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Engineering Economy
LEC UW 8:30-9:45 CP35 / SSE
Fall 2012
Course Objectives
The primary goal of this course is to provide the students with the ability to apply
economic approaches to evaluate investment opportunities and to assess the feasibility of
engineering and business projects.
Course Outcomes
With the successful completion of this course you will be able to:
1. Apply the basic concepts of engineering economy as part of a decision making
process.
2. Derive and use the different engineering economy factors.
3. Evaluate investment opportunities and compare between alternatives using single and
combined engineering economy factors.
4. Perform a replacement study considering inflation and indirect cost allocation.
5. Use depreciation and depletion models.
6. Perform breakeven analysis and sensitivity analysis under uncertainty conditions.
7. Utilize spreadsheet functions to perform economic calculations.
Text
White, Case, Pratt and Agee, 2010, Principles of Engineering Economic Analysis, 5th
edition, John Wiley & Sons, Inc. ISBN 978-0-470-11396-7.
Software
We will use Microsoft Excel to assist in processing and analyzing data for assignments.
Use of Computers
Students can use their personal computers, iPads, or other computers to which they have
access. In addition to using computers, students should have a good engineering
calculator (TI 83 or TI 89) to use for some class assignments and quizzes.
Course Website: Blackboard
Lectures, handouts, assignments, announcements and other information will be available
on the course website on Blackboard. The following modules are included on
Blackboard:
1.
2.
3.
4.
5.
6.
Course outline
Lectures
Handouts
Review problems
Assignments
Projects
beginning of class on the due date. Please turn in your assignment as you enter class.
Students who enter late should turn in their assignment when they arrive, not at the end of
the class after any review has taken place. Assignments turned in by students after the
due date will not receive any credit unless prior arrangements have been made.
Assignment
1
2
3
4
5
Quizzes
Unannounced quizzes will be given at regular intervals covering recent material
discussed in class. No make up allowed if you miss a quiz.
If you miss a class because of illness, notify the department office (2615-3063, 26153153) immediately (same day). If a quiz is given that day, you will be given the quiz
at a later date provided: 1. You notified the department about your illness
immediately, 2. You provide a medical note from AUC Medical Clinic.
Missing class, because of travel or engagement in AUC activities requires prior
instructor written approval one week before that date.
Project
Students are divided into groups of 3-4 and are assigned a project were they are expected
to use some of the tools learned in this course. The project grade is determined based on:
1. Content
2. Written Report
3. Class Presentation
4. Student participation
The report must be type written (3 5 pages). No special cover required. Title sheet
stapled to the report is recommended. The report will be graded for writing style as well
as analysis, recommendations and conclusions.
The outline to be followed is:
Executive summary
Introduction
Analysis
Conclusions & recommendations
References
A 15 minutes power point presentation done as a group:
Describe the scope of your analysis
- What did you consider?
Results
- What is the economic merit of project?
Sensitivity/Monte Carlo simulation
- What conditions / assumptions effect your results?
Recommendations
Exams
The first midterm examination covers topics discussed in week 1-5. The second midterm
examination covers topics discussed in week 6-10. The final examination is
comprehensive. Students will be tested on material covered in class. All exams will be
closed book and notes.
If you miss an exam because of illness, notify the department office (2615-3063,
2615-3153) immediately (same day) & provide a medical note from AUC Medical
Clinic before a make-up exam will be allowed. Failure to do so will earn you zero
credit on the exam.
If you miss an exam because of travel or other circumstances, prior instructor written
approval is required one week before the exam.
Tentative Dates
Midterm Exam I will be given on Sunday October 7, 2012.
Midterm Exam II will be given on Wednesday November 14, 2012.
Final Exam will be given during Final week.
Class Participation
The student is expected to read the material to be discussed before the class meeting.
Several handouts will be distributed in class or posted on Blackboard to supplement the
textbook. These handouts will be discussed in class. Each student is responsible for the
material discussed and the instructions given in class even if he or she is absent. Always
bring your textbook and calculator or iPad to class. Active student participation in class
discussions is encouraged. Come to class prepared by reading the material assigned and
solving homework problems.
Grading
Spreadsheet Assignments
Quizzes
Project
Midterm 1
Midterm 2
Final Exam
10 %
10 %
10 %
20 %
20 %
30 %
93% or better = A
83% - 86.99% = B 87% - 89.99% = B+
73% - 76.99% = C 77% - 79.99% = C+
65% - 69.99% = D+
Topical Breakdown
Academic Dishonesty
Academic dishonesty is not tolerated at AUC and is subject to academic discipline
ranging from a mark of zero on the exam or assignment/quiz to dismissal from the
university.
Academic Regulations
Class policy regarding add, drops, incomplete, absences, cheating, etc. will be in accordance
with the university rules and regulations. Students will turn their cell phones off or put them on
vibrate mode while in class. They will not answer their phones in class or send text messages.
Important Dates
September
- This class begins Sunday September 2 2012
October
- Deadline to drop courses, October 24, 2012
- Eid El Edha (H) October 25 29, 2012
November
- Deadline for withdrawal from the semester (undergraduate) Sunday November 25, 2012
December
- Last day of regular classes, Thursday December 13, 2012
- Final Exams, December 15 20, 2012
(P / A,i, n) =
(1 + i)n 1
i(1 + i)n
(A / P,i, n) =
i(1 + i)n
(1 + i)n 1
(1 + i)n 1
(F / A,i, n) =
i
i
(A / F,i, n) =
(1 + i)n 1
(1 + i)n in 1
(P / G,i, n) =
i 2 (1 + i)n
1
n
(A / G,i, n) =
i (1 + i)n 1
1 (1 + j)n (1 + i) n
A1
i j
for
P =
nA1
1+ i
ieffective = (1 +
i j
i= j
r m
) 1
m
Period
interest Rate =
Given
Factor
rn
P
F
ern
Symbol
(P / F, r, n)
(F / P, r, n)
ern 1
er 1
(F / A, r, n)
er 1
ern 1
(A / F, r, n)
ern 1
ern (er 1)
Bonds
P = Vr (P/A, i, n) + F (P/F,i,n)
where
P = the purchase price of a bond
F = the sales price (redemption value) of a bond
V = the par or face value of a bond
r = the bond rate per interest period
i = the yield rate (return on investment or rate of return) per
interest period
n = the number of interest payments received by the bondholder
A = Vr = the interest or coupon payment received
(P / A, r, n)
Loans
1. Principal outstanding (unpaid principal) at beginning of period k
1 (1 + i)( n + k 1)
= A
Capitalized Cost
P=
A
i
Annuity
1
1
P = A[
]
i i(1 + i)t
An annuity is an asset that pays a fixed sum each year for a
specified number of years. Present value of annuity. To to consider a growth g,
then replace A by A/(1+g) and I by (i-g)/1+g)
R
r=0
n
jt
(1 + rt )
n t
= C jt (1 + i ' )n t
t =0
where
i'
R jt
is the ERR
Positive cash flow for investment j during period t
rt
SIR j (i) =
jt
(1 + i)t
jt
(1 + i)t
t =0
n
t =0
where
Is the savings / investment ratio for investment
Alternative j based on a MARR of i%
SIR j (i)
R jt
C jt
Depreciation
SL Depreciation
Dt
Bt
Expected Value:
E[X] = xi p(xi) or
i
xf (x)dx
Variance:
Var[X] = (xi - E[X]) 2p(xi) or
(x E(x))
f (x)dx
Part 6 NPV function - For the cash flows shown, calculate the present worth in year 0.
Assume i = 14% per year.
Year
Cash Flow$
1
4000
2
3200
3
2400
4
1600
Problem 2
You borrow $100 for n years & you want to compare the following two rates:
- At 10% per year simple interest
- At 10% per year compound interest
Plot the amount owed after n years for both simple & compound interest, for n = 1, 2, ,
20, and compare on the same graph. (The x-axis should be n = 1, 2, , 20).
Discuss the results.
Problem 3
You borrow $100 for n years & you want to compare & plot the amount owed after n
years at the following compound rates, 5%, , 10%, 15%, & 20%. Plot the amount owed
versus n for all rates on the same graph. (The x-axis should be n = 1, 2, , 10).
Discuss the results.
Problem 4
For the Uniform Series Present Worth Factor (P/A, i, n), plot the following curves for
n = 1, 2, 10, and the compound interest i = 0%, 5%, 10%, 15%, & 20% on the same
graph. Discuss the results. (The x-axis should be n = 1, 2, , 10)
Amount
owed
Interest
owed
Total owed
Principal
Payment
Total
Payment
1
2
3
4
5
SUM
Set up the table to allow the user to change the amount and interest rate charged.
Problem 5
Repeat problem 4 and create a similar table if you pay the principal and interest in one
payment at the end of 5 years.
Problem 6
Repeat problem 4 and create a similar table if you pay interest due at the end of each year
and principal in one payment at the end of 5 years.
Hatem Elayat
1.
CF $
EOY
CF $
EOY
CF $
-80,000
22,000
22,000
10,000
28,000
16,000
16,000
28,000
10,000
2.
CF $
EOY
CF $
EOY
CF $
-70,000
14,000
14
7,000
20,000
13,000
15
6,000
19,000
12,000
16
5,000
18,000
10
11,000
17
4,000
17,000
11
10,000
18
3,000
16,000
12
9,000
19
2,000
15,000
13
8,000
20
1,000
4.
5.
6.
7.
8.
MARR=
0.1
Time
Cash flow
-$ 25,000.00
-$5000.00
$8000.00
$8000.00
$8000.00
$8000.00
10
$18000.00
11
PW=
12
AW=
13
FW=
14
IRR=
15
SIR=
TC = (220 + 88X + 2X 2 )A
where X = number of floors, and A = floor area in ft2 / floor
A. Create a table (using Excel) that shows the total building cost, average cost,
and marginal cost for configurations ranging from floor 1 to 12 floors,
inclusive.
B. Plot the total cost versus number of floors (1 12). Based on the plot, what is
optimal number of floors for the building.
C. Demonstrate using differential calculus that your answer to part B is correct.
Hatem Elayat
that pays 10% compounded annually. How much money will be in each fund 4
years after the transfer?
7) A debt of $1000 is incurred at t = 0. What is the amount of four equal payments at
t = 1, 2, 3, and 4 that will repay the debt if money is worth 10% compounded per
period?
8) Five deposits of $500 each are made at t = 1, 2, 3, 4, and 5 into a fund. paying 6%
compounded per period. How much will be accumulated in the fund at (a) t = 5,
and B(b) t = 10?
9) What equal annual deposits must be made at t = 2, 3, 4, 5, and 6 in order to
accumulate $25,000 at t = 8 if money is worth 10% compounded annually?
Hatem Elayat
John borrows $15,000 at 18% compounded annually; he pays off the loan over
a 5-year period with annual payments. Each successive payment is $700 greater
than the previous payment. How much was the first payment?
2)
Solve Problem 1 for the case in which each successive payment is to be 10%
greater than the previous payment.
3)
4)
Dr. Shieh deposits $3000 in a money market fund. The fund pays interest at a
rate of 12% compounded annually. Just 3 years after making the single deposit,
he withdraws one third the accumulated money in his account. Then, 5 years
after the initial deposit, he withdraws all of the accumulated money remaining in
the account. How much does, he withdraw 5 years after his initial deposit?
5)
6)
7)
Mary Lib purchases a house for $250,000; a down payment of $20,000 is made
at the time of purchase; and the balance is financed at 12% compounded
monthly, with monthly payments made over a 10-year period.
a. What is the size of the monthly payments?
b. If the loan period had been 20 years, what would have been the size of the
monthly payments?
8)
It is desired to determine the size of the uniform series over the time period [2,
5] that is equivalent to the cash flow profile shown below using an interest rate
of 10%.
9)
Given the following cash flows, what single sum at t = 4 is equivalent to the
given data.
Assume i = 15%.
10)
Given the cash flow profiles shown below, determine the value of X such that
the two cash flow profiles are equivalent at 20% compounded annually.
EOY
CF (A)
CF(B)
-$12,000
$ -X
1,000
7,000
4,000
9,000
6,000
10,000
7,000
10,000
5,000
7,000
Hatem Elayat
2)
3)
Tom and Dale purchase a boat for $150,000; the down payment is $15,000; the
balance is financed over a 10-year period. Equal monthly payments are made.
Determine the amount of interest paid the first month if the monthly interest rate
is 1 %.
4)
Dr. Schultz is considering purchasing a bond having a face value of $2500 and
a bond rate of 10% payable semiannually. The bond has a remaining life of 8
years. How much should she pay for the bond in order to earn a return on
investment of 14% compounded semiannually? Assume the bond will be
redeemed for face value.
5)
Dr. Ramirez wishes to purchase a bond having a face value of $10,000 and a
bond rate of 15% payable annually. The bond has a remaining life of 8 years. In
order to earn a 20% rate of return on the investment, what amount should be paid
for the bond?
6)
Kristin buys a $2000 bond for $2100. The bond has a bond rate of 12% with
bond premiums paid annually. If the bond is kept for 8 years and sold for par
value, determine the equivalent annual yield rate (rate of return) for Kristin's
bond investment.
Hatem Elayat
Consider the net cash flows (NCF) and salvage values (SV) for each of
Alternatives 1 and 2 having lives of 3 and 5 years, respectively.
EOY
Alternative 1
NCF1
Alternative 2
SV1
NCF2
SV2
-$60,000
$60,000
35,000
30,000
30,000
60,000
35,000
10,000
30,000
40,000
35,000
30,000
25,000
30,000
15,000
30,000
10,000
2)
-$100,000 $100,000
EOY
Alternative 1
NCF1
Alternative 2
SV1
NCF2
Alternative 3
SV2
NCF3
SV3
-$20,000
-$40,000
$40,000
-$70,000
$70,000
8,000
20,000
30,000
30,000
50,000
8,000
20,000
20,000
30,000
30,000
28,000
20,000
10,000
30,000
20,000
20,000
30,000
10,000
30,000
5,000
30,000
2,000
3)
NCF(B)
NCF(C)
$400,000
$600,000
$300,000
8 years
12 years
6 years
Annual receipts
$320,000
$380,000
$400,000
Annual disbursements
$230,000
$240,000
$400,000
Salvage value
$100,000
$200,000
$400,000
Life
4)
Machine 2
First cost
$15,000
$20,000
Estimated life
5 years
10 years
$12,000
$14,000
$6,000
$8,000
$1,500
$5,000
5)
Two mutually exclusive proposals, each with a life of 5 years, are under
consideration. MARR is 12%. Each proposal has the following cash flow
profile:
EOY
6)
NCF (A)
NCF (B)
-$30,000
-$42,000
9,300
12,625
9,300
12,625
9,300
12,625
9,300
12,625
9,300
12,625
NCF (A)
NCF (B)
NCF (C)
Initial investment
$600,000
$800,000
$470,000
Planning horizon
10 years
10 years
10 years
Salvage values
$70,000
$130,000
$65,000
Annual receipts
$400,000
$600,000
$260,000
Annual disbursements
7)
$130,000
$270,000
$70,000
Consider the net cash flows of the following three alternatives. None is
renewable. MARR is 12%.
EOY
NCF (1)
NCF (2)
NCF (3)
-$3,000
-$4,000
-$6,000
1,000
4,000
3,000
1,500
2,000
3,000
3,000
4,000
6,000
to be $1500. The company has 10% MARR. Based on the probability distributions given
below for N and L; what is the expected equivalent uniform annual cost for the machine?
N
p(N)
$5,000
0.2
3,000
0.4
10
1,000
0.4
5. The Ajax Manufacturing company wishes to choose one of the following machines:
Machine 1
Machine 2
First cost
$10.000
$12.000
Planning horizon
6 years
6 years
Salvage value
$ 1.000
$ 1.000
800 + 80K
200+ 100K
MARR is 12%
A. Clearly specify the net cash flow profiles for each mutually exclusive alternative.
B. Determine which machine should be selected. Use the ranking approach and the
present worth method.
C. Repeat part (B) using the annual worth method.
D. Repeat part (B) using the future worth method.
E. Based on incremental cash flows, what is the discounted payback period?
F. Determine which machine should be selected. Use an incremental cash flow
approach and the internal rate of return method.
G. Repeat part (F) using external rate of return method.
H. Repeat part (F) using the saving/investment ratio method.
6. The telephone Company of America purchased a numerically controlled production
machine 5 years ago for $300,000. The machine currently has a trade-in value of $
70,000. If the machine is continued in use, another machine, X, must be purchased to
supplement the old machine. Machine X costs$200,000, has annual operating and
maintenance costs of $ 40,000, and will have a salvage value of $ 30,000 in 10 years. If
the old machine is retained, it will have annual operating and maintenance costs of $
70,000, has anticipated annial operating and maintenance costs of $70,000 and will have
a salvage value of $ 15,000 in 10 years.
Using a MARR of 15% and a present worth comparison, determine the preferred
economic alternative.
7. A highway construction firm purchased a particular earth-moving machine 3 years ago
for $ 125,000. The salvage value at the end of 8 years was estimated to be 35% of first
cost. The firm earns average annual gross revenue of $ 105,000 with the machine and the
average annual operating costs have been and are expected to be $ 65,000.
The firm now has opportunity to sell the machine for $70,000 and subcontract the work
normally done by the machine over the next 5 years. If the subcontracting is done, the
average annual gross revenue will remain$105,000 but subcontractor charge
$85,000 /end-of-years for these services.
If a 15% rate of return before taxes is desired, determine by the annual worth method
whether or not the firm should subcontract.
0 = 0 otherwise
) + (0.60 Q + 150)
Note that the total annual inventory cost TC (Q) is a function of the order size q
a) Determine the value of Q that will minimize the total annual inventory cost(i>e>
determine the economic order quantity Q*)
b) What will be corresponding total annual inventory cost, TC (Q*) ?
c) For the economic order Q* , determine the number of orders that will be placed
each year.
d) If the cost of placing a purchase order is decreased by 50% what is the effect on
the economic order quantity?