Lecture Materials

Introduction to Engineering Economy

HUM 2115
Engineering Economy
Zahid Hasan Shuvo
Industrial and Production Engineering
Department of MPE
Definition
 A collection of mathematical technique which simplify economic
comparisons.
 A decision assistance tool by which one method will be chosen will
be most economical one.
 Is the dollars-and-cents side of the decisions that engineers make
or recommend as they work to position a firm to be profitable in a
highly competitive marketplace.
 Involves the systematic evaluation of the economic merits of
proposed solutions to engineering problems.

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Definition (Cont.)
To be economically acceptable (i.e., affordable), solutions to engineering
problems must demonstrate a positive balance of long-term benefits over
long-term costs, and they must also
 Promote the well-being and survival of an organization,
 Embody creative and innovative technology and ideas,
 Permit identification and scrutiny of their estimated outcomes, and
 Translate profitability to the “bottom line” through a valid and acceptable
measure of merit.

The mission of engineering economy is to balance these trade-offs in the

most economical manner.
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Principles of Engineering Economy
 Develop the Alternatives
 Focus on the Differences
 Use a Consistent Viewpoint
 Use a Common Unit of Measure
 Consider All Relevant Criteria
 Make Risk and Uncertainty Explicit
 Revisit Your Decisions

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Relationship between the Engineering Economic Analysis
Procedure and the Engineering Design Process
Engineering Economic Analysis
Engineering Design Process
Procedure
Problem/need definition, formulation
Problem recognition, definition, and evaluation.
and evaluation.
Synthesis of possible solutions
Development of the feasible alternatives
(alternatives).
Development of the outcomes and cash flows for
each alternate
Analysis, optimization, and
Selection of a criterion (or criteria) evaluation
Analysis and comparison of the alternatives
Selection of the preferred alternative Specification of preferred alternative
Performance monitoring and post evaluation of
Communication
results 5
Engineering Design Process

Figure: Engineering Design Process 6

Engineering Economic Decision
Engineering economic decision refers to the process of making choices among
different engineering alternatives by considering their economic implications.
It involves evaluating various options based on economic criteria to
determine the most cost-effective and financially viable solution for a given
engineering project or problem. Engineering economic decisions are crucial in
areas such as project management, process optimization, equipment selection,
and resource allocation.
To facilitate the decision-making process, various quantitative techniques such
as net present value (NPV), internal rate of return (IRR), benefit-cost ratio
(BCR), sensitivity analysis, and scenario analysis are employed. These
techniques help in comparing alternatives, assessing their economic viability,
and selecting the option that best meets the project's objectives while
optimizing financial resources. Ultimately, engineering economic decisions aim
to maximize benefits and minimize costs to achieve the desired outcomes
efficiently. 7
Engineering Economic Decision (Cont.)
When making engineering economic decisions, engineers and decision-makers
typically consider factors such as:
 Costs: This includes both initial investment costs and ongoing operational
costs associated with the alternatives being evaluated. Engineers need to
compare these costs to find the most economical solution.
 Benefits: Engineering projects often aim to achieve specific objectives, such as
increased efficiency, reduced environmental impact, or enhanced performance.
Decision-makers assess the benefits offered by each alternative to determine
their value and impact on the overall project goals.
 Time: Time-related factors, such as project duration, construction time, and
delivery schedules, are essential considerations. Delays can have financial
implications, and engineering decisions often need to balance time constraints
with economic feasibility.

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Engineering Economic Decision (Cont.)
 Risks and Uncertainties: Engineers assess the risks associated with
different alternatives, considering factors like market volatility,
technological uncertainties, and regulatory changes. Decision-makers
use risk analysis techniques to account for uncertainties and make
more informed choices.
 Environmental and Social Impact: Modern engineering practices
often require evaluating the environmental and social impact of
projects. Sustainable and socially responsible decisions are becoming
increasingly important in engineering economic analysis.
 Laws and Regulations: Compliance with legal requirements and
regulations is critical. Engineers must consider the costs associated
with meeting these standards when evaluating different options.

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Time Value of Money
 Change in the amount of money ones a given
time period is called the time value of money.
 The idea that a currency today is worth more
than a currency in the future because the
currency received today can earn interest.
 The economic value of a sum depends on
when it is received. Because money has both
earning as well as purchasing power over
time.
 Purchasing power is the value of a currency
expressed in terms of the amount of goods
or services that one unit of money can buy.

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Simple Interest
 When More than one interest period is involved, the term simple
interest must be considered.
 Simple interest is interest earned on only the principal amount
during each interest period.
 With simple interest, the interest earned during each interest
period does not earn additional interest in the remaining periods,
even though you do not withdraw it.
 for a deposit of P dollars at a simple interest rate of i for N
periods, the total earned interest would be 𝐼 = 𝑖𝑃 𝑁
 The total amount available at the end of N periods thus would be
𝐹 = 𝑃(1 + 𝑖𝑁)
 Here i= Interest rate, P= Principal, N= No. of period
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Simple Interest (Cont.)
If you borrow $1000 for 3 years at 14% per year of simple interest
rate, how much money will you owe at the end of 3 years?

Solution:
Interest per year = 1000 × 0.14 = 140
For 3 years total interest = 1000 × 0.14 × 3 = 420
Total amount after 3 years = 1000 + 420 = 1420

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Compound Interest
 When More than one interest period is involved, this term must be considered too.
 Compound Interest for an interest period is calculated on the principal plus the
total amount of interest accumulated in previous periods.
 i (interest amount) = Principal + Total amount of interest accumulated in
previous periods
 This total amount includes the original principal plus the accumulated interest that
has been left in the account.
 In general, if you deposited (invested) P dollars at interest rate i, you would have
𝑃 + 𝑖𝑃 = 𝑃(1 + 𝑖) dollars at the end of one period. If the entire amount (principal
and interest) is reinvested at the same rate i for another period, at the end of the
second period you would have

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Compound Interest (Cont.)
Continuing, we see that the balance after the third period is

This interest-earning process repeats, and after N periods the total

accumulated value (balance) F will grow to-

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Compound Interest (Cont.)
If you borrow $1000 for 3 years at 14% per year of compound
interest rate, how much money will you owe at the end of 3 years?
Solution:
Interest Total after
𝑌𝑒𝑎𝑟 1 = 1000 × 0.14 = 140 Year 1 = 1140

𝑌𝑒𝑎𝑟 2 = 1140 × 0.14 = 159.60 Year 2 = 1299.60

𝑌𝑒𝑎𝑟 3 = 1299.60 × 0.14 = 181.94 Year 3 = 1481.54

Time value of money is especially recognized in compound interest.

Thus with compound interest the original $1000 would accumulated
an extra 1481.54-1420 = 61.54 compared with simple interest.
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Compound Interest (Cont.)
Suppose you deposit $1,000 in a bank savings account that pays
interest at a rate of 10% compounded annually. Assume that you don’t
withdraw the interest earned at the end of each period (one year),
but let it accumulate. How much would you have at the end of year 3?

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Compound Interest (Cont.)
The total interest earned is $331, which is $31 more than was
accumulated under the simple-interest method. We can keep track of
the interest accruing process more precisely as follows:

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Comparing Simple with Compound Interest
In 1626, Peter Minuit of the Dutch West India Company paid $24 to
purchase Manhattan Island in New York from the Indians. In
retrospect, if Minuit had invested the $24 in a savings account that
earned 8% interest, how much would it be worth in 2007?
Solution:

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Interest Calculation
 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 – 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡
 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑤𝑒𝑑 – 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑙𝑜𝑎𝑛
 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 × 𝑛𝑜. 𝑜𝑓 𝑃𝑒𝑟𝑖𝑜𝑑 × 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑐𝑐𝑟𝑢𝑒𝑑 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑡𝑖𝑚𝑒
 𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 = × 100%
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝐴𝑚𝑜𝑢𝑛𝑡

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Interest Calculation (Cont.)
“A” Company invest $ 1,00,000 on May-1 and withdrew a total of $
1,06,000 exactly one year later. Compute - (a) Interest (b) Interest
Rate.
Solution:
𝑎 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = $ 1,06,000 – $1,00,000 = $6000

6,000 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

𝑏 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 = × 100%
1,00,000
= 6% (𝑝𝑒𝑟 𝑦𝑒𝑎𝑟)

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Interest Calculation (Cont.)
“A” Company plans to borrow $ 20,000 for 1 year at 15% interest
rate. Compute - (a) Interest (b) Total amount due after 1 year.

(𝑎) 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = $ 20,000 × (0.15) = $ 3,000

(𝑏) 𝑇𝑜𝑡𝑎𝑙 𝑑𝑢𝑒 𝑎𝑓𝑡𝑒𝑟 𝑜𝑛𝑒 𝑦𝑒𝑎𝑟 = $ 20,000 + $ 3,000

= $ 23,000
𝑇𝑜𝑡𝑎𝑙 𝑑𝑢𝑒 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 (1 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)
= $ 20,000 (1 + 0.15)
= $ 23,000

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