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Eng Econ Patel 03 Nov 04
Eng Econ Patel 03 Nov 04
November 3, 2004
Engineering Economy
It deals with the concepts and techniques
of analysis useful in evaluating the worth
of systems, products, and services in
relation to their costs
Engineering Economy
It is used to answer many different
questions
Which engineering projects are worthwhile?
Has the mining or petroleum engineer shown that
the mineral or oil deposits is worth developing?
Basic Concepts
Cash flow
Interest Rate and Time value of money
Equivalence technique
Cash Flow
Engineering projects generally have economic
consequences that occur over an extended
period of time
For example, if an expensive piece of machinery is
installed in a plant were brought on credit, the simple
process of paying for it may take several years
The resulting favorable consequences may last as
long as the equipment performs its useful function
Cash flow
+$1000
-$580 (-$500 - $80)
-$540 (-$500 - $40)
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$580
$540
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Compound Interest
Interest that is computed on the original
unpaid debt and the unpaid interest
Compound interest is most commonly
used in practice
Total interest earned = In = P (1+i)n - P
Where,
P present sum of money
i interest rate
n number of periods (years)
I2 = $100 x (1+.09)2 - $100 = $18.81
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Notation for
Calculating a Future Value
Formula:
F=P(1+i)n is the
single payment compound amount factor.
Functional notation:
F=P(F/P,i,n) F=5000(F/P,6%,10)
F =P(F/P) which is dimensionally correct.
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Notation for
Calculating a Present Value
P=F(1/(1+i))n=F(1+i)-n is the
single payment present worth factor.
Functional notation:
P=F(P/F,i,n) P=5000(P/F,6%,10)
Interpretation of (P/F, i, n): a present sum P,
given a future sum, F, n interest periods
hence at an interest rate i per interest
period
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Spreadsheet Function
P = PV(i,N,A,F,Type)
F = FV(i,N,A,P,Type)
i = RATE(N,A,P,F,Type,guess)
Where, i = interest rate, N = number of interest
periods, A = uniform amount, P = present sum
of money, F = future sum of money, Type = 0
means end-of-period cash payments, Type =
1 means beginning-of-period payments,
guess is a guess value of the interest rate
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Equivalence
Relative attractiveness of different
alternatives can be judged by using the
technique of equivalence
We use comparable equivalent values of
alternatives to judge the relative
attractiveness of the given alternatives
Equivalence is dependent on interest rate
Compound Interest formulas can be
used to facilitate equivalence
computations
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Technique of Equivalence
Determine a single equivalent value at a
point in time for plan 1.
Determine a single equivalent value at a
point in time for plan 2.
Both at the same interest rate and at the same time point.
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Plan 1
$1,000
$1,000
$1,000
$1,000
$1,000
$5,000
Plan 2
$5,000
$5,000
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P = $5,000
Alternative 2 is better
than alternative 1 since
alternative 2 has a
greater present value
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