Engineering Economics
Objective of the Company
 Increase the market value of the company
 Market value – stock price reflected in the financial
market
 Market values of some of well known U.S. firms
Company
Stock Price Market Value
(mil) 2010
Market Value
(mil) 2014
Google
$581.13
$141.138
$344,458.8
Apple
$102.64
$295,886.3
$560,337.4
Microsoft
$46.56
$238,784.5
$344,458.8
Wal-Mart
$75.60
$200.68B
$256,322.8
Exxon
Mobile
$96.03
$368,711.5
$432,357.3
Factors that Affect Market Value
 How is the company doing at a particular time?
 What is happening to other stock prices, that is, how are
the competitors doing?
 How do investors expect the company to perform in the
future – Decisions to invest in various projects and the
actual performance of these projects
A. Why Engineers need to understand
the financial statements?
Understanding Financial
Statements



Accounting: The Basis
of Decision-Making
Financial Statements:
Financial Status for
Businesses
Financial Ratios: Using
Ratios to Make
Business Decisions
Accounting – The Language of Business
Methods of Reporting Income
Income is not counted until cash
(or a check) is actually received,
and expenses are not counted
until they are actually paid.
Cash Basis
method
Transactions are counted when the
order is made, the item is
delivered, or the services occur,
regardless of when the money for
them (receivables) is actually
received or paid
Accrual Basis
method
Financial Status for Business
B. Understanding the Balance Sheet

The basic accounting equation and the definition of
capital

How to instantly determine liquidity and too much
debt

How the firm gets equity: only two ways
The Basic Accounting Equation
 For the Balance Sheet Presentation
Assets = Liabilities + Owners’ Equity
 For the Financial Analysis
Assets - Liabilities = Owners’ Equity
The Balance Sheet Statement for RIM, Ltd.
Using the Four Quadrants of the Balance
Sheet and Why?
ASSETS
LIABILITIES
Current Liabilities
Current Assets
=
Long-Term Liabilities
Long-Term Assets
Equity
1.
2.
Owner Contributions
Retained Earnings
How to Instantly Determine Liquidity and
Too Much Debt?
 Liquidity
 Too Much Debt?
Liquidity – Current Ratio
ASSETS
Current Assets
LIABILITIES
Current Liabilities
Long-Term Liabilities
Long-Term Assets
Equity
1.
2.
Owner Contributions
Retained Earnings
Too Much Debt? – Debt to Equity Ratio
Current Assets
LIABILITIES
Current Liabilities
Debt
ASSETS
Long-Term Assets
Equity
1.
2.
Owner Contributions
Retained Earnings
Equity
Long-Term Liabilities
How the Firm Gets Equity: Only Two Ways
 Owners’ Contributions
 By issuing stocks through financial markets
 Retained Earnings
 By retaining operating profits instead of paying
C. Using the Income Statement to Manage
a Business

How to use profit check points

Why gross margin is the critical measure for
engineers?

How does inventory production impact
profit?
Basic Income Statement Equation
Revenue
Expenses
Net Income (Loss)
Why Gross Margin is a Critical Measure for
Engineers?
Sales
Cost of Goods Sold
Gross Margin
How Inventory Production Impacts Profit
Calculating the Cost of Goods Sold
Beginning Inventory
+ Additions to Inventory
- Ending Inventory
Cost of Goods Sold
How to Use Profit Check Points
ABC Company, Inc.
Statement of Operations (Year Ended December 31, 20xx)
Sales
Less: Cost of Goods Sold
Gross Profit (margin)
Less: Selling, G&A Expenses
Operating Profit (margin)
Less: Interest
Net Income Before Taxes (NIBT)
Less: Taxes
Net Income (margin)
$5,000,000
100.0%
3,250,000
65.0%
1,750,000
35.0%
1,000,000
20.0%
750,000
15.0%
250,000
5.0%
500,000
10.0%
175,000
3.5%
$325,000
6.5%
Bottom line
The Income Statement – Research In Motion Ltd.
FY 2009
100.00%
Revenue
46.07%
Gross margin
24.60%
Operating margin
17.10%
Net margin
Relationship Between Balance Sheets
and Income Statement
Balance Sheet (12/31/09)
Assets
Current assets
Fixed assets
Total
74,300
95,000
169,300
Income Statement
(01/01/10 - 12/31/10)
Net sales
Cost of Goods Sold
Gross Profit
O&M Expenses
Net Operating profit
Liabilities & Equities
Current liabilities
Other liabilities
Total
44,500
32,000
76,500
Preferred stock
Common stock
Capital surplus
Retained earnings
Total
10,000
40,000
10,000
32,800
169,300
Non-operating Profit
Taxable Income
Income Taxes
Net Income
Cash Dividends
Retained earnings
Balance Sheet (12/31/10)
300,000 Assets
208,000 Current assets
92,000 Fixed assets
58,720
Total
33,280
Liabilities & Equities
5,200
28,080 Current liabilities
8,424 Other liabilities
19,656
Total
10,056
9,600
Preferred stock
Common stock
Capital surplus
Retained earnings
Total
76,400
84,000
160,400
28,000
30,000
58,000
10,000
40,000
10,000
42,400
160,400
D. Understanding the Statement of
Cash Flows
 The business operating cycle: How a
business earns its cash
 Sources and Uses of Cash
 The engineer’s focus on the investing
section: Capital Budgeting
Cash Flow Transactions within Business
Shareholders
To pay dividend,
To purchase back
shares
To purchase
From sale
of shares
Government
To pay taxes
From sale
CASH
To pay interest
and principal
From cash sales
Customers
Fixed Assets
From credit
sales
From sale
of debt
To pay labor,
materials, and
overhead
Inventory
Debt holders
The Cash Flow – Business Cycle
• Pay taxes
• Changes in equity
• Pay interest
• Pay dividends
• Changes in liabilities
Cash
Collection of
receivable
Production
• Labor
• Materials
• Overhead
Investment
Accounts
receivable
Credit
Sales
Inventory
Depreciation
Fixed assets
Cash
Sales
The Cash Flow Statement – Research In Motion, Ltd.
Operating
Activities
Financing
Activities
Investing
Activities
Sources and Uses of Cash
Financial
position
Balance Sheet
March 1, 2010
Statement of
Changes in
Financial Position
Sources and
Uses of Funds
Sources
Increase in equity
Decrease in assets
Increase in liabilities
Financial
position
Balance Sheet
Feb. 28, 2009
Uses
Decrease in equity
Increase in assets
Decrease in liabilities
The Engineer’s focus on the Investing
Section: Capital Budgeting

Cash from Operations
•
•


Cash from Investments
Cash from Financing
•
Cash from
operations (profit)
Cash spent on
Property, Plant,
Equip.
Cash received from
bonds and stocks
What is Capital Budgeting?
 Capital: fixed assets used
in production
 Budget: a plan which
details projected cash
flows during some future
period
 Capital Budgeting: a
process of analyzing
projects and deciding
whether they should be
included in the capital
budget
Capital Budgeting Framework
Investment
Decision
Financing
Decision
Dividend
Decision
Major Investment Decision