Introduction to Engineering Economy
•
Engineering Economy is about making decisions
•
It is based on the systematic evaluation of the costs and
benefits of proposed technical projects
• The principles and methodology of engineering economy
are utilized to analyze alternative uses of financial
resources, particularly in relation to the physical assets
and the operation of an organization.
1
Example 1: How BD100 a month can grow
Year
Interest
0%
1%
3%
6%
9%
12%
1
BD1,200
BD1,206
BD1,217
BD1,234
BD1,251
BD1,268
5
BD6,000
BD6,150
BD6,465
BD6,977
BD7,542
BD8,167
10
BD12,000
BD12,615
BD13,974
BD16,388
BD19,351
BD23,004
15
BD18,000
BD19,411
BD22,697
BD29,082
BD37,841
BD49,958
20
BD24,000
BD26,556
BD32,830
BD46,204
BD66,789
BD98,926
25
BD30,000
BD34,067
BD44,601
BD69,299
BD112,112
BD187,885
2
Example 2: When BD12K exceeds BD70K
Interest Rate
12%
Ahmed
Start Investing
Age 20
Stop Investing
Age 25
Total
Investment
Total
Accumulation at
Age 60
Annual Investment
BD2,000/yr
for 6 years
(monthly
BD166.67)
BD12,000
BD1,078,425
Ali
Start Investing
Age 26
Stop Investing
Age 60
Annual Investment
BD2,000/yr
for 35 years
(monthly
BD166.66)
BD70,000
BD1,014,147
3
Example 3: The Real Cost of a BD1,000 Credit
Balance
YOU:
New
Balance
Month
Balance
Interest
 have a BD1,000 balance on your credit
card
0
0
BD1,000
BD18.33
BD1,018.
33
BD20.37
0
1
BD997.9
6
BD18.29
BD1,016.
25
BD20.32
 pay 21.99% interest rate
0
2
BD995.9
2
BD18.25
BD1,014.
17
BD20.28
0
3
BD993.8
9
BD18.21
BD1,012.
10
BD20.24
0
4
BD991.8
6
BD18.18
BD1,010.
03
BD20.20
38
10
BD80.06
BD1.47
BD81.52
BD10.00
38
11
BD71.52
BD1.31
BD72.83
BD10.00
39
0
BD62.83
BD1.15
BD63.98
BD10.00
39
1
BD53.98
BD0.99
BD54.97
BD10.00
39
2
BD44.97
BD0.82
BD45.80
BD10.00
39
3
BD35.80
BD0.66
BD36.45
BD10.00
39
4
BD26.45
BD0.48
BD26.94
BD10.00
39
5
BD16.94
BD0.31
BD17.25
BD10.00
39
6
BD7.25
BD0.13
BD7.38
BD7.38
39
7
BD0.00
BD0.00
BD0.00
BD0.00
 pay the required minimum payment of 2%
of the balance or BD10, whichever is greater
 make no new purchases
How much will it take to pay off the credit
card?
How much will be the total amount you
paid?
Year
Total Payments:
Payment
BD6,34
45
Decision Making and Problem Solving
Simple Problems
•
Can be analyzed in one’s head without extensive analysis
– Do I buy a semester parking pass, use parking meters, or buy a
bicycle?
– How often should I eat out?
Intermediate Problems
•
•
•
(Principle subject of this course!!!)
They are sufficiently important to justify serious thought and action
They can’t be worked in one’s head; must be organized
The economic aspects are significant component in the analysis leading to
a decision
Complex Problems
•
Represent a mixture of economic, political, and humanistic elements
– Selection of a president in USA
– Building a nuclear power plant
5
“Intermediate Problem” Example
A student is buying a car, which costs BD12,000. He can borrow money in
the bank with a 10% yearly interest rate (quarterly compounding). The
dealer offers one of the two promotions:
1.
Discount of BD2,000 off the price of the car
2. Financing for one year with interest 0% (4 quarterly payments,
BD3,000 each)
Which promotion should the student take?
(Suppose inflation is 0%.)
6
“Intermediate Problem” Example
Promotion 1
• Get BD2,000 and borrow BD12,000 - BD2,000 = BD10,000
with interest 10%
BD2,625 (5% more than BD2,500) [?]
BD2,658 (6.3% more than BD2,500) [?]
car
BD2,750 (10% more than BD2,500) [?]
BD3,000 (20% more than BD2,500) [?]
• Actual Payment: 4*BD2,658 = BD10,632
7
“Intermediate Problem” Example
Promotion 2:
• Borrow BD12,000 with interest 0%.
car
BD3,000
• Actual Payment: 4*BD3,000 = BD12,000
• Conclusion: Select the first promotion!!
8
Engineering Economic Analysis
Key Questions:
• Which engineering projects are worthwhile?
• Which projects should have higher priority?
• How the project should be designed?
• How to achieve long-term financial goals?
• How to compare different ways to finance purchases?
• How to make short and long-term financial decisions?
9
Engineering Economic Analysis
Examples of Non-Monetary Factors:
• Meeting customer expectations consistently
• Maximization of employee satisfaction
• Maintaining flexibility to meet changing demand
• Maintenance of a desired public image
• Leveling cyclic fluctuations in production
• Improvement of safety in operations
• Reduction of pollutants
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Rational Decision Making
1.
Recognize the problem
–
2.
“I need a place to live this term.”
Define the Goal or Objective
–
3.
“I’ll find a nice apartment that is not too expensive.”
Assemble Relevant Data
–
4.
“I need information on rent, utilities, apartment age, parking, driving time
to UF, driving time to shopping, the neighborhood, other amenities
provided (swimming, table tennis, etc.).”
Identify Feasible Alternatives
–
“I’ll use the Yellow Pages, information from friends, apartment finding
services, information from UF, the local newspaper, and my personal
experience, to look for apartments.”
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Rational Decision Making
5.
Select Criterion to Determine the Best Alternative
–
6.
“Most important is rent plus utilities cost. I’m also very concerned about driving
time to UF, and the kind of neighborhood the apartment is in.”
Construct the model
–
–
7.
“I’ll make a spreadsheet. The rows will be the apartment choices, the columns
the evaluation criteria. Then I’ll try to fill in the interactions between the
apartments and the criteria.”
This includes determining cash flows for engineering economic analysis!!!
Predict Outcomes of Each Alternative
–
8.
“I’ll fill in the estimated costs for the spreadsheet and rate the amenities, driving
time, etc.”
Choose the Best Alternative
–
“Apartment C looks cheapest, but I don`t like the neighborhood. If I pay BD50
more per month for Apartment B I get a nicer neighborhood, and a 15-minute
drive to UF. Maybe I’ll choose Apartment B.”
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Rational Decision Making
9.
Audit the Results
–
“Did I make a good choice”
–
“After living in Apartment B for six months, I am very happy
with my choice!”
–
But this certainly isn’t the case every time!!
13
“Accident Car” Example
Bad news – you just wrecked your car!
An automobile wholesaler offers you BD2,000 for
the car “as is.” Your insurance company
estimates that there is BD2,000 of damage to
your car. The insurance company can fix the car
right away in a repair shop belonging to this
company. Because you have collision insurance
with a BD1,000 deductibility provision, the
insurance company mails you a check for
BD1,000. The odometer reading on your wrecked
car is 58,000 miles.
Additional Information:

You have BD7,000 in savings.

You can buy a newer car for BD10,000 with an odometer reading of 28,000
miles.

After repairing the wrecked car, it can be sold for BD4,500.

A discount repair shop charges BD1,100 and requires 1 month.

A car rental for one month is BD400.
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“Wrecked Car” Example
Alternatives
• Buy newer car. Sell now, but don`t repair:
– Cash flow = BD3,000 - BD10,000 = -BD7,000
• Repair now. Sell, and buy the newer car:
– Cash flow: = -BD1,000 + BD4,500 - BD10,000 = -BD6,500
• Repair at discount shop. Sell and buy the newer car:
– Cash flow: = -BD100 + BD4,500 - BD10,000 = -BD5,600
• Repair now. Keep your car.
– Cash flow: = -BD1,000
• Repair at discount shop.Rent a car, then keep your car.
– Cash flow: = -BD100 - BD400 = -BD500
NOTE: Don’t forget factors such as mileage, repair shop reliability,
investment opportunity for your savings et.
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