ECE492 Capstone Design I: Engineering Economics Exercises

1) The three economic criteria for choosing the best alternative are minimize input, maximize output,
and maximize the difference between output and input. For each of the following situations, what
is the appropriate economic criterion?

a) A manufacturer of plastic drafting triangles can sell all the triangles he can produce at a
fixed price. As he increases production, his unit costs increase as a result of overtime pay
and so forth. The manufacturer’s criterion should be __________.
b) An architectural and engineering firm has been awarded the contract to design a wharf for
a petroleum company for a fixed sum of money. The engineering firm’s criterion should be
_______________.
c) A book publisher is about to set the list price (retail price) on a textbook. The choice of a
low list price would mean less advertising than would be used for a higher list price. The
amount of advertising will affect the number of copies sold. The publisher’s criterion
should be ________.
d) At an auction of antiques, a bidder for a particular porcelain statue would be trying to
__________________.

2) A firm is planning to manufacture a new product. The sales department estimates that the quantity
that can be sold depends on the selling price. As the selling price is increased, the quantity that can
be sold decreases. Numerically they estimate:

P = $35.00 - 0.02Q

Where P = selling price per unit and Q = quantity sold per year

On the other hand, the management estimates that the average cost of manufacturing and selling
the product will decrease as the quantity sold increases. They estimate

C = $4.00Q + $8000

Where C = cost to produce and sell Q per year

The firm’s management wishes to produce and sell the product at the rate that will maximize
profit, that is, where income minus cost will be a maximum. What quantity should the decision-
makers plan to produce and sell each year?

3) A painting operation if performed by a production worker at a labor cost of $1.40 per unit. A
robot spray painting machine, costing $15,000, would reduce the labor cost to $0.20 per unit. If the
device would be valueless at the end of 3 years, what is the minimum number of units that would
have to be painted each year to justify the purchase of the robot machine?

4) Company A has fixed expenses of $15,000 per year and each unit of product has a $2.002 variable
cost. Company B has fixed expenses of $5000 per year and can produce the same product at a
$0.05 variable cost. At what number of units of annual production will Company A have the same
overall cost as Company B?
5) The local garbage company charges $6 a month for garbage collection. It had been their practice to
send out bills to their 100,000 customers at the end of each 2-month period. Thus, at the end of
February it would send a bill to each customer for $12 for garbage collection during January and
February.

Recently the firm changed its billing date; it now sends out the 2-month bills after one
month’s service has been performed. Bills for January-February, for example, are sent out at the
end of January. The local newspaper points out that the firm is receiving half its money before
the garbage collection. This unearned money, the newspaper says, could be temporarily invested
for one month at 1% per month interest by the garbage company to earn extra income.

Compute how much extra income the garbage company could earn each year if it invests the
moneys described by the newspaper.

6) Consider the following cash flow:

0 -$P
1 +1000
2 +850
3 +700
4 +550
5 +400
6 +400
7 +400
8 +400

Alice was asked to compute the value of P for the cash flow at 8% interest. She wrote three
equations. Which is correct?

a) P = 1000(P/A, 8%, 8) - 150(P/G, 8%, 8) + 150(P/G, 8%, 4)(P/F, 8%, 4)

b) P = 400(P/A, 8%, 8) + 600(P/A, 8%, 5) - 150(P/G, 8%, 4)
c) P = 150(P/G, 8%4) + 850(P/A, 8%, 4) + 400(P/A, 8%, 4)(P/F, 8%, 4)

7) The council members of a small town have decided that the earth levee that protects the town
from a nearby river should be rebuilt and strengthened. You are the town engineer and estimate
that the cost of the work at the end of the first year will be $85,000. You estimate that in
subsequent years the annual repair costs will decline by $10,000, making the second-year cost
$75,000; the third-year $65,000, and so forth. The council members want to know what the
equivalent present cost is for the first 5 years of repair work if interest is 4%.

8) PARC Company has money to invest in an employee benefit plan, and you have been chosen as
the plan’s trustee. As an employee yourself, you want to maximize the interest earned on this
investment and have found an account that pays 14% compounded continuously. PARC is
providing you $1200 per month to put into to our account for 7 years. What will be the balance in
this account at the end of the 7-year a period?
9) How much would the owner of a building be justified in paying for a sprinkler system that will
save $750 a year in insurance premiums if the system has to be replaced every 20 years and has a
salvage value equal to 10% of its initial cost? Assume money is worth 7%.

10) In a present worth analysis of certain equipment, one alternative has a net present worth of +420,
based on a 6-year analysis period that equals the useful life of the alternative. A 10% interest rate
was used in the computations. The alternative device is to be replaced at the end of the 6 years by
an identical item with the same cost, benefits, and useful life. Based on a 10% interest rate,
compute the net present worth of the alternative equipment for the 12-year analysis period.

11) A machine costs $980,000 to purchase and will provide $200,000 a year in benefits. The company
plans to use the machine for 13 years and then will sell the machine for scrap, receiving $20,000.
The company interest rate is 12%. Should the machine be purchased?

12) The president of the Advanced Circuits Corporation thought it would be appropriate for his firm
to “endow a chair” in the Department of Electrical and Computer Engineering of the local
university; that is, he was considering giving the university enough money to pay the salary of one
professor forever. That professor, who would be designated the Advanced Circuits Professor of
Electrical and Computer Engineering, would be paid from the fund established by the Advanced
Circuits Corporation. If the professor holding that chair will receive $100,000 per year, and the
interest received on the endowment fund is expected to remain at 6.25%, what lump sum of
money will the Advanced Circuits Corporation need to provide to establish the endowment fund?

13) A battery manufacturing plant has been ordered to cease discharging acidic waste liquids
containing mercury into the city sewer system. As a result, the firm must now adjust the pH and
remove the mercury from its waste liquids. Three firms have provided quotations on the necessary
equipment. An analysis of the quotations provided the following table of costs.

Bidder Installed Annual Annual Income Salvage

Cost Operating Cost from Mercury Value
Recovery
Foxhill Instrument $35,000 $8,000 $2,000 $20,000
Quicksilver $40,000 $7,000 $2,200 $0
Almaden $100,000 $2,000 $3,500 $0

If the installation can be expected to last 20 years and money is worth 7%, which equipment
should be purchased?

14) A firm is considering three mutually exclusive alternatives as part of a production improvement
program. The alternatives are:

A B C
Installed cost $10,000 $15,000 $20,000
Uniform annual benefit $1,625 $1,530 $1,890
Useful life, in years 10 20 20
 The salvage value at the end of the useful life of each alternative is zero. At the end of 10 years,
Alternative A could be replaced with another A with identical cost and benefits. The maximum
attractive rate of return is 5%. Which alternative should be selected?

15) An electronics firm invested $60,000 in a precision inspection device. It cost $4,000 to operate and
maintain in the first year and $3,000 in each of the subsequent years. At the end of 4 years, the firm
changed their inspection procedure, eliminating the need for the device. The purchasing agent was
very fortunate in being able to sell the inspection device for $60,000, the original price. The plant
manager asks you to compute the equivalent Uniform annual cost of the device during the 4 years
it was used. Assume interest at 10% per year.

16) A firm is about to begin pilot plant operation on a process it has developed. One item of optional
equipment that could be obtained is a heat exchanger unit. The company finds that a unit now
available for $30,000 could be used in other company operations. It is estimated that the heat
exchanger unit will be worth $35,000 at the end of 8 years. This seemingly high salvage value is due
primarily to the fact that the $30,000 purchase price is really a rare bargain. If the firm believes
15% is an appropriate rate of return, what annual benefit is needed to justify the purchase of the
heat exchanger unit?

17) A manufacturer is considering replacing a production machine tool. The new machine, costing
$3,700, would have a life of 4 years and no salvage value, but would save the firm $500 per year in
direct labor costs and $200 per year indirect labor costs. The existing machine tool was purchased
4 years ago at a cost of $4,000. It will last 4 more years and will have no salvage value at the end of
that time. It could be sold now for $1,000 cash. Assume that money is worth 8% and that the
difference in taxes, insurance, and so forth, for the two alternatives is negligible. Use an annual
cash flow analysis to determine whether the new machine should be purchased.

18) A certain industrial firm desires an economic analysis to determine which of two different
machines should be purchased. Each machine is capable of performing the same task in a given
amount of time. Assume the minimum attractive return is 8%. The following data are to be used in
this analysis:

Machine X Machine Y
First cost $5,000 $8,000
Estimated life, in years 5 12
Salvage value 0 $2,000
Annual maintenance cost 0 150

Which machine would you choose? Base your answer on annual cost.

19) A company must decide whether to buy Machine A or B:

Machine A Machine B
Initial cost $10,000 $20,000
Useful life, in years 4 10
End-of-useful-life salvage value $10,000 $10,000
Annual maintenance 1,000 0
 At a 10% interest rate, which machine should be installed? Use an annual cash flow analysis in
working this problem.

20) The town of Dry Gulch needs an additional supply of water from Pine Creek. The town engineer
has selected two plans for comparison; a gravity plan (divert water at a point 10 miles up Pine Creek
and carry it through a pipeline by gravity to the town) and a pumping plan (divert water at a point
closer to the town and pump it to the town). The pumping plant would be guilt in two stages, with
half-capacity installed initially and the other half installed 10 years later. An analysis will assume a
40 year life, 10% interest, and no salvage value. Costs are as follows:

Gravity Pumping
Initial investment $2,800,000 $1,400,000
Additional investment in 10th yr None $200,000
Operation and maintenance $10,000/yr $25,000/yr
Power cost
Average first 10 years None $50,000/yr
Average next 30 years None $100,000/yr

Use an annual cash flow analysis to determine the more economical plan.