MENG 300 Engineering Economics Chapter 1: Founda0ons of Engineering Economy Prepared by Ahmed Ali Engineering Economy; Blank Leland and Tarquin Anthony, Seventh EdiEon, McGraw Hill, 2012 1 Outline Purpose: Understand and apply fundamental concepts and use the terminology of engineering economics. 1.1 Roles of Engineering Economics (EE) 1.2 Study approach of EE 1.4 Interest Rate and Rate of Return 1.5 Terms and Symbols 1.6 Cash Flow 1.7 Economic Equivalence 1.8 Simple and Compound Interest 2 1.1 Roles of Engineering Economics (EE) • Why study Engineering Economy? – Engineers not only design and create, but analyze, and conclude for decision making. – Engineering economic is at the heart of making decisions. – Most decisions involve money over Eme. – AlternaEve selecEon is based on future added value. EE involves formula0ng, es0ma0ng, and evalua0ng the expected economic outcomes of alterna0ves designed to accomplish a defined purpose. 3 1.2 Engineering Economy Study It follows structured approach to select the best soluEon to a problem: 1. Understand the problem and define the objecEve. 2. Collect relevant informaEon. 3. Define the feasible alternaEve soluEons. 4. IdenEfy the criteria for decision making. 5. Evaluate each alternaEve, using sensiEvity analysis. 6. Select the “best “alternaEve. 7. Implement the soluEon. 8.Monitor the results. 4 1.4 Interest Rate and Rate of Return Interest -­‐ the manifestaEon of the Eme value of money. (the amount paid to use money) Two perspecEves to an amount of interest exist: 5 1.5 Terms and Symbols P = a present sum of money at a Eme designated as t = 0. F = a future amount of money at some point in Eme later than t = 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 Eme period, in percent. t = Eme, stated in periods, years, months, days. 6 1.6 Cash Flow: Es0ma0on and Diagrams • Engineering economy bases its computaEons on Eming, size and direcEon of cash flows. Cash Flow: money es2mated for future projects R D 7 1.6 Cash Flow: Es0ma0on and Diagrams • The cash flow diagram is a graphical representaEon of cash flows drawn on a Eme scale. – The arrow poinEng up indicates a posiEve cash flow (upward arrows represent receipts). – An arrow poinEng down indicates a negaEve cash flow (downward arrows represent expenditure). 8 1.6 Cash Flow: Es0ma0on and Diagrams • End of period is end of interest period where cash flows are assumed to occur. 9 1.6 Cash Flow: Es0ma0on and Diagrams Example: A new graduate plans to borrow $ 10,000 now to help in buying a car. She has arranged to repay the enEre principal plus 8% per year interest ager 5 years. IdenEfy the engineering economy symbols and the cash flow. P = $10,000 t=0 t=1 i = 8% n = 5 F = ? t=4 Graduate Prospec2ve years 10 1.6 Cash Flow: Es0ma0on and Diagrams Note: To improve your understanding you need to do • Example 1.7 • Example 1.9 • Example 1.10 • Example 1.11 11 1.7 Economic Equivalence Equivalent terms are used very ogen in the transfer from one scale to another. • Some common equivalencies or conversions are: 100 cenEmeters = 1 meter, 1000 meters = 1 kilometer (independent of Eme) Economic equivalence is the different sums of money at different 0mes would be equal in economic value. 12 1.7 Economic Equivalence Principle 13 1.7 Economic Equivalence 14 1.8 Simple and Compound Interest Interest rate comes in two types: 1-­‐ Simple Interest. 15 1.8 Simple and Compound Interest 2-­‐ Compound Interest. -­‐ Interest on top of interest for each previous period. -­‐ Reflects the effect of Eme value of money on the interest. • Called “Reducing Rate”: is mainly used to calculate the interest payable for housing / mortgage / property loans, overdrag (OD) faciliEes, and credit cards. 16 1.8 Simple and Compound Interest Example 1: 17 1.8 Simple and Compound Interest Example 2:
A man borrowed $1000 for 3 years at i = 5% per year.
What is his repayment after 3 years with
a) simple interest
b) compound interest?
Show your results using Cash flow diagram
18 1.8 Simple and Compound Interest 19