Engineering Economy

Chapter 1
Fall 2018

Dr. Ako Rashed Hama

 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

1. Alternatives:
Different solutions (approaches) >>> best economical one
2. Cash Flows:
The estimated inflows (revenues) and outflows (costs ) of money
3. Alternative Selection:
Inaction, do-nothing (DO), as-is, status quo >>> several solutions
4. Evaluation Criteria:
Choosing the best alternative = the lowest cost (highest income)
5. Intangible (untouchable )Factors:
unreal (noneconomic) = goodwill, friendship, morale
6. Time Value of Money: time is (makes) money!
The change in the amount of money over a given time period
The most important concept in engineering economy
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

7. Interest: rent paid for use of the money

difference in an ending amount of money and the beginning amount

positive  vs zero or negative 

paid (borrow money, loan) vs earned (lend money, save)
Interest = end amount (owed now) - original amount (principal) [1.1]
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

8. Interest Rate:
interest rate or rate of return (ROR) = interest over a specific time unit in %
𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑝𝑝𝑝 𝑡𝑡𝑡𝑡 𝑢𝑢𝑢𝑢
𝑅𝑅𝑅 = × 100% [1.2]
𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑎𝑎𝑎𝑎𝑎𝑎 (𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝)

normally % per year (annually), if not >>> must be mentioned!

9. Return On Investment (ROI): same as ROR dependent on the industry

Interest rate paid (borrower) vs rate of return earned (investor)
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 1:
 Engineering Economy
Chap 1: Foundation of Engineering Economy
Basic Terminology and Fundamental Concepts

Example 2:
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 3:
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 3:
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

10. Equivalence:
different sums of money at different times would be equal
in economic value!

e.g. If the interest rate is 6% per year, $100 today (present time) is
equivalent to $106 one year from today:
Amount in one year = $100 + $100 (0.06) = $100 (1 + 0.06) = $106
A total of $100 now is equivalent to $100/1.06 = $94.34 one year ago
$94.34 last year = $100 now = $106 next year (interest rate of 6% / year)

$6 $5.66
6% 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑝𝑝𝑝 𝑦𝑦𝑦𝑦 = × 100% = × 100%
$100 $94.34
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

10. Equivalence:
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 4
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 4

11. Simple Interest:

more than one interest period and if using the principal only

Simple Interest = (principal)(number of periods)(interest rate) [1.3]

 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 5

$1,000,000 = $1,000 unit

 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

12. Compound Interest

principal + total amount of interest accumulated in all previous periods
interest on top of interest

Compound Interest = (principal + all accrued interest)(interest rate) [1.4]

Total due after a number of years = principal(1 + interest rate)number of years
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 6
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

13. Terminology and Symbols:

P = value or amount of money at the present or time 0

present worth (PW), present value (PV), net present value (NPV); dollars
F = value or amount of money at some future time. Also, F is called future
worth (FW) and future value (FV); dollars
A = series of consecutive, equal (uniform), end-of-period amounts of money
annual worth (AW); dollars per year, dollars per month
n = number of interest periods; years, months, days
i = interest (mostly compound unless stated as simple) rate or rate of return
per time period; percent per year, percent per month, percent per day
t = time, stated in periods; years, months, days
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 7
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

14. Cash Flows:

Inflows: “ + ” Outflows: “— ”
cash receipts cash disbursements
revenues expenses
incomes costs
take give
win loss

Net cash flow = receipts – disbursements [1.5]

Net cash flow = cash inflows - cash outflows

* under end-of-period convention (assumption) = end of interest period

 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

15. Cash Flow Diagram:

Graphical representation of cash flows drawn on a time scale

year 1 year 4

0 1 2 3 4 5 Time [year]

Time 0: normally Present; time 0, 1, 2, 3, and 4 + (inflow); time 5 – (outflow)

 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 8
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

Example 9
 Engineering Economy
Chap 1: Foundation of Engineering Economy

Basic Terminology and Fundamental Concepts

16. Applying Spreadsheet Functions in Microsoft Excel©:

Financial Functions one of the specific Worksheet Functions in Excel
To find the present value P of an A series: =PV(i%,n,A,F)
To find the future value F of an A series: =FV(i%,n,A,P)
To find the equal, periodic value A: =PMT(i%,n,P,F)
To find the number of periods n: =NPER(i%,A,P,F)
To find the compound interest rate i: =RATE(n,A,P,F)
To find the compound interest rate i: =IRR(first_cell:last_cell)
To find the present value P of any series: =NPV(i%, second_cell:last_cell)
first_cell

Excel Examples