What is this course about?
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Time value of money
Importance of interest, inflation, etc.
Cash flow comparisons
Project and Investment Analysis
Making good economic decisions
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Some interesting questions
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Buy or lease?
Buy car or land for an investment?
Buy a bond, stock, keep money in bed?
Which investment to make?
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Cash flow comparisons
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Needed for all kinds of decision making
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Example: Buying a car
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Alternatives:
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$18,000 now, or
$600 per month for 3 years(= $21,600 total)
Which is better?
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Cash flow comparisons
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Needed for all kinds of decision making
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Example: Buying a car
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Alternatives:
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$18,000 now, or
$600 per month for 3 years (= $21,600 total)
Which is better?
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It depends!
 Issue: how much is money now worth compared
to money in the future?
Leads to idea of Time value of money!
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Time value of money
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Would you rather have:
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$100 today, or
$100 a year from now?
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Time value of money
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Would you rather have:
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$100 today, or
$100 a year from now?
Basic assumption:
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Given a fixed amount of money, and a choice of
having it now or in the future,
Most people would prefer to have it
sooner rather than later
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Time value of money
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Basic assumption:
Given a fixed amount of money, and a choice of
having it now or in the future, most people would
prefer to have it sooner
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Reasons:
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Security
Interests
Currency strength
Uncertainty
?
?
?
?
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Time value of money
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A consequence:
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Suppose you are willing to exchange a certain
amount now for some other amount later
Then the later amount has to be _______ ?
A bird at hand is better than two birds in the bush.
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What this means for us
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In this course, we will learn methods to:
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Using the interest rate or discount rate:
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Compare different cash flows over time
How much more a dollar today is worth, compared
to a dollar in the future
For example, if the interest rate is 5% per
year:
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Then $1 today is worth as much as $1.05 next
year
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Interest rates
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Interest factor: The ratio between an
amount one period in the future and an
equivalent amount now.
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Example: If you are indifferent between $5
now and $6 one period in the future, the
interest factor is 6/5 = 1.20 (per period)
Interest rate = interest factor - 1
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In above example, it’s 0.20 = 20%
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Chapter 1
Engineering Economic Decisions
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Rational Decision-Making Process
Economic Decisions
Predicting Future
Role of Engineers in Business
Large-scale engineering projects
Types of strategic engineering
economic decisions
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Rational Decision-Making
Process
1.
2.
3.
4.
5.
6.
Recognize a decision
problem
Define the goals or
objectives
Collect all the relevant
information
Identify a set of feasible
decision alternatives
Select the decision
criterion to use
Select the best
alternative
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Engineering Economic
Decisions
Manufacturing
Planning
Profit
Investment
Marketing
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Predicting the Future
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Required investment
Forecasting product
demand
Estimating selling
price
Estimating
manufacturing cost
Estimating product
life
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Role of Engineers in Business
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Participate in a variety
of decision-making
processes, ranging from
manufacturing, through
marketing, to financing
decisions
Plan for the acquisition
of equipment
Design products from
the concept to shipping
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Role of Engineers in Business
Create & Design
• Engineering Projects
Analyze
Evaluate
Evaluate
• Production Methods
• Engineering Safety
• Environmental Impacts
• Market Assessment
• Expected
Profitability
• Timing of
Cash Flows
• Degree of
Financial Risk
• Impact on
Financial Statements
• Firm’s Market Value
• Stock Price
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Accounting Vs.
Engineering Economy
Evaluating past performance
Accounting
Evaluating and predicting future events
Engineering Economy
Past
Future
Present
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A Large-Scale Engineering
Project
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Requires a large
sum of investment
Takes a long time to
see the financial
outcomes
Difficult to predict
the revenue and
cost streams
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A Large-Scale Engineering
Project
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Types of Strategic Engineering
Economic Decisions
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Equipment and Process Selection
Equipment Replacement
New Product and Product Expansion
Cost Reduction
Service Improvement
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Equipment & Process Selection
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How do you choose between Plastic
Sheet Molding Compound (glass fiber
reinforced polymer) and Steel sheet
stock for the auto body panel?
The choice of material will dictate the
manufacturing process for the body
panel as well as manufacturing costs.
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Which Material to Choose?
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Equipment Replacement
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Now is the time to
replace the old
machine?
If not, when is the
right time to replace
the old equipment?
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New Product and Product
Expansion
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Shall we build or acquire a new facility
to meet the increased demand?
Is it worth spending money to market a
new product?
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Example - MACH 3 Project
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R&D investment: $750 million
Product promotion through advertising:
$300 million
Priced to sell at 35% higher than Sensor
Excel (about $1.50 extra per shave).
Question 1: Would consumers pay $1.50
extra for a shave with greater smoothness
and less irritation?
Question 2: What would happen if the
blade consumption dropped more than
10% due to the longer blade life of the new
razor?
Gillette’s MACH3
Project
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Cost Reduction
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Should a company
buy equipment to
perform an
operation now done
manually?
Should spend money
now in order to save
more money later?
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Service/Quality Improvement
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Make-to-order Levi’s for women
How many more jeans would Levi’s need to sell to justify the
cost of additional robotic tailors?
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Fundamental Principles in
Engineering Economics
Principle 1: A nearby dollar is worth
more than a distant dollar
Today
6-month later
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Fundamental Principles in
Engineering Economics
Principle 2: All it counts is the
differences among alternatives
Option Monthly Monthly Cash
Monthly Salvage
payment Value at
end of
year 3
Fuel
Cost
Mainten outlay
ance
at
signing
Buy
$960
$550
$6,500 $350
$9,000
Lease
$960
$550
$2,400 $550
0
Irrelevant items in decision making
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Fundamental Principles in
Engineering Economics
Principle 3: Marginal revenue must
exceed marginal cost
Marginal
cost
Manufacturing cost 1 unit
Sales revenue
1 unit
Marginal
revenue
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Fundamental Principles in
Engineering Economics
Principle 4: Additional risk is not
taken without the expected
additional return
Investment
Class
Potential
Risk
Low/None
Savings
account (cash)
Bond (debt)
Moderate
Stock (equity) High
Expected
Return
1.5%
4.8%
11.5%
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