Introduction to Engineering Economy

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Introduction to Engineering Economy

• Engineering Economy is about making decisions
• It is based on the systematic evaluation of the
  costs and benefits of proposed technical projects
• The principles and methodology of engineering
  economy are utilized to analyze alternative uses
  of financial resources, particularly in relation
  to the physical assets and the operation of an
  organization.

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Example 1 How BD100 a month can grow
Year Interest 0 1 3 6 9 12
1 BD1,200 BD1,206 BD1,217 BD1,234 BD1,251 BD1,268
5 BD6,000 BD6,150 BD6,465 BD6,977 BD7,542 BD8,167
10 BD12,000 BD12,615 BD13,974 BD16,388 BD19,351 BD23,004
15 BD18,000 BD19,411 BD22,697 BD29,082 BD37,841 BD49,958
20 BD24,000 BD26,556 BD32,830 BD46,204 BD66,789 BD98,926
25 BD30,000 BD34,067 BD44,601 BD69,299 BD112,112 BD187,885
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Example 2 When BD12K exceeds BD70K
Interest Rate 12 Ahmed Ahmed Ali Ali
Interest Rate 12 Start Investing Age 20 Annual Investment BD2,000/yr for 6 years (monthly BD166.67) Start Investing Age 26 Annual Investment BD2,000/yr for 35 years (monthly BD166.66)
Interest Rate 12 Stop Investing Age 25 Annual Investment BD2,000/yr for 6 years (monthly BD166.67) Stop Investing Age 60 Annual Investment BD2,000/yr for 35 years (monthly BD166.66)
Total Investment BD12,000 BD12,000 BD70,000 BD70,000
Total Accumulation at Age 60 BD1,078,425 BD1,078,425 BD1,014,147 BD1,014,147
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Example 3 The Real Cost of a BD1,000 Credit
Balance
Year Month Balance Interest New Balance Payment
0 0 BD1,000 BD18.33 BD1,018.33 BD20.37
0 1 BD997.96 BD18.29 BD1,016.25 BD20.32
0 2 BD995.92 BD18.25 BD1,014.17 BD20.28
0 3 BD993.89 BD18.21 BD1,012.10 BD20.24
0 4 BD991.86 BD18.18 BD1,010.03 BD20.20
38 10 BD80.06 BD1.47 BD81.52 BD10.00
38 11 BD71.52 BD1.31 BD72.83 BD10.00
39 0 BD62.83 BD1.15 BD63.98 BD10.00
39 1 BD53.98 BD0.99 BD54.97 BD10.00
39 2 BD44.97 BD0.82 BD45.80 BD10.00
39 3 BD35.80 BD0.66 BD36.45 BD10.00
39 4 BD26.45 BD0.48 BD26.94 BD10.00
39 5 BD16.94 BD0.31 BD17.25 BD10.00
39 6 BD7.25 BD0.13 BD7.38 BD7.38
39 7 BD0.00 BD0.00 BD0.00 BD0.00
Total Payments Total Payments BD6,345

• YOU
• have a BD1,000 balance on your credit card
• pay 21.99 interest rate
• pay the required minimum payment of 2 of the
  balance or BD10, whichever is greater
• make no new purchases
• How much will it take to pay off the credit card?
• How much will be the total amount you paid?

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Decision Making and Problem Solving

• Simple Problems
• Can be analyzed in ones head without extensive
  analysis
• Do I buy a semester parking pass, use parking
  meters, or buy a bicycle?
• How often should I eat out?
• Intermediate Problems
• They are sufficiently important to justify
  serious thought and action
• They cant be worked in ones head must be
  organized
• The economic aspects are significant component in
  the analysis leading to a decision
• Complex Problems
• Represent a mixture of economic, political, and
  humanistic elements
• Selection of a president in USA
• Building a nuclear power plant

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Intermediate Problem Example

• A student is buying a car, which costs BD12,000.
  He can borrow money in the bank with a 10 yearly
  interest rate (quarterly compounding). The dealer
  offers one of the two promotions
• 1. Discount of BD2,000 off the price of the car
• 2. Financing for one year with interest 0 (4
  quarterly payments, BD3,000 each)
• Which promotion should the student take?
• (Suppose inflation is 0.)

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Intermediate Problem Example

• Promotion 1
• Get BD2,000 and borrow BD12,000 - BD2,000
  BD10,000
• with interest 10
• BD2,625 (5 more than BD2,500) ?
• BD2,658 (6.3 more than BD2,500) ?
• BD2,750 (10 more than BD2,500) ?
• BD3,000 (20 more than BD2,500) ?
• Actual Payment 4BD2,658 BD10,632

car
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Intermediate Problem Example

• Promotion 2
• Borrow BD12,000 with interest 0.
• Actual Payment 4BD3,000 BD12,000
• Conclusion Select the first promotion!!

car
BD3,000
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Engineering Economic Analysis

• Key Questions
• Which engineering projects are worthwhile?
• Which projects should have higher priority?
• How the project should be designed?
• How to achieve long-term financial goals?
• How to compare different ways to finance
  purchases?
• How to make short and long-term financial
  decisions?

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Engineering Economic Analysis

• Examples of Non-Monetary Factors
• Meeting customer expectations consistently
• Maximization of employee satisfaction
• Maintaining flexibility to meet changing demand
• Maintenance of a desired public image
• Leveling cyclic fluctuations in production
• Improvement of safety in operations
• Reduction of pollutants

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Rational Decision Making

• Recognize the problem
• I need a place to live this term.
• Define the Goal or Objective
• Ill find a nice apartment that is not too
  expensive.
• Assemble Relevant Data
• I need information on rent, utilities, apartment
  age, parking, driving time to UF, driving time to
  shopping, the neighborhood, other amenities
  provided (swimming, table tennis, etc.).
• Identify Feasible Alternatives
• Ill use the Yellow Pages, information from
  friends, apartment finding services, information
  from UF, the local newspaper, and my personal
  experience, to look for apartments.

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Rational Decision Making

• 5. Select Criterion to Determine the Best
  Alternative
• Most important is rent plus utilities cost. Im
  also very concerned about driving time to UF, and
  the kind of neighborhood the apartment is in.
• Construct the model
• Ill make a spreadsheet. The rows will be the
  apartment choices, the columns the evaluation
  criteria. Then Ill try to fill in the
  interactions between the apartments and the
  criteria.
• This includes determining cash flows for
  engineering economic analysis!!!
• Predict Outcomes of Each Alternative
• Ill fill in the estimated costs for the
  spreadsheet and rate the amenities, driving time,
  etc.
• Choose the Best Alternative
• Apartment C looks cheapest, but I dont like the
  neighborhood. If I pay BD50 more per month for
  Apartment B I get a nicer neighborhood, and a
  15-minute drive to UF. Maybe Ill choose
  Apartment B.

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Rational Decision Making

• Audit the Results
• Did I make a good choice
• After living in Apartment B for six months, I am
  very happy with my choice!
• But this certainly isnt the case every time!!

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Accident Car Example

• Bad news you just wrecked your car!
• An automobile wholesaler offers you BD2,000 for
• the car as is. Your insurance company
• estimates that there is BD2,000 of damage to
• your car. The insurance company can fix the car
• right away in a repair shop belonging to this
• company. Because you have collision insurance
• with a BD1,000 deductibility provision, the
• insurance company mails you a check for
• BD1,000. The odometer reading on your wrecked
• car is 58,000 miles.
• Additional Information
• You have BD7,000 in savings.
• You can buy a newer car for BD10,000 with an
  odometer reading of 28,000 miles.
• After repairing the wrecked car, it can be sold
  for BD4,500.
• A discount repair shop charges BD1,100 and
  requires 1 month.
• A car rental for one month is BD400.

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Wrecked Car Example

• Alternatives
• Buy newer car. Sell now, but dont repair
• Cash flow BD3,000 - BD10,000 -BD7,000
• Repair now. Sell, and buy the newer car
• Cash flow -BD1,000 BD4,500 - BD10,000
  -BD6,500
• Repair at discount shop. Sell and buy the newer
  car
• Cash flow -BD100 BD4,500 - BD10,000
  -BD5,600
• Repair now. Keep your car.
• Cash flow -BD1,000
• Repair at discount shop.Rent a car, then keep
  your car.
• Cash flow -BD100 - BD400 -BD500
• NOTE Dont forget factors such as mileage,
  repair shop reliability, investment opportunity
  for your savings et.