Introduction to Engineering

Engineering is the profession in which a knowledge of

the mathematical and natural sciences gained by study,
experience and practice is applied with judgment to
develop ways to utilize economically the materials and
forces of nature for the benefit of mankind.

Importance of economics in engineering in today’s world:

Nature of Engineering
• Environments in which engineers have to work & correlation
between them

• Use of economic analysis by engineers

• Efficiency in economics

• Different phases in an engineering process

• Engineering using life cycle approach

Value and Utility
• Value is a measure of the worth that a person ascribes to a
good or a service.
• The value of an object is inherent not in the object but in the
regard that a person has for it.
• Utility is a measure of the power of a good or a service to satisfy
human wants.
• The utility that an object has for a person is the satisfaction he
or she derives from it.
• Value is an appraisal of utility in terms of a medium of
exchange.

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Value and Utility
• Evaluation of utility of various items is not ordinarily constant,
but may be expected to change
• Same goods and services may be ascribed different utilities
by different persons.
• Possibility of exchange occurs when each of the two persons
possesses utilities desired by the other.
• All that has utilities, be it tangible or intangible, is physically
manifested.
• Utility can be increased by altering physical condition

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 Consumer and Producer Goods
• Two classes of goods are recognized by economists: consumer
goods and producer goods.
• Consumer goods are the goods and services that directly satisfy
human wants.
• Producer goods are the goods and services that satisfy human
wants indirectly as part of the production or construction
process.
• Utility of consumer goods is primarily determined subjectively,
the utility of producer goods is considered usually objectively.

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ECONOMIC ASPECTS OF EXCHANGE
• Economy of exchange occurs when utilities are exchanged
by two or more people.

Exchanges occur because of

• Mutual Benefit in Exchange

• From buyer’s and seller’s perspective
• Both must believe that they benefit

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ECONOMIC ASPECTS OF EXCHANGE
• Persuasion in Exchange

• It consists of taking a person on excursion into future in an

attempt to show or demonstrate the consequences if
person acts in accordance.

• Purpose of economic analysis is to estimate consequences

of a decision.

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Interest and Interest rate
• Interest is a rental amount charged by financial
institution for the use of money.

• Interest rate is the rate of gain received from an

investment.

• Interest rate has different meaning from the viewpoint

of lender and borrower.

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 Interest rate
• From lender’s viewpoint
• May exchange money for personal satisfaction (by
purchasing consumer/producer goods)

• May hoard the money and wait for opportunity to use

• May lend the money on condition that may or may not

charge interest from borrower.

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Interest rate
Factors deciding interest rate for lender

• probability of not repaying loan by borrower

• expense in investigating the borrower, loan
agreement etc.
• adequate return (comparing among all alternatives)
• Inflationary effects

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 Time value of Money
• Because money can earn at certain interest rate, an amount in
hand now is not equivalent to the same amount at some point
of time in future.

• This relationship between interest and time gives the concept of

time value of money.

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 INTEREST & CASH FLOW DIAGRAMS
• In engineering economic analysis, different engineering
alternatives are evaluated. These alternatives estimate amount
and timing of future receipts and disbursements.

• Effect of time and interest rate must be given due consideration

while dealing with monetary transactions.

• interest may be charged in different way over time by the

lender (to the borrower).

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 Cntd…

• The rental rate for a sum of money is usually expressed as

certain percentage of the sum to be paid for its use for a
period of one year.

• Interest rates are also quoted for periods other than one year,
known as interest period.

• Simple and compound interest approaches will be studied

for determining the effect of time value of money.

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 SIMPLE INTEREST
• Simple Interest: interest owed upon repayment of a loan is
proportional to length of time the principal sum has been
borrowed.
I = P.n.i
I is interest earned, P is principal amount, n is number of
interest period and i is interest rate.

• A simple interest loan may be made for any period of time.

Interest and principal become due only at the end of the time
period.

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COMPOUND INTEREST
• When a loan is made for several interest periods, interest is
calculated and payable at the end of each interest period.
• At the end of a year, one may pay the interest when it is due or may
allow the interest to accumulate until the loan is due.
• If the borrower does not pay the interest earned at the end of each
period and is charged interest on the total amount owed (principal
+ interest), the interest is said to be compounded.
• The interest owed in previous year becomes part of the total
amount owed for this year.
• Effect of compound interest depends on the payment amounts and
when they are made.

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 COMPOUND INTEREST
Calculation of compound interest Calculation of compound interest
when interest is paid annually when interest is permitted to
compounded
Amount Interest Amount Amount Amount Interest Amount Amount
owed at to be paid owed at paid by owed at to be paid owed at paid by
beginning of year end of borrower beginni of year end of borrower
of year year at end of ng of year at end of
Year year year year

1
-
-
n

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CASH FLOW OVER TIME
• It is actual inflow (receipts) and outflow (disbursements) at
different points in time that occur over the life of an
investment.
• It depends upon the points of view taken (of two parties
involved).
• Net cash flow at any time t(Ft) is arithmetic sum of receipts (+)
and disbursements (-) that occurs at same point in time.
• If Ft < 0, net cash disbursement
If Ft > 0, net cash receipt

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Cash Flow Diagrams
• It is graphical representation of cash transactions by each
alternative.

• Similar to free body diagram or circuit diagram.

• cash flow can occur at any point of time during the year.

• End of period convection (an assumption) is normally used

i.e. all cash flow transactions are placed at end of interest
period.

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 Types of cash flows
• Single cash flow

• Equal (uniform) cash flow

• Linear gradient series

• Geometric gradient series

• Irregular series

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 INTEREST FORMULAS
• DISCRETE COMPOUNDING, DISCRETE PAYMENTS
• Symbols: i, n, P, A, F
• End of one year is beginning of next year.
• P is at beginning of a year (present time)
• F is at the end of nth year
• Occurrence of A (When A & P are involved) and (When A and F
are involved)

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Single Payment Compound Amount Factor (F/P, i, n)

Single Payment Present Worth Factor (P/F, i, n)

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Equal Payment Series Compound Amount Factor (F/A, i, n)

Equal Payment Series Sinking Fund Factor (A/F, i, n) 22

 Equal payment series Capital Recovery
Factor (A/P, i, n)
(A/P, i, n)= i(1+i)n /(1+i)n-1)

Equal payment series Present Worth Factor

(P/A, i, n)

(P/A, i, n)= (1+i)n-1)/ (i(1+i)n)

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Ex: A person 35 years old is planning to invest an equal sum of
Rs. 10,000 at the end of every year for the next 25 years starting
from the end of the next year. The bank gives 20% interest rate,
compounded annually. What amount will he get when he will
be 60 years old.
(F/A, 20,25)=471.98 (Ans 4719810)

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Ex: A company has to replace its present facility after 15 years
at a cost of Rs. 15,00,000. It plans to deposit an equal amount at
the end of every year. What equal amount should he deposit at
the end of every year for the next 15 years at an interest rate of
18% compounded annually to meet the cost.
(A/F,18,15=0.0164) Ans:24600

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Ex: A bank loan to a company of Rs. 10,00,000 at 18% interest rate
compounded annually is to be repaid in 15 yearly equal installments.
Find the installment amount?
(A/P, 18,15)=.1964, ANS: 196400

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A company wants to set up a reserve which will help the company
annually with amount of Rs. 10,00,000 for the next 20 years towards its
employees welfare measures. The reserve is assumed to grow at the
rate of 15% annually. Find the single-payment that must be made now
as the reserve amount?
(P/A,15,20)=6.2593, Ans: 6259300

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Uniform Gradient Series
• End of year payment increases linearly (has a fixed
component and a linear gradient component)
• If F1 is payment at the end of year 1 and G is the linear
gradient in payment in subsequent years, end of year
payment for n=2 is F1 +G, for n=3 is F1 +2G and so on.
• The aim is to find the equivalent, equal end of year payment
for the gradient amount paid every year end.
• Gradient amount at end of year 1 is 0, at end of year 2 is G,
at end of year 3 is 2G and so on.

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 Cntd…
• The cash flow diagram can be represented as sum of two equal
payment series with year end values as F1 (known vale) and A
(to be found out as a function of G, I and n.
End Gradie Series of Annual
of nt gradient payment
yea amou amount series
r nt
0 0 0
1 0 0 A
2 G G A
3 2G G+G A
- -
n (n-1)G G+G+------- A
----+G 30
• A(F/A,i,n)= G(F/A,i,1)+G(F/A,i,2)+----------------G(F/A,i,n-1)
= G/i[((1+i)n -1)/i] – nG/i

𝟏 𝒏 A/F,i,n
• A=G[(1/i) – (n/((1+i)n -1))] =𝑮[ − ( )]
𝒊 𝒊 31