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Engineering Economics COE109 Prelim Reviewer

Engineering economy involves evaluating economic outcomes of alternatives to accomplish a defined purpose. Decisions are based on estimated cash flows over time and interest rates. Sensitivity analysis determines how decisions change with varying estimates. The best alternative is selected using measures of worth that consider economic value and time value of money. An engineering economy study identifies the problem, defines objectives, estimates cash flows, performs financial analysis, and selects the optimal decision.

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683 views7 pages

Engineering Economics COE109 Prelim Reviewer

Engineering economy involves evaluating economic outcomes of alternatives to accomplish a defined purpose. Decisions are based on estimated cash flows over time and interest rates. Sensitivity analysis determines how decisions change with varying estimates. The best alternative is selected using measures of worth that consider economic value and time value of money. An engineering economy study identifies the problem, defines objectives, estimates cash flows, performs financial analysis, and selects the optimal decision.

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santoniajhonmark50
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Engineering economy - involves formulating, estimating, and evaluating the expected

economic outcomes of alternatives designed to accomplish a defined purpose.

Capital/Capital Funds - Money involved in decisions

Decisions - are based on a combination of economic and noneconomic elements.

Essential Elements of Engineering Economy


● Cash Flows
● Times of Occurrence of Cash Flows
● Interest rates for time value of money
● Measure of Economic worth for selecting an Alternative

Sensitivity analysis - is utilized to determine how a decision might change according to varying
estimates, especially those expected to vary widely

Measure of Worth - The criterion used to select an alternative in engineering economy for a
specific set of estimates
● Present Worth
● Future Worth
● Annual Worth
● Rate of Return
● Benefit/Cost
● Capitalized Cost
● Payback Period
● Economic Value Added
● Cost Effectiveness

Time Value of Money - Money makes money over time, explains the change in the amount of
money over time for funds that are owned (invested) or owed (borrowed). This is the most
important concept in the engineering economy.

Engineering Economy Study - involves many elements: problem identification, definition of the
objective, cash flow estimation, financial analysis, and decision making.

The steps in an engineering economy study are as follows:


1. Identify and understand the problem; identify the objective of the project.
2. Collect relevant, available data and define viable solution alternatives.
3. Make realistic cash flow estimates.
4. Identify an economic measure of worth criterion for decision making.
Time value of money
5. Evaluate each alternative; consider noneconomic factors; use sensitivity analysis as
needed.
6. Select the best alternative.
7. Implement the solution and monitor the results.

Problem Description and Objective Statement - A succinct statement of the problem and
primary objective(s) is very important to the formation of an alternative solution

Morals - A standard of being good or bad that is different from one person to another. Not
dictated by law but by the general perception of what is appropriate or not. form the character
and conduct of a person in judging right and wrong.

● Personal Morals - developed and applied through personal experience


● Universal Morals - collectively applied by a certain group

Ethics - The study of what is morally right or wrong; governed by rules, principles, or a code of
conduct.

● Professional Ethics - applied in a workplace or professional environment, and a crucial


part in achieving industry standards.
● Code of Ethics - guidelines that ensure safety, integrity, and quality of a certain
profession. Each profession has its own code.

Interest - amount that is added to a principal amount of money over time.

● Simple Interest - calculated using the principal only, ignoring any interest accrued in
preceding interest periods
● Compound Interest - calculated using both the initial principal amount and the
accumulated interest from previous periods.

Interest Period - time when an interest is charged; the time unit of the interest rate and rate of
return.

Rate of Return - interest earned over a specific as a percentage of the original amount. Rate at
which the interest pays off the principal amount.

Return on Investment (ROI) - time period when a certain amount spent will become breakeven
with the profit.

Inflation - represents a decrease in the value of a given currency, which can greatly increase an
interest rate; cost and revenue cash flow estimates increase over time.

Supply - quantity of goods or services that producers are able to offer.


Demand - quantity of goods or services that a consumer is willing and able to purchase.

Equilibrium - point where supply and demand curves intersect; indicates the price where
quantity supplied equals the quantity demanded.

Cash Flow - measures the movement of money into and out of businesses, investments, etc.
over a period of time.

● Cash inflows are the receipts, revenues, incomes, and savings generated by project
and business activity. A plus sign indicates a cash inflow.
● Cash outflows are costs, disbursements, expenses, and taxes caused by projects and
business activity. A negative or minus sign indicates a cash outflow.

Cash Flow Diagram - a graphical representation of cash flows drawn on the y axis with a time
scale on the x axis.

Economic equivalence - a combination of interest rate and time value of money to determine
the different amounts of money at different points in time that are equal in economic value.

Minimum Attractive Rate of Return (MARR)/Hurdle Rate - a reasonable rate of return


established for the evaluation and selection of alternatives.

Two Ways of developing Capital


● Equity Financing - corporation uses its own funds from cash on hand, stock sales, or
retained earnings.
● Debt Financing - The corporation borrows from outside sources and repays the
principal and interest according to some schedule.

Arithmetic Gradient - cash flow series that either increases or decreases by a constant amount
each period. The amount of change is called the gradient.

Geometric Gradient - is a cash flow series that either increases or decreases by a constant
percentage each period. The uniform change is called the rate of change.

Perpetuity - a stream of cash flows that continues forever.

Four Fundamental Principles of Engineering Economics (Chan S. Park)


1. An earlier dollar is worth more than a later dollar
2. All that counts is the differences among alternatives
3. Marginal revenue must exceed marginal cost
4. Additional risk is not taken without expected additional return
Simple Interest Formula

Compound Interest/Economic Equivalence Formula

Uneven Payment Series Formula (F or P)


Spreadsheet Functions
Examples:

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