IE 342 Engineering Economic Analysis 2018 Summer Semester

IE 342 - Engineering Economic Analysis 2018 Summer Semester 1

IE 342 - Engineering Economic Analysis Instructor Dr. Emre Uzun E-mail: emreu@bilkent. edu. tr Offıce: EA 328 Tel: x 3484 Office Hours: By appointment via email 2

n Required Text Book: Park, C. S. , Contemporary Engineering Economics, 6 th Ed. , Prentice Hall, 2016 3

Web Site/Email: n n n All announcements and course related material (e. g. Study sets, lecture notes) will be posted on the course web page. Students are responsible for all the announcements made in class, or via e-mail. It is the students’ responsibility to be aware of what has been covered in lectures, and to check the web page and e-mail accounts regularly and not miss any activity or information. 4

Course Description n n n Concepts of time value of money. Analysis of engineering decisions Principles and methodology of comparing decision alternatives, such as various engineering designs, manufacturing equipment, or industrial projects. Effects of depreciation, inflation and taxation on economic decisions, cost benefit analysis of public projects. Dealing with uncertainty and risk; rational decision making when future outcomes are uncertain. Replacement analysis. 5

Grading n n Midterm - 35 % Final Exam - 40 % 2 Quizzes - 16 % Class Participation - 9 % 6

Policies n Attendance: q n There may be random attendances taken which may count towards your class participation grade. FZ Grade Policy: q No FZ this semester! 7

Policies n Makeup Policy: q n A make-up examination for the midterms will only be given under highly unusual circumstances (such as serious health or family problems). The student should contact the instructor as early as possible and provide the instructor with proper documentation (such as a medical note certified by Bilkent University’s Health Center). Classroom Policy: q No need to come to classroom if you are not in the mood for learning! 8

Tentative Course Outline: n n n n Ch. 1: Engineering Economic Decisions Ch. 3: Time Value of Money Ch. 3: Economic Equivalence Ch. 3: Interest Formulas - Single Cash Flows Ch. 3: Interest Formulas – Equal Payment Series Ch. 3: Interest Formulas – Gradient Series Ch. 3: Unconventional Equivalence Calculations Ch. 4: Nominal and Effective Interest Rates Ch. 4: Equivalence Analysis using Effective Interest Rates Ch. 4: Debt Management Ch. 4: Investing in Financial Assets Ch. 5: Payback Period Ch. 5: Discounted Cash Flow Analysis 9

n n n n Ch. 5: Variations of Present Worth Analysis Ch. 5: Comparing Mutually Exclusive Alternatives Ch. 6: Annual Equivalent Worth Criterion Ch. 6: Applying Annual Worth Analysis Ch. 7: Rate of Return Analysis Ch. 7: Finding Ro. R Ch. 7: Internal Rate of Return Criterion Ch. 7: Incremental Analysis Ch. 9: Asset Depreciation Ch. 9: Depreciation Methods Ch. 9: Corporate Income Taxes Ch. 10: Developing Project Cash Flows Ch. 11: Meaning and Measure of Inflation Ch. 11: Equivalence Calculation under Inflation Ch. 11: Effects of Inflation of Project Cash Flows 10

n n n n n Ch. 12: Project Risk Ch. 12: Estimating Risk Ch. 12: Decision Tree Analysis Ch. 14: Replacement Analysis Fundamentals Ch. 14: Replacement Decision Models Ch. 15: Methods of Financing Ch. 15: Cost of Capital Ch. 15: Choice of MARR Ch. 16: Benefit-Cost Ratio 11

Engineering Economic Decisions Lecture 1 Presentation based on the book Chan S. Park, Contemporary Engineering Economics Chapter 1, © Pearson Education International Edition 12

Getting a Car in the USA 13

Getting a Car in the USA 14

A Simple Illustrative Example: Car to Finance – Audi or BMW? § § § Recognize the decision problem Collect all needed (relevant) information Identify the set of feasible decision alternatives Define the key objectives and constraints Select the best possible and implementable decision alternative n Need to lease a car n Gather technical and financial data Select cars to consider Wanted: small cash outlay, safety, good performance, aesthetics, … Choice between Audi and BMW (or others) Select a car n n 15

Large-Scale Engineering Projects These typically n require a large sum of investment n can be very risky n take a long time to see the financial outcomes n lead to revenue and cost streams that are difficult to predict All the above aspects (and some others not listed here) point towards the importance of EEA 16

Types of Strategic Engineering Economic Decisions q q q Service Improvement Equipment and Process Selection Equipment Replacement New Product and Product Expansion Cost reduction or profit maximization can be seen as generic (common, eventual) objectives In the most general sense, we have to make decisions under resource constraints, and in presence of uncertainty – not only in the EEA context 17

The Four Fundamental Principles of Engineering Economics n n 1: An instant dollar is worth more than a distant dollar… 2: Only the relative (pair-wise) difference among the considered alternatives counts… 3: Marginal revenue must exceed marginal cost, in order to carry out a profitable increase of operations 4: Additional risk is not taken without an expected additional return of suitable magnitude 18

Principle 1 An instant dollar is worth more than a distant dollar… Today 6 months later 19

Principle 2 Only the cost (resource) difference among alternatives counts Option Monthly Fuel Cost Monthly Maintenance Cash paid at signing (cash outlay ) Monthly payment Salvage Value at end of year 3 Buy $960 $550 $6, 500 $350 $9, 000 Lease $960 $550 $2, 400 $550 0 The data shown in the green fields are irrelevant items for decision making, since their financial impact is identical in both cases 20

Principle 3 Marginal (unit) revenue has to exceed marginal cost, in order to increase production Manufacturing cost 1 unit Marginal cost Marginal revenue Sales revenue 1 unit 21

Principle 4 Additional risk is not taken without a suitable expected additional return Investment Class Potential Risk Expected Return Savings account (cash) Lowest 1. 5% Bond (debt) Moderate 4. 8% Stock (equity) Highest 11. 5% A simple illustrative example. Note that all investments imply some risk: portfolio management is a key issue in finance 22

Summary n n The term engineering economic decision refers to any investment or other decision related to an engineering project The five main types of engineering economic decisions are (1) service improvement, (2) equipment and process selection, (3) equipment replacement, (4) new product and product expansion, and (5) cost reduction The factors of time, resource limitations and uncertainty are key defining aspects of any investment project Notice that all listed decision types can be seen and modeled as a constrained decision (optimization) problem 23