Applied Science University

Faculty of Engineering
Mechanical and Industrial Engineering
Engineering Economy [CH4 +CH5+ CH6]

Problems #2
P1. A credit card company charges an interest rate of 1.375% per month on the unpaid balance
of all accounts. The annual interest rate, they claim, is 16.5%. What is the effective rate of
interest per year being charged by the company?

Answer: 17.81%/year

P2. Suppose that a $100 lump-sum amount is invested for 10 years at a nominal interest rate of
6% compounded quarterly. How much is it worth at the end of the 10th year?

Answer: $181.40

P3. Stan Moneymaker has a bank loan for $10,000 to pay for his new truck. This loan is to be
repaid in equal end-of-month installments for five years with a nominal interest rate of 12%
compounded monthly. What is the amount of each payment?

Answer: $222

P4. A loan of $15,000 requires monthly payments of $477 over a 36-month period of time.
These payments include both principal and interest.
(a) What is the nominal interest rate (APR) for this loan?
(b) What is the effective interest rate per year?

Answer: (a) 9% per year, compounded monthly (b) 9.38% per year

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P5. Suppose that you have a money market certificate earning an annual rate of interest, which
varies over time as follows:

If you invest $10,000 in this certificate at the beginning of year one and do not add or
withdraw any money for five years, what is the value of the certificate at the end of the fifth
year?

Answer: $12,042.83

P6. Determine the present equivalent value of the cash-flow diagram of Figure below when the
annual interest rate varies as indicated.

Answer: $4,606

P7. Compute the effective annual interest rate in each of the following situations.
(a) 5.75% nominal interest, compounded quarterly.
(b) 5.75% nominal interest, compounded daily.

Answer: (a) 5.875% (b) 5.92%

P8. Determine the current amount of money that must be invested at 12% nominal interest,
compounded monthly, to provide an annuity of $10,000 (per year) for 6 years, starting 12
years from now. The interest rate remains constant over this entire period of time.

Answer: $10,847.43

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P9. Evaluate a combined cycle power plant on the basis of the PW method when the MARR is
12% per year. Pertinent cost data are as follows:

Power Plant
(thousands of $)
Investment cost $13,000
Useful life 15 years
Market value $3,000
Annual operating expenses $1,000
Overhaul cost—end of 5th year $200
Overhaul cost—end of 10th year $550

Answer: −$19,553.38

P10. Three mutually exclusive design alternatives are being considered. The estimated sales and
cost data for each alternative are given below. The MARR is 20% per year. Annual
revenues are based on the number of units sold and the selling price. Annual expenses are
based on fixed and variable costs. Determine which selection is preferable based on PW.

Answer: Select Design B to maximize the present worth.

P11. Two manufacturers supply MRI systems for medical imaging. St. Jude’s Hospital wishes to
replace its current MRI equipment that was purchased 8 years ago with the newer
technology and clarity of a state of- the-art system. System K will have a first cost of
$1,600,000, an operating cost of $70,000 per year, and a salvage value of $400,000 after its
4-year life. System L will have a first cost of $2,100,000, an operating cost of $50,000 the
first year with an expected increase of $3000 per year thereafter, and no salvage value after
its 8-year life. Which system should be selected on the basis of a future worth analysis at an
interest rate of 12% per year?

Answer: FWK=$-6,310,780 , FWL= $-5,922,079 Select system L

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P12. Compare the alternatives shown on the basis of their capitalized costs using an interest rate
of 10% per year.

Answer: CCM = $-882,600 CCN = $-920,000 Select alternative M

P13. The cost of maintaining a certain permanent monument in Washington, DC occurs as

periodic outlays of $1000 every year and $5000 every 4 years. Calculate the capitalized
cost of the maintenance using an interest rate of 10% per year.

Answer: CC = $-20,774

P14. A corporate jet costs $1,350,000 and will incur $200,000 per year in fixed costs
(maintenance, licenses, insurance, and hangar rental) and $277 per hour in variable costs
(fuel, pilot expense, etc.). The jet will be operated for 1,200 hours per year for five years and
then sold for $650,000. The MARR is 15% per year.
(a) Determine the capital recovery cost of the jet.
(b) What is the total annual expense of the jet?

Answer: (a) $306,310. (b) $838,710

P15. Eight years ago, Ohio Valley Trucking purchased a large-capacity dump truck for
$115,000 to provide short-haul earthmoving services. The company sold it today for
$45,000. Operating and maintenance costs averaged $10,500 per year. A complete overhaul
at the end of year 4 cost an extra $3600. Calculate the annual cost of the truck at 8% per
year interest.

Answer: $-26,741per year

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P16. A company is considering constructing a plant to manufacture a proposed new product. The
land costs $300,000, the building costs $600,000, the equipment costs $250,000, and
$100,000 additional working capital is required. It is expected that the product will result in
sales of $750,000 per year for 10 years, at which time the land can be sold for $400,000, the
building for $350,000, and the equipment for $50,000. All of the working capital would be
recovered at the EOY 10. The annual expenses for labor, materials, and all other items are
estimated to total $475,000. If the company requires a MARR of 15% per year on projects
of comparable risk, determine if it should invest in the new product line. Use the AW
method.

Answer: $70,245

P17. Ten years ago, Jacobson Recovery purchased a wrecker for $285,000 to move disabled 18-
wheelers. He anticipated a salvage value of $50,000 after 10 years. During this time his
average annual revenue totaled $52,000. (a) Did he recover his investment and a 12% per
year return? (b) If the annual M&O cost was $10,000 the first year and increased by a
constant $1000 per year, was the AW positive or negative at 12% per year? Assume the
$50,000 salvage was realized.

Answer: (a) $-47,590 per year (b) $- 9,175 per year

P18. TT Racing and Performance Motor Corporation wishes to evaluate two alternative CNC
machines for NHRA engine building. Use the AW method at 10% per year to select the
better alternative.

Answer: AWR= $-134,485 AWS= $-142,824

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P19. Compare two alternatives for a security system surrounding a power distribution substation
using annual worth analysis and an interest rate of 10% per year.

Answer: AWC= $-18,146 per year AWT = $-15,500 per year

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