1b: P equivalent to F

12/14/2023 emastine 21
 P
Cash-in

0 1 2 3 4 n-1 n

Cash out

Figure 1c: P equivalent to F

12/14/2023 emastine 22
• Figure 1a represents generic relationships on the equivalence
between P and F.
• Figure 1b shows that this alternative plan gives out the money, i.e.
P value; and at some time later, it would earn the cash-in (F).
• Figure 1c shows that an alternative plan earns money, i.e. P
value, and it would give them out in the years later (i.e. F value)

Examples (1)
The sum of $ 1000 is borrowed at 10 percent compounded annually
to be repaid in the lump sum at the end of three years. How much
should the lump sum repayment to at the end of three-year
period? F = ?

We want an investment to regard repayment so that replacement

when it is written off is possible!!!
12/14/2023 emastine 23
 F=?

1 2 3

P = 1000

12/14/2023 emastine 24
• i = 10%, n = 3 years, P = 1000, F = ?
• F = P(1 + i)n = 1000(1 + 0.1)3 = F = $ 1,331

A Table may also been used,

• Use designated notation F = P(F/P, i, n)

• Using the Table for i = 10%

• Proceed down the n column to n = 3
• Go horizontally to the right along the n = 3 line to the
F/P column, finding F/P = 1.3310 = (F/P, 10, 3)
• Since F/P = 1.3310, then, F = P X 1.3310, since P = 1000
• F = 1000 X 1.3310 = $ 1, 331
12/14/2023 emastine 25
• Example 2,
• If $ 1000 is deposited now at 8 percent
compounded annually, what is the
accumulated sum after 10 years.
• Soln.
• F = P(1 + i)n; F = ?
• P = 1000, i = 0.08, n = 10
• Using formula, and F = P(F/P, 8%, 10), F = $
2,159.
• Use Table to make computations

12/14/2023 emastine 26
 The value of one future payment compared to a uniform series of
payments (F/A, A/F)

• Representing cash flow diagrams to illustrate

F/A relationships, see Figure 2a.
In the Figures 2b and 2c, they are enlighten on
the incorrect representation of the F/A
relationships as indicated:
• In Figure 2b, incorrect representation of F/A
relationship, with extra (initial) deposit
• In Figure 2c, incorrect representation of F/A
relationship, with missing (final) deposit
12/14/2023 emastine 27
Think of water problem in Dodoma from a
previous slide:

Recall the alternative sources proposed

• Describe the courses of action at each case;
• Determine the consequential issues;
• Fix monetary terms to each;
• Determine P and F for assumed n and I;
• Can make comparisons in terms of P or F.

12/14/2023 emastine 28
 A A A A A
0 1 2 3 4 5

Figure 2a: Equivalent future value (F) from a series of

uniform periodic [CORRECT ARRANGEMENT]

12/14/2023 emastine 29
 A A A A A A
0 1 2 3 4 5

Figure 2b: Equivalent future value (F) from a series of

uniform periodic [INCORRECT REPRESENTATION]

12/14/2023 emastine 30
 A A A A

0 1 2 3 4 5

Figure 2c: Equivalent future value (F) from a series of

uniform periodic [INCORRECT REPRESENTATION]

12/14/2023 emastine 31
• Thus, our abbreviations for the F/A
expressions are as follow:
• i = interest rate per period
• n = number of periods
• A = uniform series of n end of period
payments or receipts with interest
compounded at rate i, on the balance in the
account at the end of each period.

12/14/2023 emastine 32
• If no more is deposited at the beginning of the first
period, and A1 dollars are deposited at the end of the
first period, the future sum F accumulated at the end
of that one period is simply F1 = A1, since A1 has not
had time to earn any interest.

• If A1 dollars are deposited at THE end of THE 1st

period, and the same amount (A2 dollars) is deposited
at the end of 2nd period, the future sum F accumulated
at the end of 2nd period is A2 + A1 + iA1;
• F2 = A[1 + (1 + i)], since A1 = A2, we will have the
following:

12/14/2023 emastine 33
End of period, accumulated amount at the end of each
period:

1, F1 = A1, [no interest at this time]

2, F2? = in year 2, interest = iA1; F2 = A1 + iA1 + A2
= A[1 + (1 + i)],
3, F3 = ? in yr 3, interest = iA[1 + (1 + i)],
F3 = A[1 + (1 + i)] + iA[1 + (1 + i)] + A3…
but A3 = A
• Thus, F3 = A[1 + (i)] (1 +i) + A = A[1 + (1 + i) + (1 + i)2]
•
• N, Fn = A[1 + (1 +i) + (1 + i)2 +……..+ (1 + i)n-1]
12/14/2023 emastine 34
• General equation:
• Fn = A[1 + (1 +i) + (1 + i)2 +……..+ (1 + i)n-1] …..
(a)
• Multiply by (1 +i) in both sides
• Fn(1 + i) = A[1 + (1 +i) + (1 + i)2 +……..+ (1 + i)n]
…….(b)

• Subtract equation b from a

12/14/2023 emastine 35
• F = A[-1 + (1 + i)n] = [(1 + i)n -1]

• F = A[(1 + i)n – 1]n/i] or F/A = (1 + i) -1/i

• Thus, F = A[(1 + i)n – 1/i] …(iii).

• The equation is designated as F = A(F/A, i, n)

• A = F[i/(1 + i)n -1] ………..(iv).

• The equation is designated as A = F(A/F, i, n)

• The expression [(1 + i)n -1/i] is called uniform series compound amount
factor F/A

• The expression i/(1 + i)n 1 is called sinking fund factor A/F

12/14/2023 emastine 36
Example:
• A consulting firm is depositing $ 10,000 per year into an investment fund
earning interest compounded at 10% annually. Find the balance in the
fund (including deposits and accumulated interest) at the end of five
years.

• Given A = 10,000, i = 10%, n = 5, F = ?

• F = A[(1 + i)n – 1/i] = 10,000 [(1 + 0.1)5 – 1/ 0.10 = $ 61, 051

• By using the Table, represented by F/A

• F = A(F/A, i, n); take Table of i = 10%, proceed down to an n = 5, moving

along this row horizontally to the F/A column, getting F/A = 6.1051

• Therefore, F = 10,000 X 6.1051 = $ 61,051.

12/14/2023 emastine 37
The value of one present payment compared to a uniform series of payments
(P/A, A/P)

• P dollars are borrowed now, and a uniform series of

repayments, A, will be made at the end of n periods.
• In Figures 3b and 3c, errors in representing the cash
flow diagrams may occur,
For example:
• in 3b, annual payment is wrongly represented at the
beginning of time zero.
• Likewise, in Figure 3c, there is lacking of annual
payments at the end.
• The correct representation is depicted in figure 3a.
12/14/2023 emastine 38
 P=?

0 1 2 3 4 5 6 n -2 n-1 n

A A A A A A A A A

Figure 3a: Representing P/A relationships [CORRECT

REPRESENTATION]

12/14/2023 emastine 39
 p

0 1 2 3 4 5 n

A A A A A A A

Figure 3b: Relationships of P & A; i.e. annual payments is

wrongly presented at the beginning

12/14/2023 emastine 40
 p

0 1 2 3 4 5 n

A A A A

Figure 3c: Relationships of P & A; i.e. lacking

annual payments in the end

12/14/2023 emastine 41
• To derive the equation of P/A, simply we
combine the two previous equations:
• P = F(1/(1 + i)n ……..(ii) and F = A[(1 +i)n – 1/i]
………(iii)

• Substituting equation iii into ii, we get,

• P = A[(1 +i)n – 1/i] x (1/(1 + i)n
• P = A[(1 +i)n – 1 / i(1 + i)n]……………..(v)

• A = P[i(1 + i)n / (1 +i)n – 1]………….(vi)

12/14/2023 emastine 42
• The factor [(1 +i)n – 1/i(1 + i)n] is termed as the
uniform series present worth factor and it is
designated as the P = A(P/A, i, n)

• The factor [i(1 + i)n/(1 +i)n – 1] is termed the

uniform series capital recovery factor here
designated as A = P(A/P, i, n)

12/14/2023 emastine 43
Example:
• An economist decides to budget $ 600 per month
for repayments on a new car. The bank offers a 60
month repayment period on new vehicle loans at
1 percent per month on the unpaid balance. How
much can be financed under these terms?
• P =?
• A = $ 600;
• i = 1%
• N = 60 months
12/14/2023 emastine 44
 p

0 1 2 …………… 58 59 60

A A A A A A A A A

12/14/2023 emastine 45
• P = A[(1 +i)n – 1 / i(1 + i)n]

• Substituting the given values, P = 600 [(1 +

0.01)60 – 1] / 0.01 (1 + 0.01) 60
P = $ 26, 797

• Using the Table,

• P = A(P/A, i, n): i.e. i = 1%, n = 60, P/A = 44.955

• = 600 X 44.955 = $26,797.

12/14/2023 emastine 46
• Exercises [use both formula and a table]
• How many years must $ 1000 stay invested at 6%
compounded in order to accumulate to $2000?
• MKT now 22, expects to retire in 40 years at age
of 62. He anticipates that a lump sum retirement
fund of $ 400,000 will see him nicely through his
good years. How much should be deposited
annually into an investment fund earning 9%
compounded for the next 40 years to accumulate
a $400,000 retirement fund?

12/14/2023 emastine 47
 Solution
We use A & F’s equation
Using the formula
For question 2:
• N = 40, F = 400,000, i= 9%, A =?
• A = F(A/F, i, n)
• A = 400,000 X 0.00296 = 1,184/year
Solve the eqn. by using the formula

12/14/2023 emastine 48
 Exercises
By using relationship diagrams, exercise the following
questions:
1. If $ 840 is invested at 6% on January 1, 1978, what
equal year-end withdraws can be made each year for
ten years, leaving nothing in the fund after the tenth
withdraw?
2. How much will be accumulated in a fund, earning 6%
interest, at the end of 10 years if $114 is deposited at
the end of each year for ten years, beginning 1978?
3. How much would you invest at 6% interest on January
1, 1985, in order to accumulate $ 1,791 on January 1,
1991?
12/14/2023 emastine 49
 If the concepts for P & F, P & A and F & A
are well grasped, an advanced stage of
their combination can be though out
and exercised.

12/14/2023 emastine 50
 Brainstorming ideas
Creation/Development of each of the following:

Think of any three alternative

proposals/investments to solve certain problems in

certain places and determine the following:

• Principles/capitals
• Annual/Annuity - cash flows
• Future value
12/14/2023 emastine 51