IE 343 Section 1 Engineering Economy

Exam 1 Review Problems – Solution

Instructor : Tian Ni
Feb. 10, 2012

1. A firm is planning to manufacture a new product. The sales department estimates the unit
selling price is P=$35-0.02D. The fixed cost of manufacturing and selling the product is
$8,000 and the variable cost per each unit sold is $4.
a. Suppose the firm wants to reach a profit of $3,900. How many units do they need to sell
in order to achieve that? (Notice that there may be more than one choice for the company,
and you are expected to report them all)

We want Profit (D) = 3,900

Therefore, if the firm sells 700 units or 850 units, it will realize a profit of $3,900.

b. What is the number of units that the firm has to sell in order to achieve the maximum
profit?

c. What is the firm’s maximum possible revenue?

Revenue= 35 D-0.02 D2

Maximum Revenue = Revenue(875) = 35 * 875 – 0.02 * 875 *875 = $15,312.5

2. Calculate the equivalent uniform annual cost of the following schedule of payments.
Let: i=18%

500 500 500

400 400 400
300 300 300
200 200 200
100 100 100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

(a) Decompose the cash flow diagram into several Basic Components.

100 100 100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

400
300
200
100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

400
300
200
100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

400
300
200
100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
 (b) Calculate the uniform equivalent annual cost of the cash-flow diagram.

Method 1:

Based on the cash flow decomposition in part(a), we can first find out the present
equivalent value P of the basic components and then find out the annual equivalent
cost A

P = 100(P/A,18%, 15) + 100(P/G, 18%, 5) + 100(P/G, 18%, 5)(P/F, 18%, 5) +

100(P/G, 18%, 5)(P/F, 18%, 10) = 1360.9

A = 1360.9(A/P,18%,15) = 267.28

Method 2:

Since cash flows repeat every 5 years, the annual equivalent cost for the first 5 years
period is the same as the annual equivalent cost for the whole 15 years period. So we
can analyze for 5 years only. Therefore, we get

A = 100 + 100 (A/G, 18%, 5) = 100+100*1.6728=267.28

3. What is the value of K that makes the 2 cash flows equivalent? Assume i = 12% a year.

5K
1250
4K 1000
750
2K 500
250

0 1 4 6 0 1 2 3 4 5

(a) Write an expression for that makes the two cash-flow diagrams equivalent to each
other. should be the only variable on the left side of the equation (i.e., ). You
don’t need to calculate the final numerical answer.
Present value of cash flow 1 = 5K (P/F, 0.12, 1) + 2K (P/F, 0.12, 4) + 4K (P/F, 0.12, 6)

Cash flow 2 consists of a standard annuity of $250 paid for 5 years and a standard 5
years uniform gradient series with G = $250.

Present value of cash flow 2 = 250 (P/A, 12%, 5) + 250 (P/G, 12%, 5)

Present value of cash flow 1 = Present value of cash flow 2

5K (P/F, 0.12, 1) + 2K (P/F, 0.12, 4) + 4K (P/F, 0.12, 6) = 250 (P/A, 12%, 5) + 250 (P/G,
12%, 5)

K = [250 (P/A, 12%, 5) + 250 (P/G, 12%, 5)] / [5 (P/F, 0.12, 1) + 2 (P/F, 0.12, 4) + 4 (P/F,
0.12, 6)]

(b) Calculate the numerical answer for based on your expression in (a).

Present value of cash flow 1 = 5K/(1.12) + 2K / (1.12)4 + 4K / (1.12)6 = 7.7618K

Present value of cash flow 2 = 250 (P/A, 12%, 5) + 250 (P/G, 12%, 5) = 250 (3.6048) +
250 (6.397) = $2500.45

Therefore, 7.7618K = 2500.45

K = $322.15
4. Suppose you have a bank account that pays 6% annual interest compounded monthly.
Answer the following questions

a. If you deposit $100 into the account at the end of every month starting from the end
of month 1 for the next 4 years, how much will you have in the account at the end of
the 4th year?

The payment period is in month, so we have to find out the effective monthly
interest rate.
Since the 6% interest is compounded monthly, so the nominal interest rate per
month is the same as effective interest rate per month = 6% / 12= 0.5%
In 4 years, we make totally 4*12 = 48 deposits.

F = 100(F/A, 0.5%, 48) = 5409.8

b. If you deposit $100 into the account at the end of every 6 months for the next 4 years,
how much will you have in the account at the end of the 4th year? Write an expression
only.

The payment period is in 6 months, so we have to find out the effective interest
rate per 6 months.
The nominal interest rate per 6 months is 6% / 2 = 3%
The effective interest rate per 6 months is
In 4 years, we make totally 4*2 = 8 deposits.

F = 100(F|A, 3.04%, 8)

c. Say you deposit $100 at the end of the first quarter, $200 at the end of the second
quarter, $300 at the end of the third quarter, and so on for 4 years. Every quarter you
deposit $100 more than the previous quarter. How much will you have in the account
at the end of the 4th year? Write an expression only.
First draw the cash flow diagram from the banks prospective

400
300
200
100 …….

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

The payment period is in quarters, so we have to find out the effective interest
rate per quarter.
The nominal interest rate per quarter is 6% / 4 = 1.5%
The effective interest rate per quarter is
In 4 years, we make totally 4*4 = 16 deposits.

To calculate the F of the cash flow diagram, we make a standard decomposition

of the cash flow diagram into a standard annuity with A = 100 for 16 periods
and a standard uniform gradient series of G = 100.

F = 100(F/A, 1.51%, 16) + 100(F/G, 1.51%, 16)