İMÜ 376

11.10.2019

İMÜ 376 - ENGINEERING ECONOMICS

TODAY’S TOPICS:
• Course information

• Introduction to economic decision parameters

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INSTRUCTOR - ACADEMIC BACKGROUND

• Hüseyin Erol

• Research Assistant in METU: 2012-2019

• Instructor in Hacettepe University since 2019 2
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INSTRUCTOR - RESEARCH INTERESTS

• Project management
• Risk and complexity management
• Mega construction projects
• Construction planning and scheduling
• Probabilistic models
• Lean construction
• BIM and 4D models
• Portfolio management

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INSTRUCTOR - CONTACT INFORMATION

• e-mail: erolhuseyin@hacettepe.edu.tr

• Room: A-418

• Course Hours: Fridays, 09.00-11.50 @B-402

• Communication channel: IMU376-2019 (Google Group)

https://groups.google.com/d/forum/imu376-2019 (Apply for the membership)

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COURSE OBJECTIVE
• The aim of the course is to teach time value of money and techniques that can
be utilized to compare the alternatives from an economic point of view.
• Skills developed in this course enable students to make the right decisions for
real-life engineering problems related to the economy.

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TENTATIVE COURSE SCHEDULE

Weeks Topics
# 1: 11.10.2019 Course Information & Introduction to economic decision parameters
# 2: 18.10.2019 Time value of money
# 3: 25.10.2019 Nominal and effective interest
# 4: 01.11.2019 Methods for comparison of alternatives
# 5: 08.11.2019 Midterm 1
# 6: 15.11.2019 Replacement and economic life
# 7: 22.11.2019 Benefit/cost analysis
# 8: 29.11.2019 Depreciation
# 9: 06.12.2019 N/A (Military Service)
# 10: 13.12.2019 Midterm 2
# 11: 20.12.2019 N/A (Military Service)
# 12: 27.12.2019 Payback period analysis
# 13: 03.01.2020 Break-even analysis
# 14: 10.01.2020 Effect of inflation 6
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REFERENCE BOOKS

• İMÜ 376 - Lecture Slides

• Blank, L. and Tarquin, A. (2018). “Engineering Economy”, 8th edition, McGraw-

Hill, USA.

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COURSE GRADING
• Midterm Exam 1: %30
• Midterm Exam 2: %30
• Final Exam: %40
• Attendance: 0%

• Why should I come to the lectures?

➢ It is the most effortless way of learning the course subjects
➢ Class exercises
➢ Exam hints

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COURSE POLICIES
• Punctuality!
➢ The 10 Minutes Rule:
If you are late more than 10 minutes, please wait for the next lecture.

• No cell phone in the class please!

• Try to use English as much as you can ☺

• Problem Sets: They will be uploaded to the Google Group 9

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WHAT IS ENGINEERING ECONOMICS?

• Micro Economics: Decision-making behavior of individuals or firms in relation to
the economy
➢ Supply and demand
➢ Economic equilibrium
➢ Market structure, competition, personal preferences etc.
• Macro Economics: Overall behavior of the regional, national or global economy
➢ National income and Gross Domestic Product (GDP)
➢ Economic growth and employment rates
➢ Interest and inflation, etc.
• Engineering Economics: Time value of money
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WHAT IS ENGINEERING ECONOMICS?

• Engineering economics is a set of mathematical techniques that facilitates the
selection of an alternative among others.
• It enables to make better choices to invest funds (capital).
• Decision making parameters in engineering problems:
➢ Technical requirements
➢ Safety
➢ Economy → IMU 376
➢ Environmental impact
➢ Compliance to company strategy
➢ Risk attitude
➢ …
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

ALTERNATIVES
• An alternative is an independent option used to resolve an economic problem.
• Factors to be considered while evaluating the economic feasibility of an
alternative:
➢ First/Initial cost (purchase/investment cost)
➢ Expected useful/service life
➢ Annual maintenance and operating costs (yearly cost of maintaining the assets)
➢ Book value or market value (expected resale value at any time)
➢ Salvage value (expected resale value at the end of the service life)
➢ Interest rate
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

CASH FLOWS
• A cash flow is the estimated inflows and outflows of the money.
Income, revenue, earning, drawing, receipt, etc. (+)

0 1 2 3 4 n Time period
(Year, month, quarter, etc.)

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Cost, expense, disbursement, expenditure, etc. (-)
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CLASS EXERCISE-1
• Draw the cash flow diagram of a car with the following inflows and outflows:
➢ Initial cost: 200 000 TL
➢ Yearly maintenance and operating cost: 20 000 TL
➢ Service life: 5 years
➢ Salvage value: 150 000 TL

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CLASS EXERCISE-1
150 000 TL

0 1 2 3 4 5

20 000 TL 20 000 TL 20 000 TL 20 000 TL 20 000 TL

200 000 TL
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CLASS EXERCISE-2
• You borrowed 100 000 TL from a bank. The debt will be paid back in 5 months
with 5 payments. The initial payment at the end of the first month will be 15 000
TL. Monthly payments will increase by 5 000 TL each month. Draw the cash
flow diagram of your debt.

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CLASS EXERCISE-2
100 000 TL 30 000 TL 35 000 TL
20 000 TL 25 000 TL
15 000 TL
0 1 2 3 4 5

0 1 2 3 4 5

15 000 TL 20 000 TL
25 000 TL 30 000 TL
35 000 TL 100 000 TL
Borrower's perspective Lender's perspective 17
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

ALTERNATIVE SELECTION
• Cash flows are analyzed to select the best alternative.
150 000 TL

100 000 TL

0 1 2 3 4 5 0 1 2 3 4 5

20 000 TL 20 000 TL 20 000 TL 20 000 TL 20 000 TL

30 000 TL 30 000 TL 30 000 TL 30 000 TL 30 000 TL

150 000 TL

200 000 TL
Car A Car B
• “Do nothing (taking no action)” is also considered as the alternative selection. 18
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

EVALUATION CRITERIA
• “Financial units” (e.g.: Turkish Lira, Dollar, Euro, etc.) are generally used as the
tangible basis for the evaluation of an alternative in economic analysis.

• For the selection of the economically best alternative, the alternative with the
“lowest overall cost” or “highest overall net income” should be identified.

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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

TIME VALUE OF MONEY
• Time value is the change in the amount of money over a given time period.
100 000 TL

0 1 2 3 4 5

15 000 TL 20 000 TL
25 000 TL 30 000 TL
35 000 TL
• Inflow ≠ Outflow (In terms of mathematics)
• 100 000 TL ≠ 125 000 TL (15000 + 20000 + 25000 + 30000 + 35000) 20
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

TIME VALUE OF MONEY
• The earning power of money enables to make more profit over time.
• 1000 TL earned today ≠ 1000 TL earned a year after (Because of the interest)
• Purchasing power of 1000 TL today ≠ Purchasing power of 1000 TL a year after
(Because of the inflation)
• Example: 1000 TL can buy →

6.06 m3 Concrete 5.57 m3 Concrete

In 2017 In 2018

• In order to buy the same amount of concrete in 2018, an interest rate of 8.8%
must be earned in a year. 21
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

ECONOMIC EQUIVALENCE
• When considered together, the time value of money and the interest rate help
to develop the concept of “economic equivalence”.
• Economic equivalence means that different sums of money at different times
would be equal in terms of economic value.
• Example: Value of the 1000 TL a year later with the annual interest rate of 10%
1 000 TL

0 1

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1 100 TL
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

ECONOMIC EQUIVALENCE
100 000 TL

0 1 2 3 4 5

15 000 TL 20 000 TL
25 000 TL 30 000 TL
35 000 TL

• Inflow (100 000 TL) ≠ Outflow (125 000 TL) → In terms of mathematics
• Inflow (100 000 TL) = Outflow (125 000 TL) → In terms of economics 23
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

INTEREST
• The interest is the difference between the future amount of money and the
present amount of money. It can also be described as the money paid for the
use of borrowed money.
1 000 TL

• Interest = Future Amount – Principal 0 1

Interest = 1100 – 1000 = 100 TL

1 100 TL

• There are always two perspectives for the amount of interest:

➢ Interest paid: The money is borrowed and repaid as a larger amount over time
➢ Interest earned: The money is invested and earned as a larger amount over time 24
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

INTEREST RATE AND INTEREST PERIOD
• The interest rate is the percentage of the amount paid or earned over the
principal.
1 000 TL

Interest
• Interest Rate = x 100
Principal 0 1

100
Interest Rate = x 100 = 10%
1000
1 100 TL

• The interest period is the time unit of the interest rate. It is usually expressed in
terms of years.
E.g.: 10% per year 25
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CLASS EXERCISE-3
• What is the interest rate per year if 250 000 TL borrowed from a bank will be
paid back as 300 000 TL at the end of the one year?

• Interest = Future Amount – Principal

• Interest = 300000 – 250000 = 50 000 TL

Interest
• Interest Rate = x 100
Principal
50000
Interest Rate = x 100 = 𝟐𝟎%
250000
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

SIMPLE INTEREST (BASİT FAİZ)
• Simple interest is calculated using the principal only, ignoring any interest
accumulated in preceding interest periods.
• Simple Interest = Principal x Interest Rate x Interest Period
• Interest of 1000 TL at the end of the 3 years if the interest rate is 12% per year:
Simple Interest = 1000 x 12% x 3 = 360 TL
• Interest rates are generally given for a year. When it is necessary to calculate
the interest for a shorter period, it is common practice to consider:
➢ 1 year = 12 months (Composed of 30 days)
➢ 1 year = 360 days 27
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CLASS EXERCISE-4
• You invested 5 000 TL to a bank on the 1st
of July with the yearly interest rate of
st
6%. What is the amount of interest earned until the 1 of September?

• Simple Interest = Principal x Interest Rate x Interest Period

• Simple Interest = 5000 x 6% x 1 = 300 TL (for 1 year)

• Simple Interest = 300 x (2/12) = 50 TL (On 1 st of September)

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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

COMPOUND INTEREST (BİLEŞİK FAİZ)
• Compound interest is calculated using the principal + interest accumulated in
preceding interest periods.
• Compound interest means the interest on top of interest, reflecting the effect of
the time value of money.
• Most of the financial and economic analyses are made according to compound
interest.
• Compound Interest = (Principal + All Accumulated Interest) x Interest Rate

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CLASS EXERCISE-5
SIMPLE INTEREST VERSUS COMPOUND INTEREST
• Calculate the simple and compound interest earned from the 2 000 TL in 3
years using 10% interest rate per year.

Simple Interest Compound Interest

Year
Amount owned at the Interest earned at Amount owned at the Interest earned at
beginning of the year the end of year beginning of the year the end of year
1 2 000 2 000 x 0.1 = 200 2 000 2 000 x 0.1 = 200
2 2 000 2 000 x 0.1 = 200 2 000 + 200 = 2 200 2 200 x 0.1 = 220
3 2 000 2 000 x 0.1 = 200 2 200 + 220 = 2 420 2 420 x 0.1 = 242
Σ 2 000 + 200 + 200 + 200 = 2 600 TL 2 420 + 242 = 2 662 TL
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BASIC TERMINOLOGY AND FUNDAMENTAL CONCEPTS

COMPOUND INTEREST (BİLEŞİK FAİZ)
• Total due at the end of the n years = P(1+i)n

Year Amount owned at the beginning of the year Interest to be paid at the end of year
1 2 000 2 000 x 0.1 = 200
2 2 000 + 200 = 2 200 2 200 x 0.1 = 220
3 2 200 + 220 = 2 420 2 420 x 0.1 = 242
Σ 2 420 + 242 = 2 662 TL

• Total due at the end of the n years = 2 000 x (1+0.1)3 = 2 662 TL

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QUESTIONS AND COMMENTS?

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