ENGR 155 – Engineering economics
Jan 17: IntroductionChapter 1: Engineering economics overviewFundamental principles of engineering economicsTime value of moneySimple & compound interest
Engineering is the profession in which knowledge of the mathematical & natural sciences gained by study, experience & practice is applied w/ judgment to develop ways to use, economically, the forces of nature for the benefit of humankind.(ABET)
Engineering economics overview
Topics dealt with in chapter 1
1.Rational decision-making process2.Economic decisions3.Predicting future4.Role of engineers in business5.Large-scale engineering projects6.Types of strategic engineering economic
decisions
T1. Rational decision-making process(what engineers do)
– Recognize a decision problem
– Define the goals or objectives
– Collect all the relevant information
– Identify a set of feasible decision alternatives
– Select the decision criterion to use
– Select the best alternative
Text example: which car to lease?Saturn vs. Honda
Need a car
Want mechanical security
Gather technical as well as financial data
Choose between Saturn and Honda
Want minimum total cash outlay
Select Honda
– Recognize a decision problem
– Define the goals or objectives
– Collect all the relevant information
– Identify a set of feasible decision alternatives
– Select the decision criterion to use
– Select the best alternative
Financial data required to make an economic decision
T2. Engineering economic decisions
Planning
Marketing
Manufacturing Profit
Investment
T3. Predicting the future
- Estimating a required investment
- Forecasting a product demand
- Estimating a selling price
- Estimating a manufacturing cost
- Estimating a product life
T4. Role of engineers in business
Create & design
engineering projects
Evaluate
expected profitability
timing of cash flows
degree offinancial risk
Evaluate
impact on financial statements
firm’s market value
stock price
Analyze
production methods
engineering safety
environmental impacts
market assessment
Accounting vs. engineering economics
Evaluating past performance
Evaluating & predicting future events
Accounting Engineering economy
past futurepresent
Time & uncertainty are the defining aspects of any engineering
economic decision
T5. A large-scale engineering project
– Requires a large sum of investment
– Takes a long time to see the financial outcomes
– Has uncertainty in predicting the revenue & cost streams
T6. Types of strategic engineering economic decisions in manufacturing sector
– Service improvement – Equipment & process selection– Equipment replacement– New product & product expansion– Cost reduction
Fundamental principles of engineering economics
1. A nearby dollar is worth more than a distant dollar
2. All that counts are the differences among alternatives
3. Marginal revenue must exceed marginal cost 4. Additional risk is not taken without the
expected additional return
Principle 1: A nearby dollar is worth more than a distant dollar
today 6-month later
Principle 2: All that counts are the differences among alternatives
Option Monthly fuel cost
Monthly mainten-ance
Cash outlay at signing
Monthly payment
Salvage value at end of year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant items in decision making
Principle 3: Marginal revenue must exceed marginal cost
Marginal cost
1 unitManufacturing cost
Marginal revenueSales revenue 1 unit
Ignore sunk costs
Principle 4: Additional risk is not taken without expected additional return
Investment class
Potential risk
Expected return
Savings account (cash)
Low/none 1.5%
Bond (debt) Moderate 4.8%Stock (equity) High 11.5%
Summary of chapter 1
– Engineering economic decision refers to all investment decisions relating to engineering projects
– Five main types of engineering economic decisions: service improvement, equipment & process selection, equipment replacement, new product & product expansion, cost reduction
– The factors of time & uncertainty are the defining aspects of any investment project
Time value of money– Money has a time value
because it can earn more money over time (earning power).
– Money has a time value because its purchasing power changes over time (inflation).
– Time value of money is measured in terms of interest rate.
– Interest is the cost of money—a cost to the borrower & an earning to the lender
What determines interest rate?– Time value of money– Risk– Overhead costs– Inflation– Supply of & demand for funds
Money supply & demand
Methods of calculating interest
Simple interest: the practice of charging an interest rate only to an initial sum (principal amount).
Compound interest: the practice of charging an interest rate to an initial sum & to any previously accumulated interest that has not been withdrawn.
Simple interest
P = Principal amounti = Interest rateN = Number of interest
periodsExample:
P = $1,000i = 8%N = 3 years
End of year
Beginning balance
Interest earned
Ending balance
0 $1,000
1 $1,000 $80 $1,080
2 $1,080 $80 $1,160
3 $1,160 $80 $1,240
Simple interest formula
( )where
= Principal amount = simple interest rate = number of interest periods = total amount accumulated at the end of period
F P iP N
PiNF N
= +
$1,000 (0.08)($1,000)(3)$1, 240
F = +=
Compound interest
Compound interest: the practice of charging an interest rate to an initial sum & to any previously accumulated interest that has not been withdrawn.
Compound interest
P = Principal amounti = Interest rateN = Number of
interest periodsExample:
P = $1,000i = 8%N = 3 years
End of
year
Beginning balance
Interest earned
Ending balance
0 $1,000
1 $1,000 $80 $1,080
2 $1,080 $86.40 $1,166.40
3 $1,166.40 $93.31 $1,259.71
Become rich by the age of 65
• Your current age: 20 years old• Amount of savings desired: $2 million• Interest earned on your savings: 10%• Required monthly savings:
Upper 5% of U.S. income bracket
Monthly savings requiredto save $2M at age 65
Required Monthly Savings at Varying Interest Rates
Starting Age
5% 7% 10% 12% 15%
20 $987 $527 $190 $93 $31
30 $1,760 $1,110 $527 $311 $136
40 $3,358 $2,469 $1,507 $1,064 $617
50 $7,483 $6,310 $4,825 $4,003 $2,998
Returns from various investment classes
Average Annual Return 1970-
1997
Best Year Worst year
U.S. stocks 13.0% 37.6% (1995)
-26.5% (1974)
International stocks
12.7% 39.4% (1993)
-26.2% (1974)
Real estate 8.8% 20.5% (1979)
-5.6% (1991)
U.S. bonds 9.3% 33.5% (1982)
-5.6% (1994)
What’s an engineering degree worth?Source: CNN Money, April 19, 2005
Majors Average starting salaryChemical engineering $54,256Electrical engineering $52,009
Civil engineering $43,462Business administration $39,448
Computer engineering $51,496Mechanical engineering $51,046
Information science $43,732Industrial engineering $49,541
For most engineering graduates, it is not difficult to set aside$100 each month for savings.
Conclusion?
Start saving Early!
