Introduction to Engineering Economy Engineering Economy is about

Introduction to Engineering Economy • Engineering Economy is about making decisions • It is based on the systematic evaluation of the costs and benefits of proposed technical projects • The principles and methodology of engineering economy are utilized to analyze alternative uses of financial resources, particularly in relation to the physical assets and the operation of an organization. 1

Example 1: How BD 100 a month can grow Year Interest 0% 1% 3% 6% 9% 12% 1 BD 1, 200 BD 1, 206 BD 1, 217 BD 1, 234 BD 1, 251 BD 1, 268 5 BD 6, 000 BD 6, 150 BD 6, 465 BD 6, 977 BD 7, 542 BD 8, 167 10 BD 12, 000 BD 12, 615 BD 13, 974 BD 16, 388 BD 19, 351 BD 23, 004 15 BD 18, 000 BD 19, 411 BD 22, 697 BD 29, 082 BD 37, 841 BD 49, 958 20 BD 24, 000 BD 26, 556 BD 32, 830 BD 46, 204 BD 66, 789 BD 98, 926 25 BD 30, 000 BD 34, 067 BD 44, 601 BD 69, 299 BD 112, 112 BD 187, 885 2

Example 2: When BD 12 K exceeds BD 70 K Interest Rate 12% Ahmed Start Investing Age 20 Stop Investing Age 25 Total Investment Total Accumulation at Age 60 Annual Investment BD 2, 000/yr for 6 years (monthly BD 166. 67) BD 12, 000 BD 1, 078, 425 Ali Start Investing Age 26 Stop Investing Age 60 Annual Investment BD 2, 000/yr for 35 years (monthly BD 166. 66) BD 70, 000 BD 1, 014, 147 3

Example 3: The Real Cost of a BD 1, 000 Credit Balance Month Balance Interest New Balance ü have a BD 1, 000 balance on your credit card 0 0 BD 1, 000 BD 18. 33 BD 1, 018. 3 3 BD 20. 37 0 1 BD 997. 9 6 BD 18. 29 BD 1, 016. 2 5 BD 20. 32 ü pay 21. 99% interest rate 0 2 BD 995. 9 2 BD 18. 25 BD 1, 014. 1 7 BD 20. 28 0 3 BD 993. 8 9 BD 18. 21 BD 1, 012. 1 0 BD 20. 24 0 4 BD 991. 8 6 BD 18. 18 BD 1, 010. 0 3 BD 20. 20 38 10 BD 80. 06 BD 1. 47 BD 81. 52 BD 10. 00 38 11 BD 71. 52 BD 1. 31 BD 72. 83 BD 10. 00 39 0 BD 62. 83 BD 1. 15 BD 63. 98 BD 10. 00 39 1 BD 53. 98 BD 0. 99 BD 54. 97 BD 10. 00 39 2 BD 44. 97 BD 0. 82 BD 45. 80 BD 10. 00 39 3 BD 35. 80 BD 0. 66 BD 36. 45 BD 10. 00 39 4 BD 26. 45 BD 0. 48 BD 26. 94 BD 10. 00 39 5 BD 16. 94 BD 0. 31 BD 17. 25 BD 10. 00 39 6 BD 7. 25 BD 0. 13 BD 7. 38 39 7 BD 0. 00 YOU: ü pay the required minimum payment of 2% of the balance or BD 10, whichever is greater ü make no new purchases How much will it take to pay off the credit card? How much will be the total amount you paid? Year Total Payments: Payment BD 6, 344 5

Decision Making and Problem Solving Simple Problems • Can be analyzed in one’s head without extensive analysis – Do I buy a semester parking pass, use parking meters, or buy a bicycle? – How often should I eat out? Intermediate Problems • • • (Principle subject of this course!!!) They are sufficiently important to justify serious thought and action They can’t be worked in one’s head; must be organized The economic aspects are significant component in the analysis leading to a decision Complex Problems • Represent a mixture of economic, political, and humanistic elements – Selection of a president in USA – Building a nuclear power plant 5

“Intermediate Problem” Example A student is buying a car, which costs BD 12, 000. He can borrow money in the bank with a 10% yearly interest rate (quarterly compounding). The dealer offers one of the two promotions: 1. Discount of BD 2, 000 off the price of the car 2. Financing for one year with interest 0% (4 quarterly payments, BD 3, 000 each) Which promotion should the student take? (Suppose inflation is 0%. ) 6

“Intermediate Problem” Example Promotion 1 • Get BD 2, 000 and borrow BD 12, 000 - BD 2, 000 = BD 10, 000 with interest 10% BD 2, 625 (5% more than BD 2, 500) [? ] BD 2, 658 (6. 3% more than BD 2, 500) [? ] car BD 2, 750 (10% more than BD 2, 500) [? ] BD 3, 000 (20% more than BD 2, 500) [? ] • Actual Payment: 4*BD 2, 658 = BD 10, 632 7

“Intermediate Problem” Example Promotion 2: • Borrow BD 12, 000 with interest 0%. car BD 3, 000 • Actual Payment: 4*BD 3, 000 = BD 12, 000 • Conclusion: Select the first promotion!! 8

Engineering Economic Analysis Key Questions: • Which engineering projects are worthwhile? • Which projects should have higher priority? • How the project should be designed? • How to achieve long-term financial goals? • How to compare different ways to finance purchases? • How to make short and long-term financial decisions? 9

Engineering Economic Analysis Examples of Non-Monetary Factors: • Meeting customer expectations consistently • Maximization of employee satisfaction • Maintaining flexibility to meet changing demand • Maintenance of a desired public image • Leveling cyclic fluctuations in production • Improvement of safety in operations • Reduction of pollutants 10

Rational Decision Making 1. Recognize the problem – 2. “I need a place to live this term. ” Define the Goal or Objective – 3. “I’ll find a nice apartment that is not too expensive. ” Assemble Relevant Data – 4. “I need information on rent, utilities, apartment age, parking, driving time to UF, driving time to shopping, the neighborhood, other amenities provided (swimming, table tennis, etc. ). ” Identify Feasible Alternatives – “I’ll use the Yellow Pages, information from friends, apartment finding services, information from UF, the local newspaper, and my personal experience, to look for apartments. ” 11

Rational Decision Making 5. Select Criterion to Determine the Best Alternative – 6. “Most important is rent plus utilities cost. I’m also very concerned about driving time to UF, and the kind of neighborhood the apartment is in. ” Construct the model – – 7. “I’ll make a spreadsheet. The rows will be the apartment choices, the columns the evaluation criteria. Then I’ll try to fill in the interactions between the apartments and the criteria. ” This includes determining cash flows for engineering economic analysis!!! Predict Outcomes of Each Alternative – 8. “I’ll fill in the estimated costs for the spreadsheet and rate the amenities, driving time, etc. ” Choose the Best Alternative – “Apartment C looks cheapest, but I don`t like the neighborhood. If I pay BD 50 more per month for Apartment B I get a nicer neighborhood, and a 15 -minute drive to UF. Maybe I’ll choose Apartment B. ” 12

Rational Decision Making 9. Audit the Results – “Did I make a good choice” – “After living in Apartment B for six months, I am very happy with my choice!” – But this certainly isn’t the case every time!! 13

“Accident Car” Example Bad news – you just wrecked your car! An automobile wholesaler offers you BD 2, 000 for the car “as is. ” Your insurance company estimates that there is BD 2, 000 of damage to your car. The insurance company can fix the car right away in a repair shop belonging to this company. Because you have collision insurance with a BD 1, 000 deductibility provision, the insurance company mails you a check for BD 1, 000. The odometer reading on your wrecked car is 58, 000 miles. Additional Information: ü You have BD 7, 000 in savings. ü You can buy a newer car for BD 10, 000 with an odometer reading of 28, 000 miles. ü After repairing the wrecked car, it can be sold for BD 4, 500. ü A discount repair shop charges BD 1, 100 and requires 1 month. ü A car rental for one month is BD 400. 14

“Wrecked Car” Example Alternatives • Buy newer car. Sell now, but don`t repair: – Cash flow = BD 3, 000 - BD 10, 000 = -BD 7, 000 • Repair now. Sell, and buy the newer car: – Cash flow: = -BD 1, 000 + BD 4, 500 - BD 10, 000 = -BD 6, 500 • Repair at discount shop. Sell and buy the newer car: – Cash flow: = -BD 100 + BD 4, 500 - BD 10, 000 = -BD 5, 600 • Repair now. Keep your car. – Cash flow: = -BD 1, 000 • Repair at discount shop. Rent a car, then keep your car. – Cash flow: = -BD 100 - BD 400 = -BD 500 NOTE: Don’t forget factors such as mileage, repair shop reliability, investment opportunity for your savings et. 15