ENGS 30 - Engineering Economics.docx

**THE BASICS OF ENGINEERING ECONOMY** - Engineering -- profession in which a knowledge of the mathematical and natural science gained by study, experience, and practice is applied with judgment to utilize economically; involved in every detail of a product's production. - Engineers...

**THE BASICS OF ENGINEERING ECONOMY** - Engineering -- profession in which a knowledge of the mathematical and natural science gained by study, experience, and practice is applied with judgment to utilize economically; involved in every detail of a product's production. - Engineers -- must consider the effective use of capital assets; to plan for the acquisition of equipment (capital expenditure) that will enable the firm to design and produce products. - Engineering Economy -- discipline concerned with the economic aspect of engineering; systematic evaluation with the economic merits of proposed solutions to engineering problems; analysis and evaluation of factors that will affect the economic success of engineering projects. - Engineering Economics -- the application of economic techniques to the evaluation of design and engineering alternatives; to assess the appropriateness of a given project, estimate its value, and justify it from an engineering standpoint. - General Economic Environment Terminology: - Consumer Goods and Services -- products or services that are directly used by people to satisfy their wants and needs. - Producer Goods and Services -- used to produce consumer goods and services. - Prices of Goods and Services -- present amount of money or its equivalent which is given in exchange for it. - Demand -- quantity of certain commodity that is bought at a certain price. - Supply -- quantity that is offered for sale at a certain price. - Perfect Competition -- occurs in a situation in which any given product is supplied by a large number of vendors and there is no restriction on additional suppliers entering the market. - Perfect Monopoly -- exists when a unique product or service is available from a single supplier and that vendor can prevent the entry of all others not the market. - Oligopoly -- occurs when there are few suppliers and any action taken by anyone of them will alter the course of action of others. - Total Revenue -- product of selling price per unit and number of units sold. - Total Cost -- sum of the fixed and variable costs. - Profit/Loss -- difference between total revenue and costs. - Cost Terminology: - Cost Considerations and Comparisons -- fundamental aspects of engineering practice. - Fixed Cost -- unaffected by changes in activity level over a feasible range of operations for the capacity or capability available (Insurance, Taxes, License Fees). - Variable Cost -- associated with an operation that vary in total with the quantity of output or other measures of activity level (Cost of Material, Labor). - Incremental Cost -- additional cost or revenue that results from increasing the output of the system. - Recurring Cost -- repetitive and occur when an organization produces similar goods or services on a continuing basis. - Nonrecurring Cost -- not repetitive even though total expenditure may become cumulative over a relatively short period of time. - Direct Cost -- can be reasonably measured and allocated to a specific output or work activity (Labor and Material Costs) - Indirect Cost -- difficult to attribute or allocate to a specific work or activity (Cost of Common Tools, General Supplies, Equipment Maintenance). - Overhead Cost -- consists of plant operating costs that are not direct labor or direct material costs. - Standard Cost -- representative costs per unit of output that are established in advance of actual production. - Cash Cost -- involves payment of cash. - Noncash Cost/Book Cost -- does not involve cash payment, but rather represent the recovery of past expenditures over a fixed period of time (Depreciation Charge). - Sunk Cost -- occurred in the past and has no relevance to estimate future costs and revenues related to an alternative course of action. - Opportunity Cost -- 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. - Life-Cycle Cost -- summation of all the costs, recurring and nonrecurring, related to a product, structure system, or service during its lifespan. - Investment Cost -- capital required for most of the activities in the acquisition phase. - Working Capital -- required for current assets that are needed for the startup and support of operational activities. - Operational and Maintenance Cost -- recurring annual expense items associated with the operation phase of the life cycle. - Disposal Cost -- nonrecurring costs of shutting down the operation and the retirement and disposal of assets at the end of life cycle; offset in some instances by receipts from the sale of assets with remaining value. - Economic Life -- coincides with the period of time extending from the date of acquisition to the date of abandonment, demotion in use, or replacement from intended service. - Ownership Life -- period between the date of acquisition and the date of disposal by a specific owner. - Physical Life -- period between original acquisition and final disposal of asset over the succession of owner. - Useful Life -- period that an asset is kept in productive service; estimate of how long an asset is expected to be used in a trade or business to produce income. **I. THE ECONOMIC ENVIRONMENT** - Necessities -- products or services that are required to support human life and activities. - Luxuries -- products or services desired by humans. - Types of Demand: - Elastic Demand -- occurs when a decrease in selling price results in a greater than proportionate increase in sales. - Inelastic Demand -- occurs when a decrease in selling price produces a less than proportionate increase in sales. - Unitary Elasticity of Demand -- occurs when the math product of volume and price is constant. - 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." - Law of Diminishing Returns: "When the use of one of the factors of the production is limited, either in increasing cost or by absolute quantity, a point will be reached beyond which an increase in variable factors will result in a less than proportionate increase in output." **II. INTEREST AND MONEY-TIME RELATIONSHIP** - Capital -- refers to wealth in the form of money or property that can be used to produce more wealth. - Equity Capital -- owned by individuals who have invested their money in a property in the hopes of receiving a profit. - Borrowed Capital -- obtained form lenders for investment, with a promise to repay the principal and interest on a specific date. - Cash Flow -- stream of monetary values (costs and benefits) resulting from a project investment. - Single Cash Flows -- simples case involves the equivalence of a single cash present amount and its future worth. - Equal Uniform Series -- includes transactions arranged as a series of equal cash flows at regular intervals (equal-payment series/uniform series). - Linear Gradient Series -- consists of cash flows that increase or decrease by uniform amount each period. - Geometric Gradient Series -- increase or decrease by a fixed percentage. - Irregular Series -- cash flows that change with no pattern. - Cash Flow Diagram -- graphic representation of cash flows drawn in a time scale. - Elements of Cash Flow Diagram: - Horizontal Line -- represents time with progression of time moving from left to right. - Time Interval -- divided into an appropriate number of equal periods. - Arrows -- represent cash flows and are placed at the specified period. - Downward Arrows -- outflows (expenditures, disbursements). - Upward Arrows -- represents cash inflows (income). - Depends on the Person's Viewpoint -- all cash flows are considered to occur at the end of their respective periods. - P = present sum of money - F = future sum of money - N = number of interest periods - i = interest rate per period. - Money -- has a time value due to: - Inflation - Risk - Cost of Money (Interest) - Cost of Money -- the most predictable and is the essential component of economic analysis; represented by money paid for the use of borrowed money; determined by an interest rate. - Interest Rate -- a percentage that is periodically applied and added to an amount of money over a specified length of time. - Interest -- amount of money paid for the use of borrowed capital. - Interest from the Viewpoint of the Lender -- income produced by money which has been loaned. - Interest from the Viewpoint of the Borrower -- amount of money paid for the use of borrowed capital. - Simple Interest -- calculated using the principal only, ignoring any interest that had been accrued in the preceding periods. - I = Pni - F = P + I = P + Pni - F = P (1 + in) - I = interest - P = principal/present worth - N = no. of interest periods - i = rate of interest per interest period - F = accumulated amt. or future worth - Types of Simple Interest: - Ordinary Simple Interest -- computed on the basis of 12 months. - 1 Interest Period/Banker's Year = 360 days - 1 Banker's Month = 30 days - Exact Simple Interest -- based on exact number of days a year. - 1 Interest Period = 365/366 days. - Compound Interest -- calculated on the principal plus total amount of interest accumulated in previous periods; interest on top of interest. - Discrete Compounding -- interest is compounded at the end of each finite length period. - Discrete Cash Flows -- assume discrete cash flows spaced at the end of equal time intervals. - Single Payment Compound Amount Factor: F = P (1 + i)^n^ - Single Payment Present Worth Factor: F = P (1 + i)^-n^ - Rate of Interest -- defined as the amount earned by one unit of principal during a unit of time. - Nominal Rate of Interest -- specifies the rate of interest and a number of interest periods in one year. - i = r/m - n = Tm - Compounding Periods: - Semiannual = 2 - Quarter = 4 - Bimonthly = twice a month; 24 interest periods per year - Monthly = 12 months - Daily = 365 if year not specified - Effective Rate of Interest -- actual or exact rate of interest on the principal for one year. - r = (1 + r/m)^m^ -- 1 - Rule of 72: t = 72/r (as percent, not decimal) - Compound Continuously: A = Pe^Rt^ - Converting from one nominal rate to another = (1 + r~1~/m~1~)^m1^ = (1 + r~2~/m~2~)^m2^ - Equation of Value -- obtained by setting the sum of the values on a certain comparison or focal date of one set of obligations equal to the sum of the values. - Application of Compound Interest: - Deposits -- Withdrawals - Loans -- Repayments - Investment -- Income - Cash Inflow -- Cash Outflow - Discount -- difference between present worth and worth at some time in the future; interest paid in advance. - Rate of Discount: d = 1 -- (1 + i)^-1^ or discount/principal - Rate of Interest: i = d / 1 -- d or discount/present worth - Inflation -- increase in the prices for goods and services from one year to another, decreasing the purchasing power of money. - FC = PC (1 + f)^n^ - PC = present cost - FC = future cost - f = annual inflation rate - n = number of years - F = P/(1+f)^n^ - F = P(1+i)^n^ / (1+f)^n^ - Annuities -- series of equal payments occurring at equal periods of time; can be certain or uncertain. - Annuity Certain -- specific number of payments are set to begin and end at a specific length of time. - Annuity Uncertain -- the annuitant may be paid according to certain event. - Simple Annuity -- payment period is the same as the interest period; payment is made monthly. - General Annuity -- payment period is not the same as interest period. - Types of Annuities: - Ordinary Annuity -- series of uniform cash flows where the first amount of the series occurs at the end of the first period and every succeeding cash flow occurs at the end of each period. - Characteristics: - Present Equivalent Value (P) -- occurs one interest period before the first A (uniform amount). - Future Equivalent Value (F) -- occurs at the same time as the last A and n intervals after P. - Annual Equivalent Value (A) -- occurs at the end of each period. - - P = present money - F = future money - A = series of equal amounts of money - n = number of interest periods - i = interest rate - Mortgage: -  -