Syllabus

Financial Management: Financial analysis, ratio analysis, different types of ratios and their uses,
limitations and trend analysis, time value of money, decision making based on PW, EUAW, B/C
ratio, break even analysis, value engineering.
Basic Concepts
of
Engineering Economic Analysis
 Why Engineering Economic analysis is Important :
3
•Decisions made by engineers, managers, corporation presidents, and individuals are
commonly the result of choosing one alternative over another.

•Decisions often reflect a person’s educated choice of how to best invest funds (capital).

•The amount of capital is usually restricted, just as the cash available to an individual is
usually limited. The decision of how to invest capital will invariably change the future,
hopefully for the better; that is, it will be value adding.

•Engineers play a major role in capital investment decisions based on their analysis,
synthesis, and design efforts.

•The factors considered in making the decision are a combination of economic and
noneconomic factors.

•Fundamentally, engineering economic analysis involves formulating, estimating, and

evaluating the economic outcomes when alternatives to accomplish a defined purpose
are available.
4 Time Value of Money

• An important concept in engineering economy

• Money can “make” money if invested.
E.G: Investment of 1 taka today would grow to (1+r) after a year (r=rate of return)

• The change in the amount of money over a given time period is

called the time value of money.
 Why “Time” Factor is important in Time value of money

• In general , people preferers current consumption than to future consumption

• Money (Capital) can be employed productively to generate positive return.
• E.G: Investment of 1 taka today would grow to (1+r) after a year (r=rate of
return/inflation)
• In the period of inflation a Taka today represents a greater deal than a taka year
ahead
6 The Big Picture

 Engineering economy is at the heart of making decisions.

 These decisions involve the fundamental elements of cash flows of
money, time and interest / inflation rates.
 This lecture introduces the basic concepts and terminology necessary
for an engineer to combine these three essential elements in organized,
mathematically correct ways to solve problems that will lead to better
decisions.
 Annotation of few terms used in Engineering Economic Analysis

• Cash flow diagram: It is a graphical representation of money flow (as ordinate) and time (as
base)

• Salvage Value: The worth of the assets or an items , that we received after expiry of life.

• Time value of money : Value (worth) of money over a period of times . Or buying power of a
money after time interval.

• Causes of variation of money value : 1. Inflation , 2. Return of investment

• Few important terms and symbols used in Engineering Economy :

• Present value : P
• Future value : F
• Uniform annual worth : A
• Pay back period : n
• Rate of return : I
 Annotation …..

• Present value (P) : Equivalent worth of money at present for some future investment.

• Future value(F) : The value (worth) will be received in future for an amount depositedor
invested today

• Uniform annual worth (A) : The amount distributed as an uniform rate throw-out the year
or life cycle.

• Pay back period (n): The time period to recover the invested amount.

• Rate of return : A rate of return (RoR) is the net gain or loss of an investment over a
specified time period, expressed as a percentage of the investment's initial cost. Its
expressed as I %.

• Capitalized Cost: Refers to the present worth of the project that is assumed to be last for
ever. Some public works , hospital , University campus , Railroad considered to be
permanent structure. For capitalized cost , P = A/ i
Annotation …..
MARR (P) : ( Minimum Attractive Rate of Return) : The reasonable rate of return
for safe investment.

Depreciation: Loss of value due to use. Generally used in tax calculation.

Depletion: Sudden loss of value due to excessive use or natural disaster.

Depletion is an accounting and tax concept used most often in the mining,
timber, and petroleum industries.It is similar to depreciation in that it is a cost
recovery system for accounting and tax reporting: "The depletion deduction"
allows an owner or operator to account for the reduction of a product's
reserves. Wikipedia
10 Cash flow

 Any engineering project that we encounter will be made up a series of expenses in

credits that run over the lifetime of the projects existence, these transactions are known
as cash flow.

 whether it is a construction project or in R&D project, monetary transactions can take

place at any point during the lifetime of the project and can be anything ranging from the
costs of a piece of equipment (called an expense, disbursement, payment, etc.) to a
favorable return on investment.

 their last as long as a piece of equipment is in operation this is called a credit or

revenue.
11 Problem Solving Approach

1. Understand the Problem and define the objective.

2. Collect all relevant data/information
3. Define the feasible alternative solutions and make realistic
estimates.
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor
Operating Activities
Cash inflows from:
 Sale of goods or services
 Interest revenue
 Dividend revenue
 Sale of trading securities
 Other

583
Operating Activities

Cash outflows for:

 Purchase of inventory
 Payment of salaries and wages
 Interest expense
 Other expenses
 Purchase of trading securities

583
Cash Flow
Diagram

 The cash flow diagram is a very important tool in an economic

analysis, especially when the cash flow series is complex.
 It is a graphical representation of cash flows drawn on a time
scale. The diagram includes what is known, what is estimated,
and what is needed.
16
The Cash Flow Diagram:
CFD
Net Cash Flows

• A NET CASH FLOW is

• Cash Inflows – Cash Outflows
•(for a given time period)
• We normally assume that all cash flows
occur:
•At the END of a given time period
•End-of-Period Assumption
P = F/(1+i)n

F = P(1+i)n
Example

Interest rate = 10% 1100 Tk

0 yr

1 yr

-1000 Tk
 Annotation of few terms used in Engineering Economic Analysis

• Cash flow diagram: It is a graphical representation of money flow (as ordinate) and
time (as base)

• Salvage Value: The worth of the assets or an items , that we received after expiry of life.

• Time value of money : Value (worth) of money over a period of times . Or buying power
of a money after time interval.

• Causes of variation of money value : 1. Inflation , 2. Return of investment

• Symbols used in Engineering Economy :

• Present value : P
• Future value : F
• Uniform annual worth : A
• Pay back period : n
• Rate of return : I
 Annotation …..

• Present value (P) : Equivalent worth of money at present for some future investment.

• Future value(F) : The value (worth) will be received in future for an amount depositedor
invested today

• Uniform annual worth (A) : The amount distributed as an uniform rate throw-out the year
or life cycle.

• Pay back period (n): The time period to recover the invested amount.

• Rate of return : A rate of return (RoR) is the net gain or loss of an investment over a
specified time period, expressed as a percentage of the investment's initial cost. Its
expressed as I %.

• Capitalized Cost: Refers to the present worth of the project that is assumed to be last for
ever. Some public works , hospital , University campus , Railroad considered to be
permanent structure. For capitalized cost , P = A/ i
Annotation …..
MARR (P) : ( Minimum Attractive Rate of Return) : The reasonable rate of return
for safe investment.
 Example

P = F/(1+i)n
Example
Present Worth Analysis of Equal-Life Alternatives
Present Worth Analysis of Different-Life
Alternatives
Engineering Economy--- Leland T.Blank and Anthoony J.Tarquin
Single-Amount Factors (F/P and P/F )
Single-Amount Factors (F/P and P/F )
Single-Amount Factors (F/P and P/F )
Uniform Series Present Worth Factor and
Capital Recovery Factor ( P/A and A/P)
Uniform Series Present Worth Factor and
Capital Recovery Factor ( P/A and A/P)
Uniform Series Present Worth Factor and
Capital Recovery Factor ( P/A and A/P)
Sinking Fund Factor and Uniform Series Compound
Amount Factor ( A/F and F/A)
Sinking Fund Factor and Uniform Series Compound
Amount Factor ( A/F and F/A)
Arithmetic Gradient Factors (P/G and
A/G)
Arithmetic Gradient Factors (P/G and A/G)
Arithmetic Gradient Factors (P/G and A/G)
Arithmetic Gradient Factors (P/G and A/G)
Arithmetic Gradient Factors (P/G and A/G)
Geometric Gradient Series Factors
Example 2.7
Engineering Economy
---Blank
Formulating
Alternatives
Present Worth Analysis of Equal-Life Alternatives
Present Worth Analysis of Different-Life
Alternatives
LCM of 18 years
LCM of 18 years
Inflation rate calculation

Find i % by trial and error method

2000 7000

2 10

5000
 P= A / i

From following transaction , find the duration for sustainable payment

9000

for
1 2 3 4 5 6 7 8 9 10

100000
i%= 10%

1
From following transaction , find Present worth

200 700
1 2 4 5 6 i%= 5%
3 7 8 9 10

300
800
1000
1200 1300
PW
1400
1600
1800
Capitalized cost

Many public sector projects such as bridges, dams, highways and toll
roads, railroads, and hydroelectric
and other power generation facilities have very long expected useful
lives. A perpetual or infinite life is the effective planning horizon.

Example : An alumni interested to start a scholarship under his parents name.

Condition is that student should be at a level of 4th year and maintain few
characteristics set by alumni (doner). Amount should be paid at a level of 4000/year
for infinite time. Calculate the amount of money need to be deposited at this moment
if inflation rate is 10%.
 Sample Problem:

1. To day 150000 invested (one time)

2. 5000/year for 4 year and after that 8000/year for
3. 50000 after 10 years (one time)
4. 15000 every 13 years for time

Solution:
Ex : 5.34 Compare the machine shown below on the basis of their capitalized cost using
an interest rate of 20% per year

Machine X Machine Z
First Cost $50000 $200000
Annual operating cost $62000 $24000
Salvage value $10000 0
Overhaul after 6 years ------ $4000
Life, years 7
Chapter 6 : Equivalent Uniform Annual worth

Ex: 6.1 : Calculate the EUAW of a machine that has an initial cost of $8000 and a
salvage value of $500 after 8 years. Annual operating costs (AOC) for the machine
are estimated to be $900 and an interest rate of 20% per year is applicable
Ex 6.4 : The following costs are estimated for two equal service tomato peeling
machines in a food canning plant: (I % = 10%)

Machine A Machine B

First cost $26000 $36000

Annual maintenance cost $800 $300

Annual labour cost $11000 $7000

Extra income taxes (yearly) -------- $2600

Salvage value $2000 $3000

Life , years 6 10
Benefit / cost analysis
 Ratio analysis

• Liquidity ratio : Liquidity position of firm

• Leverage ratio : Long-term solvency of the firm
• Profitability ratio : Measures operating efficiency
• Activity ratio : Measures efficiency in asset management

Who is interested on whom

• Liquidity ratio : Short term investors

• Leverage ratio : Long-term investors
• Profitability ratio : Owners and management
• Activity ratio : Management
 Components of Liquidity ratio

• Networking capital
• Current ratio
• Acid test or quick ratio
• Super acid test

Who is interested on whom

• Liquidity ratio : Short term investors

• Leverage ratio : Long-term investors
• Profitability ratio : Owners and management
• Activity ratio : Management
 Chapter 6 : Equivalent Uniform Annual worth

Ex 6.10 : If an investor deposit $10000 now at an interest rate of 7% per year, how many years
must the money accumulate before the investor can withdraw $1400 per year forever
Chapter 7: Rate of return analysis

Figure : 7.2 Cash flow diagram to determine the value of rate of return