ENGG ECON chap 1-4

Engineering Economy

provides a systematic framework for evaluating the economic aspects of competing design solutions.

Accreditation Board for Engineering and Technology

states that engineering “is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practical is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind.”

Engineering Economy

Involves the systematic evaluation of the economic merits of proposed solutions to engineering problems.

Engineering Economy

To be economically acceptable (i.e., affordable), solutions to engineering problems must demonstrate a positive balance of long-term benefits over long term costs.

Engineering Economy

An analysis and evaluation of the factors that will affect the economic success of engineering projects to the end that a recommendation can be made which will insure the best use of capital.

Engineering economy

includes significant technical considerations

Engineering economy

involves technical analysis, with emphasis on the economic aspects

Engineering economy

has the objective of assisting decisions.

Develop the alternatives

Carefully define the problem !

Then the choice (decision) is among alternatives

The alternatives need to be identified and then efined for subsequent analysis

Focus on the differences

Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision

Use a consistent viewpoint

The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective)

Use a common unit of measure

Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of the alternatives.

Consider all relevant criteria

Selection of preferred alternative (decision making) requires the use of a criterion (or several criteria)

Consider all relevant criteria

The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner

Make risk and uncertainty explicit.

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison.

Revisit your decisions

Improve decision making results from an adaptive process; to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved.

engineering economy study

accomplished using a structured procedure and mathematical modeling techniques

economic results

used in a decision situation that normally includes other engineering knowledge and input.

(1) Classical Brainstorming (2) Nominal Group Technique

Two Developing investment alternatives

Consumer goods and services

those products or services that are directly used by people to satisfy their wants.

Producer goods and services

used to produce consumer goods and services or other producer goods

Necessities

those products or services that are required to support human life and activities, that will purchased in somewhat the same quantity even though the price varies considerably.

Luxuries

those products or services that are desired by humans and will be purchased if money is available after the required necessities have been obtained.

Demand

quantity of a certain commodity that is bought at a certain price at a given place and time

Elastic demand

occurs when a decrease in selling price result in a greater than proportionate increase in sales.

Inelastic demand

occurs when a decrease in the selling price produces a less than proportionate increase in sales.

Unitary elasticity of demand

occurs when the mathematical product of volume and price is constant

Perfect competition

occurs in a situation where a commodity or service is supplied by a number of vendors and there is nothing to prevent additional vendors entering the market.

Monopoly

exists when a unique product or service is available from a single vendor and that vendor can prevent the entry of all others into the market

Monopoly

opposite of perfect competition

Oligopoly

exists when there are so few suppliers of a product or service that action by one will almost inevitably result in similar action by the others

Supply

quantity of a certain commodity that is offered for sale at a certain price at a given place and time

law of supply and demand

Under conditions of perfect competition the price at which a given product will be supplied and purchased is the price that will result in the supply and the demand being equal

The Law of Diminishing Returns

When the use of one of the factors of production is limited, either in increasing cost or by absolute quantity, a point will be reached beyong which an increase in the variable factors will result in a less than proportionate increase in output.

Fixed costs

those unaffected by changes in activity level over a feasible range of operations for the capacity or capability available.

Fixed costs

include insurance and taxes on facilities, general management and administrative salaries, license fees, and interest costs on borrowed capital

Variable costs

those associated with an operation that varies in total with the quantity of output or other measures of activity level.

Variable costs

Examples are the costs of material and labor used in product or service because they vary in total with the number of output units, even though the costs per unit stay the same.

Incremental Costs or incremental revenue

the additional costs that results from increasing an output of a system by one (or more) units.

Direct costs

costs that can be resasonably measured and allocated to a specific outputor work activity.

Direct costs

The labor and material costs directly associated with a product, service or construction activity

Indirect costs

costs that are difficult to allocate to a specific output or work activity.

Indirect costs

They are costs allocated through a selected formula to the outputs or work activities.

Overhead costs

consists of plant operating costs that are not direct labor or direct material costs

Standard costs

planned costs per unit of output that are established in advanced of actual production or service delivery.

Cash costs

involves payment of cash.

Cash costs

are estimated from the perspective established for the analysis and are the future expenses incurred for the alternatives being analyzed.

Book costs

costs that do not involve cash payments but rather represent the recovery of past expenditures over a fixed period of time.

Sunk costs

one that has occured in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action

Opportunity costs

incurred because of the use of limited resources, such that the opportunity to use those resources to monetary advantage in an alternative use is foregone

Opportunity costs

cost of the best rejected opportunity and is often hidden or implied.

Life cycle costs

refers to a summation of all the costs related to a product, structure, system, or service during its life span.

capital

refers to wealth in the form of money or property that can be used to produce more wealth.

Capital

refers to wealth in the form of money or other assets owned by a person or organization that can be used for a particular purpose such as starting a company or investing.

Equity Capital

owned by individuals who have invested their money or property in a business project or venture in the hope of receiving a profit

Borrowed Capital

obtained from lenders for investment, with a promise to repay the principal amount and interest on a specific date

Equity Capital

Borrowed Capital

Human Capital

Social Capital

Natural Capital

Types of Capital

Cash Flow Diagram

a graphical representation of cash flows drawn on a time scale.

Horizontal line

Represents the time with progression of time moving from left to right (i.e. month, year)

Arrows

Represents cash flows.

Horizontal Line'

Arrows

Depends on the person’s viewpoint

Elements of Cash Flow Diagram

Single Cash Flows

simplest case involves the equivalence of a single present amount (P)and its future worth (F)

Equal Uniform Series

transactions arranged as a series of equal cash flows at regular intervals

Linear Gradient Series

cash flow that increase or decrease by uniform amount each periods

Geometric Gradient Series

cash flows that increase or decrease by a fixed percentage.

Irregular Series

consists of cash flow that change with no pattern.

Interest

the amount of money paid for the use of borrowed capital or income produced by money which has been loaned

SIMPLE INTEREST

the interest on a loan that is based only on the principal. Usually used for short-term loans where the period is measured in days rather than years

ORDINARY SIMPLE INTEREST

interest is computed on the basis of 12 months of 30 days each which is equivalent to 360 days a year.

ORDINARY SIMPLE INTEREST

In this case, the value of n that is used in the preceding formulas may be computed as: n= d/360; where d is the number of days the principal was invested

EXACT SIMPLE INTEREST

interest is computed based on the exact number of days in a given year which is 365 days for a normal year and 366 days during a leap year (which occurs every 4 years, or if it is a century year, it must be divided by 400).

EXACT SIMPLE INTEREST

In this case, the value of n that is used in the preceding formulas may be computed as: n= d/365 for a normal year N= d/366 for a leap year

DISCOUNT

interest deducted in advance.

DISCOUNT

the difference between the amount a borrower receives in cash (present worth) and the amount he pays in the future (future worth)

Rate of discount

the discount on one unit of principal for one unit of time

Compound Interest

interest which is based on the principal plus the previous accumulated interest.

Compound Interest

‘interest on top of interest.”

Compound Interest

This is usually used in commercial practice especially for longer periods.

Rate of Interest

the cost of borrowing money or the amount earned by a unit principal per unit time.

NOMINAL RATE OF INTEREST

basic annual rate of interest.

NOMINAL RATE OF INTEREST

specifies the rate of interest and the number of interest periods in one year.

EFFECTIVE RATE OF INTEREST

is the actual or the exact rate of interest earned on the principal during a one-year period.

NOMINAL RATE OF INTEREST

EFFECTIVE RATE OF INTEREST

TYPES OF RATES OF INTEREST

Continuous Compounding

based on the assumption that cash payments occur once per year but compounding is continuous throughout the year.

Annuities

a series of equal payments occurring at equal interval of time

Ordinary Annuity

Deferred Annuity

Annuity Due

Perpetuity

Annuity w/ Continuous Compounding

Types of Annuities

ORDINARY ANNUITY

type of annuity is one where the payments are made at the end of each period beginning from the first period.

present sum P of the series

occurs one period before the first cash flow of the series (Properties of ordinary annuity)

future sum F of the series

occurs at the same time with the last cash flow of the series (Properties of ordinary annuity)

annuity A

amount of uniform cash flows and occur at regular interval from period 1 through n, inclusive (Properties of ordinary annuity)

Deferred Annuity

type of annuity is one where the first payment is made several periods after the beginning of the annuity.

Annuity Due

when payments are made at the beginning of the payment period

Perpetuity

where the payment period extends forever, which means that the periodic payments continue indefinitely

Gradient Series

series of cash flows where the amounts change every period

1. Arithmetic Gradient Series
2. Geometric Gradient Series

Types of Gradient Series

arithmetic gradient cash flow

one wherein the cash flow changes (increase or decreases) by the same amount in each cash flow period.

gradient

In arithmetic gradient, the amount of increase or decrease is called

Equivalent Uniform Amount (A’)

equivalent uniform amount taking the equivalent of the series as ordinary annuity

Geometric Gradient Series

when the periodic payment increases or decreases by a constant percentage.

Capitalized Cost (CC)

one of the most important applications of perpetuity