Engineering Economy

Dr. Rubayet Karim

Associate Professor
Dept. of Industrial and Production Engineering

Jashore Universiy of Science and Technology,

Jashore, Bangladesh
Capitalized costs are incurred when constructing or
purchasing fixed assets.
Cost Alternatives
Cost Alternatives
Cost Alternatives
 Rate of Return (ROR)

Rate of return (ROR) is the rate paid on the unpaid balance of

borrowed money, or the rate earned on the unrecovered
balance of an investment, so that the final payment or receipt
brings the balance to exactly zero with interest considered.

The rate of return is the interest rate that makes the present
worth or annual worth of a cash flow series exactly equal to
0.

i * ≥ MARR
P - F (P/F, i, n) = 0

PW
 Removing Multiple 𝒊∗ values

❑ The two tests of cash flow sign changes sometimes

(Descartes’ and Norstrom’s) indicate multiple roots.
❑ A single, reliable rate of return value is required by
management or engineers to make a clear economic
decision.
 Removing Multiple 𝒊∗ values..
❑ You are the project manager and the project generates cash flows
each year. Some years produce positive NCF, and you want to
invest the excess money at a good rate of return. We will call this
the investment rate or reinvestment rate 𝒊𝒊 .
❑ In other years, the net cash flow will be negative and you must
borrow funds from some source to continue. The interest rate you
pay should be as low as possible; we will call this the borrowing
rate 𝒊𝒃 .
❑ MARR setting: Each year, you must consider the time value of
money, which must utilize either the investment rate or the
borrowing rate, depending upon the sign on the NCF of the
preceding year.
Using incremental analysis, we can determine whether an
investment in an alternative with a higher initial investment
cost is justified or not.
 Breakeven ROR Value

❑ The breakeven rate of return is the incremental value, Δi*, at which the
PW (or AW) value of the incremental cash flows is exactly zero.

❑ Equivalently, the breakeven ROR is the value, Δ i*, at which the PW

(or AW) values of two alternatives’ actual cash flows are exactly equal
to each other and so we can choose either A or B.

❑ Once we know the breakeven ROR, we can readily evaluate the

alternatives by comparing the position of MARR with the breakeven
ROR.

❑ If MARR < Incremental ROR (i.e., MARR on the left side of

breakeven point then choose alternative B, otherwise select alternative
A.)
C to DN
The general approach for incremental B/C analysis of two ME
alternatives:
▪ The lower total cost alternative is first compared to Do-nothing
(DN).
▪ If ∆B/C for the lower-cost alternative is < 1.0, the DN option is
compared to the ∆B/C of the higher-cost alternative.
▪ If both options lose out to the DN option, DN takes precedence
unless there is a compelling reason to choose one of the options.