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CHAPTER I
FOUNDATIONS OF
ENGINEERING ECONOMY
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1. Foundations: Overview
1. Questions
2. Decision Making
3. Study Approach
4. Interest Rate
5. Equivalence
6. Simple and Compound Interest
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1. Foundations: Overview
7. Symbols
8. Spreadsheet Functions
9. Minimum Attractive Rate of Return
10. Cash Flows
11. Doubling Time
12. Spreadsheets
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CHAPTER I Section 1
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• Engineers “Design”
• Engineers must be concerned with the economic
aspects of designs and projects they recommend
and perform
• Analysis
• Design
• Synthesis
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Major Role of
Engineering
Economy
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The Question:
Do
Alt. 1 Which One do
Nothing
we accept?
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Do
Alt. 1 ………... Alt. j
Nothing
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• Example 1.3
• You borrow $10,000 for one full year
• Must pay back $10,700 at the end of one
year
• Interest Amount (I) = $10,700 - $10,000
• Interest Amount = $700 for the year
• Interest rate (i) = 700/$10,000 = 7%/Yr
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• Inflation impacts:
• Purchasing Power (reduces)
• Operating Costs (increases)
• Rate of Return on Investments
(reduces)
• Specifically covered in Chapter 14
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Equivalence
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1.5 EQUIVALENCE
• Example
• You travel at 68 miles per hour
• Equivalent to 110 kilometers per hour
• Thus:
• 68 mph is equivalent to 110 kph
• Using two measuring scales
• Miles and Kilometers
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1.5 EQUIVALENCE
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• Economic Equivalence
• Two sums of money at two different
points in time can be made economically
equivalent if:
• We consider an interest rate and,
• No. of time periods between the two
sums
Equality in terms of Economic Value
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T=0 t = 1 Yr
$21,800 paid
back here
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$20,000 is
received here
T=0 t = 1 Yr
$21,800 paid
back here
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• $20,000 now or
• $21,800 one year from now?
• The two sums are economically equivalent
but not numerically equal!
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• Simple Interest
• Calculated on the principal amount only
• Easy (simple) to calculate
• Simple Interest is:
(principal)(interest rate)(time)
$I = (P)(i)(n)
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• Example 1.7
• Borrow $1,000 for 3 years at 5% per year
• Let “P” = the principal sum
• i = the interest rate (5%/year)
• Let N = number of years (3)
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• Simple Interest
• DEFINITION
• I = P(i)(N)
• For Ex. 1.7:
• I = $1,000(0.05)(3) = $150.00
• Total Interest over 3 Years
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1 2 3
I1=$50.00
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• Year 2
P=$1,000
1 2 3
I1=$50.00 I2=$50.00
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1 2 3
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• Assume:
• P = $1,000
• i = 5% per year compounded annually (C.A.)
• N = 3 years
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P=$1,000
Owe at t = 3
years:
1 2 3
$1,000 + 50.00 +
I1=$50.00 52.50 + 55.13 =
I2=$52.50
$1,157.63
I3=$55.13
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1.6 Analysis
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1.7 P and F
0 1 2 … … n-1 n
t=n
$P
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1.7 P and F:
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…………
0 1 2 3 .. N-1 n
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1.8 Spreadsheets
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Introduction to Solution by
Computer
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MARR - %
0%
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• CASH INFLOWS
• Money flowing INTO the firm from outside
• Revenues, Savings, Salvage Values, etc.
• CASH OUTFLOWS
• Disbursements
• First costs of assets, labor, salaries, taxes
paid, utilities, rents, interest, etc.
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• END-OF-PERIOD Convention
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• “Now” is denoted as t = 0
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Positive CF at t = 1
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A = +$1,100/yr
0 1 2 3 4 5
-$5,000
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P = +$5,000
0 1 2 3 4 5
A = -$1,100/yr
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• i approximate = 72/n
• Assume we want an investment to double in,
say, 3 years.
• Estimate i – rate would be: 72/3 = 24%
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Chapter Summary
• Engineering Economy:
• Application of economic factors and
criteria to evaluate alternatives
considering the time value of money
(interest and time)
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CHAPTER I - Summary
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Chapter Summary
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Chapter Summary
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Chapter Summary
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Chapter Summary
• Compounding of Interest
• The power of compounding is very
noticeable, especially over long periods of
time.
• Notion of computing interest on interest
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Chapter Summary
• The MARR
• The MARR is a reasonable rate of return
established as a hurdle rate to determine if an
alternative is economically viable.
• The MARR is always higher than a return
from a safe investment.
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Chapter Summary
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Chapter Summary
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