Kwara State University, Malete

Mechanical Engineering Department

GET 302 ENGINEERING ECONOMICS

Course Lecturer: Dr. K.O Oladosu

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 Introduction

Engineering Economics helps one to

understand the need for the knowledge of
economics for being an effective manager
and good decision makers
Economics theories are used to take decision
related to uncertain and changing business
environment
As the design and manufacturing process
become more complex, Engineers take
decision that involves more money than
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before
 The Engineering economics is concerned the
systematic evaluation of the benefits and costs
of projects involving engineering design and
analysis

The seven-step procedures used to assist

the decision making are:
1. The recognition, definition and evaluation of
the problem.
2. Search for potential as well as feasible

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alternatives.
 4. Decision should serve the long term interest of

the organisation.

5. Analysing the economic aspects of the

engineering problem.

6. The preferred alternative is based on the total

effort.

7. Attention to ensure feedback for improvement of

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operation.
 Simple Interest

Interest is money earned when money is

invested.

Interest is charge incurred when a loan or

credit is obtained.

It is usually expressed as per cent per annum.

Type of interest:
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a) simple interest
 Why do we need to charge interest on
principal/investment

• Interest compensate for the administrative expenses

of making the loan available

• It makes up for the risk that the loan may not be

repaid

• The loss of earning which could have been obtained if

the money had not been loan out but invested or

productive purposes
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 Simple Interest Formula

Simple interest, I is the interest calculated on

the original principal for the entire period it is
borrowed or invested.

I = PRT

P= principal
R= rate of simple interest
T= time or terms in years

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 Simple Amount Formula

Simple amount, S is the sum of the original

principal and the interest earned.

S = P+ Interest earned
=P+PRT
P(1+RT)

Where;
P= principal
R= rate of simple interest
T= time or terms in years
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 Example 1
N 10,000 is invested for 4 years 9 months in a
bank earning a simple interest rate of 10% per
annum. Find the simple amount at the end of the
investment period
Example 2
How long does it take a sum of money to triple
itself at a simple interest rate of 5% per annum?
Example 3
5 years ago, Ali invested RM 6,660 in a bank at a
simple interest rate of 7.2%. Find a) the number of

9 years required if Ali wanted the amount in the

 Four Basic Concepts

Exact time • exact number of days between

two given dates.
Approximate time • number of days
between two given dates assuming that
1month = 30 days.
Ordinary simple interest • A year is
consider to have 360 days (A year is divided
into twelve 30 days periods
Exact simple interest • A year is exactly

1 the calendar number of day (use a

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 Example 4

N 1,000 was invested on 15/03/2012. If the simple

interest rate offered was 10% per annum, calculate
(a) exact time and (b) exact simple interest and (c)
Ordinary simple interest received on 29/08/2012

(a)Exact time from 15 March to 29August of the same

year 16+ 30 +31 +30 +31 +29 =167 days

(b) I =PRT
1000x10%x167/366
N 45.63
(c) 1000x10%x167/360
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N 46.39
 Further Examples on Compound Interest
Example 1
Determine the future value of N1000 which was invested for
a) 4 years at 4% compounded annually
b) 5 years 6 month at 14% compounded semi-annually
c) 2 years 3 months at 4% compounded quarterly
d) 5 years 7months at 5% compounded monthly
e) 2 years 8 months at 9% compounded every 2 months
Example 2
N9000 is invested for 7 years 3 months. This investment is
offered 12% compounded monthly for the first 4 years and 12
% compounded quarterly for the rest of the period. Calculate
the future of this investment.
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 Assignment 1
John saved N 6000 in a saving account which pay 15%
compounded monthly,9 months later she saved another N
5000. Determine the amount in the account two years after
her first savings?

Difference Btw Nominal rate and Effective Interest rate

A Nominal :rate is interest that is calculated more than once
in a year
An Effective: rate is the actual rate that is earned in a year

Example 3
1 What is the norminal rate compounded monthly that will make
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 Example 5
N 800 is invested for one year. If the interest rate is
(a) 9.04% compounded annually
(b)8.75 % compounded quarterly
Determine the amount after one year ?

If they yield the same future value, then above rate is

equivalent
Therefore, 2 rates are Equivalent if they yield the same future
value at the end of 1 year

1 Effective Rat e of Interest Formulae

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Determine the effective rate of interest corresponding to the norminal
Rate of 8% per year compounded

(a) Anually
(b) Semianually
(c) Quarterly
(d) Monthly
(e)daily

Quiz 1

In the last 5 years MAA mutual fund grew at the rate of 10.4% per year
compounded quarterly. Over the same period public mutual fund grew
the rate of 10.6 % per year compounded semi-annually which mutual fu
has a better rate of return?

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Compound Interest-Present Value

Compound interest =total amount of principal and interest in future

Or (future value) less the principal amount at present called
Present Value (PV)

PV is the current worth of a future sum of money or stream of cash

flows given a specified rate of return

The formulae to calculate the present value is given by :

Example 8
How much money should be deposited in a bank paying interest at the
of 6% per year compounded monthly so that at the end of 3 years the
accumulated amount will be N20,000
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Example 9

A debt of #3000 will mature in three years time. By assuming

that the money worth 14% compounded semi annually, calc.

a) The present value of this debt

b) The value of this debt at the end of the first year

c) The value of this debt at the end of the fourth year

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 Discounted Cash Flow Calculations
The sum of money recorded as receipt or disbursement in a
project financial records are called Cash Flow

For example; Interest paid on a sum in a bank account will be

considered as disbursement to the bank and a receipt to the
holder of the account

Cash flow diagram can be drawn to help visualize and simplify

problems that have diverse receipt and disbursement

Convention used to standardize cash flow

The horizontal time axis
1 Direction of arrow for receipt and disbursement
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 Discounted Cash Flow Calculations
For example
A mechanical device that will cost N 20000 when purchased.
Maintenance will cost N1000 each year. The device will generate
revenue of N 5000 each year for 5 years after which the salvage is
expected to be N 7000

Standard cash flow are:

• Single payment cash flow
• Uniform series cash flow
• Gradient series cash flow

 Single payment cash flow: this can occur at the beginning of

1 the time line ,(t =0), end of time line (t=n)or at any time in
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 Discounted Cash Flow Calculations
 Uniform series cash flow: this consist of series of equal
transaction starting at t=1 and ending at t=n (representing
annual amount)
 Gradient series cash flow: start with a cash flow at t=2 and
increase by G each year until (n-1)G

Time Value of Money

Consider, N 100 placed in an account that paid 5% effective
annual interest at the end of each year
After 1st year , the account will have grown to N 105
After 2nd year N110.25
N100 today grows to N105 in one year is an example of time
value of money

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 Discounting Factor and Equivalent
(a) Receive N100 now (b) Receive N105 in 1 year (c)N 110.25 in 2
years
Procedures to determine equivalent amount is called discounting
From the table:
(1) Single Payment Equivalent
The equivalent future amount F at t=n of any present amount P at
t=0 is called Future worth
F=p(1+i)n [the factor (1+i)n is called single payment future
worth/compound amount factor]
Similarly,
P= F(1+i)n [factor (1+i) is known as single payment present worth
factor]
Standard functional notation
F=P(F/P, i%, n) ----Future value in n periods of present amount
2 F…. find
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 Discounting Factor and Equivalent

(2) Uniform Series Equivalent: Cash that repeat each year for n
years without change in amount(Annual A) future amount
Its possible to convert from annual amount to future amount use
table
F=A (F/A, i%, n )
Example 1
Suppose you deposited N200 at the end of every year for seven
years in account that earned 6% annual effective interest. At the
end of seven years, how much would the account be worth.

Note
A sunk fund is a fund into which annual deposit of A are made in
order to accumulate F at t=n. Annual deposit is calculated as
2 A=F(A/F, i% ,n) i.e the A/F is known as Sinking Fund factor see
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Example 2
Suppose you want exactly N1600 in the previous investment account at the end of the seventh year. By using the Sinking Fund Factor, calculate the necessary annual amount you would need to deposit.(Take effective annual interest as 6%)

Note
Annuity is a series of equal payments A, made over a period of time usually its necessary to buy into an investment(a bond, insurance policy etc)
Annuity start at the end of first year and continue for n year
The purchase price P is
P=A(P/A,i,n)

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Example 3
Suppose you will retire in exactly one year and want an
account that will pay N20,000 a year for the next 15 years.
(The fund will be depleted at the end of 15th year). Assuming a
6% annual effective interest rate, what is the amount you
would need to deposit now

In this case use uniform series present worth

Example 4

The national debt is approximately N4 trillion. What is the

required payment per year to completely pay off the debt in
20 years, assuming an interest rate of 6%.

Use capital recovery from table

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Example 5
The president of a growing engineering firm wishes to give each of
50 employees a holiday bonus. How much is needed to invest
monthly for a year at 12% nominal interest rate, compounded
monthly, so that each employee will receive a N1000 bonus?

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 Continuous Compounding
The discount factor for continuous compounding can be calculated
directly from the norminal interest rate r, and number of years n
without having to find the effective interest rate per

Example
If the norminal interest rate is 3%, how much is N5000 worth in 10
years in a continuous compounded account

Further Examples on discrete compounding

1. Fifteen years ago N1000 was deposited in a bank account and
today its worth N2370. The bank paid interest semi- annually.
What was the norminal annual interest paid on this account?

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2) Mr jones plans to deposit N 500 at the end of each month for 2
years
at 12% nominal annual interest, compounding monthly. The
amountthat will be available in 2 years is ?

3) The purchase price of a car is $25,000 . Mr Sulaiman makes a

down payment of $5000 and borrow the balance from a bank at 6%
annual interest, compounded monthly for five years. Calculate the
nearestvalue of the required monthly payment to pay off the loan

4.) A piece of machinery can be bought for $10,000 cash or for

$2000 down and payment of $750 per year for 15 years. What is the
annual interest rate for the time payments?

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 Comparison of Alternatives
1. Present worth analysis
2. Annual cost analysis
3. Benefit cost analysis
4. Rate of return
5. Break even analysis

6. Present worth analysis

When alternatives do the same job but have same life span ,
compare them by converting each to its cash value today. The
superior alternatives will have the highest present worth
example 1

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Example 1
There are two alternatives for purchasing a concrete mixer. Both the
alternatives have same useful life. The cash flow details of alternatives are
as follows; Alternative-1: Initial purchase cost = N300,000, Annual
operating and maintenance cost = N20,000, Expected salvage value =
N125,000, Useful life = 5 years. Alternative-2: Initial purchase cost =
N200,000, Annual operating and maintenance cost = N35,000, Expected
salvage value = N70,000, Useful life = 5 years. if the rate of interest is
10% per year.

a. What is the equivalent present worth of Alternative 1

b. What is the equivalent present worth of Alternative 2

c. Comparing the equivalent present worth of both the alternatives which

of the alternatives should be selected?
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Annual cost
When alternatives do the same job but have different life span ,
compare the cost per year of each alternative
The alternatives are assumed to be replaced at the end of their
lifes by identical alternatives

The initial cost are assumed to be borrowed an at the start and

repaid evenly during the life of the alternatives
Example 2

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Question 2 through question 4 refers to the following situation. An
industrial firm uses an economic analysis to determine which of two
different machines to purchase. Each machine is capable of performing
the same task in a given amount of time. Assume the minimum
attractive rate of return is 8%.
Use the following data in this analysis
Machine X Machine Y

Initial cost $5000 $10,000

Estimated life 7 years 13 years
Salvage value none $4000
Ann. maintenance cost $150 $175

2. What is the approximate equivalent uniform annual cost of machine

X?
3 What is the approximate equivalent uniform annual cost of machine Y
4. Which, if either, of the two machines should the firm choose?

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Question 2 through question 4 refers to the following situation. An
industrial firm uses an economic analysis to determine which of two
different machines to purchase. Each machine is capable of performing
the same task in a given amount of time. Assume the minimum
attractive rate of return is 8%.
Use the following data in this analysis
Machine X Machine Y

Initial cost $5000 $10,000

Estimated life 7 years 13 years
Salvage value none $4000
Ann. maintenance cost $150 $175

2. What is the approximate equivalent uniform annual cost of machine

X?
3 What is the approximate equivalent uniform annual cost of machine Y
4. Which, if either, of the two machines should the firm choose?

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 Comparison of Alternatives

Use the information below to answer questions 35-37

Going Broke County is using a 10% annual interest rate to decide if it should
buy snowplow A or snowplow B

Snowplow A Snowplow B
initial cost $300,000 $400,000
life 10 years 10 years
annual and $45,000 $35,000
maintenance
annual benefits $150,000 $200,000
salvage value $0 $10,000

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