ENGG 404 - Engineering Economics The amount of money or its equivalent

which can be given in exchange for a product or

Engineering Economy a service.
- engineering discipline mainly concerned with
the mathematical analysis and evaluation of cost and ➢ Market
benefits of proposed or on going business projects The place where sellers and buyers of
and ventures, with the aim of making cost-effective products and services come together to make
decisions for each projects and ventures, thus transactions.
ensuring the best use of capital.
Market Seller Buyer
Principles of Engineering Economy Perfect Competition Many Many
Monopoly One Many
Among the decisions that engineers are called Monopsony Many One
upon to make involve, but are not limited to the Duopoly Two Many
following: Duopsony Many Two
a) Deciding to implement a new project or
Oligopoly Few Many
venture
Oligopsony Many Few
b) Selecting among alternative projects or
ventures that must be implemented within a Bilateral Monopoly One One
capital budget limit Bilateral Oligopoly Few Few
c) Selecting between alternative technical
designs for a component, product, structure, ➢ Consumer Goods and Services
system, service or process Products or services that are directly used by
d) Analyzing the economic impact of people to satisfy their wants.
engineering improvements or modification
on an existing product, system or process ➢ Producer Goods and Services
e) Deciding whether and when to replace Are used to produce consumer goods and
existing equipment services or other producer goods.
f) Deciding whether to lease or purchase
equipment to improve an existing operation ➢ Necessities
Products or services that are required to
The analytical methods of engineering economy support human life and activities, that will be
make use of the CASH FLOW APPROACH. purchased in somewhat the same quantity even
➢ The analysis mainly consist of predicting or though the price varies considerably.
analyzing the economic effects of a project
or venture, or of various alternatives in terms ➢ Luxuries
of cash money to be spent and received by Products or services that are desired by
the project or venture, or a result of each humans and will be purchased only if money is
alternative being implemented, available after the required necessities have been
➢ The economic feasibility of a project or obtained.
venture or an alternative is determined by
calculating if or which alternative has ➢ Demand
economic benefits best outweighing The quantity of a certain commodity that is
economic costs. bought at a certain price at a given place and
time.
Engineering Economy and the Design Process
The discipline of engineering economy is ➢ Elastic Demand
primarily meant to aid business organization Occurs when a decrease in selling price
determine feasible projects, ventures or alternatives results in a greater than the proportionate
that they can implement, with the assurance that increase in sales.
capital is allocated and invested wisely with defined
monetary (an non-monetary benefits). ➢ Inelastic Demand
It is also meant to aid engineering designers in Occurs when a decrease in selling price
evaluating the economic costs and benefits of their results in a less than the proportionate increase
designs of a new component, product, structure, in sales.
system, service or process; or designs of engineering
improvements or modifications on an existing ➢ Unitary Elasticity of Demand
product, system or process. Occurs when the mathematical product of
volume and price is constant.
Concepts of Economics
➢ Supply
➢ Price Is the quantity of a certain commodity that is
 offered for sale at a certain price at a given place more wealth.
and time.
Types of Capital
Law of Supply
The supply of commodity varies directly as 1. Equity
the price of the commodity, though not Supplied by the owner himself, invested
proportionately. to earn expectation to earn profit from their
investment.
Cost Concepts for Engineering Economy Analysis
2. Borrowed capital
Three COST ELEMENTS: Supplied by others with a promise to
A. Materials repay the principal and interest with the
B. Labor specific date, whether or not the operations
C. Overhead of the business have been profitable or not.

Material Cost Interest from the viewpoint of the lender is the

➢ Direct Materials income produced by money which has been
Materials that are used directly in the borrowed or invested. For the borrower, it is the
finished product itself. amount of money paid for the used of borrowed
➢ Indirect Materials capital.
Materials that are used in facilitating the
production process, but are not used in the finish Rate of interest is defined as the amount of
product. earned by one unit principal during a unit of time.

Labor Cost Simple Interest

➢ Direct Labor
Labor applied directly to the production of When the total interest earned linearly
the product. proportional to the amount of loan (principal), the
➢ Indirect Labor number of the interest periods for which the
Labor that is used to facilitate the production, principal is committed, and the interest rate period,
process, but cannot be identified with a specific the interest is said to be simple.
product produced.
I = Pn i
Overhead
All other expenses necessary for the operation of Where I = total interest
the business enterprise, but cannot be classified as P = principal
direct material cost or direct labor cost, may include n = no. of interest periods (month,
but are not limited to the following: years, etc.)
i = interest of rate per interest
Examples: Periods
➢ Indirect Materials
➢ Indirect Labor The accumulated amount at the end of the
➢ Depreciation interest periods, F
➢ Taxes
➢ Insurance F= P+ I
➢ Rental F = P (1+ni)
➢ Supervision
➢ Maintenance Types of Simple Interest
➢ Utilities (power, water, communication)
➢ Office Supplies 1. Ordinary Simple Interest (Io)
➢ Fuel, oil and lubricants Based on one banker’s year which is
➢ Equipment repair equivalent to 360 days or 30 days in one
➢ Warehousing and delivery month.
➢ Transportation
➢ Marketing Io = P (d/360) (i)
➢ Government permits
➢ Professional fees Where: d = no. of days

Money-Time Relationship 2. Exact Simple Interest (Ie)

Based in the exact number of days in
Capital ordinary year or 366 days for leap year
Is any form of wealth that can be used to produce
 for ordinary year Quotes the exact rate of interest for one
year.
Ie = Pi (d/365)
ERI = (1+i)m - 1
or
Discount is defined as the interest deducted in
for leap year advance. In negotiable paper it is the difference
between the present worth of the paper and its value
Ie = Pi (d/366) sometime in the future.

Compound Interest D=F-P

Whenever the interest charge for any interest is
based on the remaining principal plus any Rate of Discount
accumulated interest changes up to the beginning of Discount of one unit of principal for one unit of
that period the interest is said to be compounded. time.

Interest Principal Interest Amount at D = P/F or d = i/(1+i)

Period at the Earned End of
Beginning During Period Application of Compound Interest
of period Period 1. deposit ---------- withdrawals
1 P Pi P + Pi = 2. loans ---------- repayments
P(1+ni) 3. investment ---------- income
2 P(1+i) P(1+i)i P(1+i) + 4. cash inflow ---------- cash outflow
P(1+i)i =
P(1+i)2
3 P(1+i)2 P(1+i)2i P(1+i)2 +
P(1+i)2i = Sample Problems:
P(1+i)3
---------- ---------- ---------- ---------- 1) A loan of Php 10,000 for 3 years at 10% simple
n P(1+i)n P(1+i)ni P(1+i)n-1 + per year. Determine the interest earned and the
P(1+i)n-1i = accumulated amount.
P(1+i)n
Given: P = 10,000
Accumulated amount F n = 3 years
The accumulated amount F, at the end of interest r = 10% per year
period n is:
F = P (1+i)n Required: a. total interest
n
The factor (1+i) is called single payment b. accumulated amount, F
compound amount factor, (F/P, i%, n ).
Solution:
The Present Value, P
Solving for P in the above equation will give us a. the total interest earned
the formula: I = Pni
P = F (1+i)-n I = (Php10,000)(3yrs)(0.1/yr)
The factor F(1+i)-n is called single payment I = Php 3,000
present worth factor, (P/F, i%, n).
b. the accumulated amount at the end of the
Where: n = number of interest period interest period
i = rate of interest per period F=P+I
F = Php 10,000 + 3.000
Rate of Interest F = Php 13,000

a) Nominal Rate of Interest 2) Determine the ordinary simple interest on Php

Specifies the rate of interest and the 8,000 loan for 8 months at 7% per year.
number of compounding period in one year.
Given: P = Php 8,000
Example: r = 12% compounded n = 8 monthly
monthly i = 7% per year
i = r/m
Therefore: i = 12%/12 = 1%/month Required: Io (simple ordinary interest)

b) Effective Rate of Interest Solution:

 i = 3 years (4) = 12 quarters
Io = P(d/360)i
Io = 8,000(240/360)(0.07) Required: the amount in the fund at the end of
or 3 years, F
Io = 8,000(8/12)(0.07)
Io = Php 373.33 Solution:
Solving for the rate of interest per period
3) Determine the ordinary and exact interest on Php i = r/m = 10/4 = 2.5% per quarter
15,000 loan at 8% per year made from January
12 to September 24, 2007. Solving for the accumulated amount F
F = P(1+i)n
Given: P = Php 15,000 F = Php10,000(1+0.025)12
n = January 12 - September 24,2007 F = 14,448.88
i = 8% per year
6) Determine the effective rates of interest for the
Required: a. Io following nominal rates of interest:
b. Ie a) 9% compounded annually
b) 9% compounded semi-annually
Solution: c) 9% compounded quarterly
Solving for the number of days, from d) 9% compounded monthly
January 12 to September 24, 2007 . There are e) 9% compounded daily
256 days. f) 9% compounded weekly

a. Solving the ordinary simple interest Solution:

Io = Pi(d/360)
Io = Php15,000(0.08/yr)(256/300)yr ERI = (1+i)m - 1
Io = Php 853.33
a) ERI = (1+0.09)1 - 1 = 0.09
b. Solving for the exact interest b) ERI = (1+0.09/2)2 - 1 = 0.0920
Io = Pi(d/365) c) ERI = (1+0.09/4)4 - 1 = 0.0931
Io = Php15,000(0.08/yr)(256/305)yr d) ERI = (1+0.09/12)12 - 1 = 0.0938
Io = Php 841.64 e) ERI = (1+0.09/365)365 - 1 = 0.0942
f) ERI = (1+0.09/52)52 - 1 = 0.0941
4) A loan of Php 10,000 for 3 years, 10%
compounded interest per year. Determine the 7) Supposed that you have just borrowed Php
accumulated amount. 75,000 at 12% nominal interest rate compounded
quarterly. What is the total lump- sum,
Given: P = Php 10,000 compounded amount to be paid by you at the end
n = 3 years of a 10 year load period?
i = 10% per year
Given: P = Php 75,000
Required: accumulated amount, F n = 10 years
i = 0.12/4
Solution:
Solution:
n
F = P(1+i)
F = Php10,000(1+0.1)3 F = P(1+i)n
F = Php 13,310 = 75,000(1+0.12/4)10(4)
F = Php 244,652.83
Period Principal Interest Principal Payment
1 10,000 1,000 11,000 0 8) A sum of Php 10,000 is invested now and left for
2 11,000 1,100 12,100 0 8 years at which the principal is withdrawn the
3 12,100 1,210 13,310 13,310 interest has accrued is left for 8 years. If the
effective annual interest rate is 5% what is the
5) The sum of the Php 10,000 was deposited in a amount of the account at the end of the 16th year?
fund earning interest at 10% per annum
compounded quarterly, what was the principal in Given: P = Php 10,000
the fund at the end of 3 years? n1 = 8 years
L1 = 0.05/1
Given: P = Php 10,000
r = 10% per year compounded Solution:
quarterly
 P2 = 10,000(1+0.05/1)8 - 10,000
P2 = Php 4774.55

F = (4774.554)(1+0.05)8(1)
= Php 7054.2

9) A businessman wants to have Php 500,000 four

years from now. What amount should he invest
now if it will earn interest of 6% compounded
quarterly for the first two years and 8%
compounded semi-annually during the next two
years?

Given: F = Php 500,000

L1 = 0.06/4
n1 = 2x4
i2 = 0.08/2
n2 = 2x2

Solution:

F = P2(1+0.08/2)2(2)
P2 = 500,000/(1+0.08/2)4
P2 = Php 427,402.0955

P1 = P2/(1+0.06/4)2(4)
= Php 379,409.59

10) How long will it take you to become a

millionaire if you invest Php 10,000 at 20%
compounded quarterly.

Given: P = Php 10,000

F = Php 1,000,000
i = 0.2/4

Solution:

1,000,000 = 10,000(1+0.2/4)n(4)
n = 23.59 years