2/10/2025

Zagazig University College of Engineering

Department of Industrial Engineering

Engineering Economy

Dr. Mansour Abou Gamila Spring 2024/2025

February, 2025 Dr. Mansour Abou Gamila 1

Your Instructor

Dr. Mansour Abou Gamila

Department of Industrial Engineering
College of Engineering
Zagazig University

Mobile: 01027330688
Email: [email protected]
[email protected]

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Course Objectives

By the end of this course, the student should be

able to:
• Formulate and solve time value of money
problems.
• Identify sources of data and apply appropriate
techniques to solve economic problems.
• Understand the importance of data interpretation
and making appropriate economic decisions
• Work in multidisciplinary teams, conduct
economical analysis, and communicate the
results

Assessment and Grading System

Assessment and grades will be determined

based on the following distribution:
Quizzes 10%
Assignments 05%
Mid Term Exam 15%
Final exam 70 %

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Time

Lectures:
Wednesday: 10:30-12:00 (Hall: 27219- 1‫)مدرج ج‬

Office hours
Saturday: 12:00-2:00
Tuesday: 09:00- 11:00
Wednesday : 12:00-02:00

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Foundations of Engineering Economy

Objectives of this lecture:
1. Understand the types of questions engineering economy can answer.
2. Determine the role of engineering economy in the decision making process.
3. Identify what is needed to successfully perform an engineering economy
study.
4. Perform calculations about interest rates and rate of return.
5. Understand what equivalence means in economic terms.
6. Calculate simple interest and compound interest for one or more interest
periods.
7. Identify and use engineering economy terminology and symbols.
8. Identify the Excel spreadsheet functions commonly used to solve engineering
economy problems.
9. Understand the meaning and use of Minimum Attractive Rate of Return.
10. Understand cash flows, their estimation, and how to graphically represent
them.
11. Develop a spreadsheet that involves simple and compound interest,
incorporating sensitivity analysis. 6
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Foundation of Engineering Economy

 Engineering economy is at the heart of making decisions. These
decisions involve the fundamentals elements of cash flows of
money, time, and interest rates.
 Engineering economy involves technical analysis, with emphasis
on the economic aspects and has the objective of assisting in
decision making.
 Engineering economy is the application of economic techniques
for the evaluation of design and engineering alternatives. The role
of engineering economy is to:-
• assess the appropriateness of a given project
• estimate its value
• justify it from an engineering point of view
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Foundation of Engineering Economy

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.
Fundamentally, engineering economy involves formulating, estimating,
and evaluating the economic outcomes when alternatives to accomplish a
defined purpose are available.
Engineering economy is as a collection of mathematical techniques that
simplify economic comparison.

 What we must know?

• Time value of money

• Estimation of cash flows

• Quantitative measurements of profitability

• Systematic comparison of alternatives 8

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Activities
• If a computer-vision system replaces the human inspector in performing
quality tests on an automobile welding line, will operating costs decrease
over a time horizon of 5 years?
• Is it an economically wise decision to upgrade the composite material
production center of an airplane factory in order to reduce costs by 20%?
• How much tax revenue does the city need to generate to pay for an
upgrade to the electric distribution system?
• Is it cost effective for the state to cost-share with a contractor to construct
a new toll road?
• Should I pay off my credit card balance with borrowed money?
• What are graduate studies worth financially over my professional career?
• Exactly what rate of return did we make on our stock investment?
• Should I buy or lease my next car, or keep the one I have now and pay
off the loan?

Dr. Mansour Abou Gamila 9

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EXAMPLE
Some questions for each alternative are as follows:
• How much will it cost each year? ( Cost estimates
are needed)
• How do we pay for it? ( A financing plan is needed)
• Are there tax advantages? (Tax law and tax rates are
needed)
• What is the basis for selecting an alternative? (A
selection criterion is needed)
• What is the expected rate of return? (Equation are
needed)
• What happens if we fly more or less than we estimate
now? (Sensitivity analysis is needed)
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1.1 Role of Engineering Economy in Decision Making

Problem Solving Approach

 In Identifying the criteria for decision making, major
tools of Engineering Economy are applied
 Present Worth, Future Worth
 Annual Worth, Rate of Return
 Benefit/Cost, Payback, Capitalized Cost, Value
Added
 This lead to the concept of time value of money

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1.2 Performing an Engineering Economy Study

1. To have a problem, one must have alternatives

(two or more ways to solve a problem)
2. Alternative ways to solve a problem must first
be identified
3. Estimate the cash flows for the alternatives
4. Analyze the cash flows for each alternative

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1.2 Performing an Engineering Economy Study

The steps of decisions making process:

1. Understand the problem and define the objective.
2. Collect relevant information
3. Define the feasible alternative solutions and make
realistic estimates.
4. Identify the criterion for decision making using one or
more attributes.
5. Evaluate each alternative, using sensitivity analysis to
enhance the evaluation.
6. Select the best solution.
7. Implement the solution.

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1.2 Performing an Engineering Economy Study

Needed Parameters
1. First cost (investment amounts)
2. Estimates of useful or project life
3. Estimated future cash flows (revenues and
expenses and salvage values)
4. Interest rate
5. Inflation and tax (not covered)

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1.2 Performing an Engineering Economy Study

• Alternative Description: The result of decision – making process
step 1 is a basic understanding of what the problem requires for
solution. There may initially be many alternatives, but only few will
be feasible and actually evaluated.
• Cash flow: The estimated inflows” revenues” and outflows “ costs”
of money are called cash flows.
• Analyzing Using Engineering Economy: Computations that
consider the time value of money are performed on the cash flows of
each alternative to obtain the measure of worth.
• Alternative Selection: The measure –of- worth values are
compared, and an alternative is selected. For example, the result of a
rate – of – return analysis may be: Select alternative 1 , where the
rate of return is estimated at 18.4% per year, over alternative 2 with
an expected 10% per year return.
• In economic analysis, When there are several ways of accomplishing a
stated objective, the alternative with the lowest overall cost or highest
overall net income is selected.
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1.4 Interest Rate and Rate of Return

• Interest is the manifestation of time value of money. Interest is the

difference between an ending amount of money and the beginning
amount.
• Interest is paid when a person or organization borrowed money
“obtain a loan” and repay a larger amount.
• Interest is earned when a person or organization saved, invested,
or lent money and obtain a return of a larger amount.
• Interest on borrowed funds = amount owed now – original
amount
• If the interest is expressed as a percentage of the original amount
then it is called the interest rate
interest accrued per time unit
Interest rate (%)   100%
original amount
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1.4 Interest Rate and Rate of Return

Example 1.3
An employee borrows $ 10,000 on May 1 and must repay a total
of $ 10,700 exactly 1 year later. Determine the interest amount
and the interest rate paid.
Interest earned = $10,700-10,000 = $700
After 1 year:
$700
Percent Interest Rate  *100%  7% per year
Example 1.4 $10,000
Stereophonics, plan to borrow $20,000 from a bank for 1 year at 9%
interest for new recording equipment. (a) Compute the interest and
the total amount due after 1 year.
(a) Interest = $20,000(0.09) = $1,800
(b) Total due = $20,000+$1,800 = $21,800, or
Total due = principal (1+ interest rate) = $20,000(1.09) = $21,800
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1.4 Interest Rate and Rate of Return

• Interest earned from the perspective of a saver, a lender, or an
investor = total amount now – original amount.

Interest accrued per time unit

Rate of return (ROR) (%)  *100%
Example 1.5: orginal amount
a. Calculate the amount deposit 1 year ago to have $1000 now at
an interest rate of 5% per year.
b. Calculate the amount of interest earned during the time period

a. If X is the original deposit, total accrued = original +original

(interest rate)
$1000 = X + X(0.05) = X(1+0.05) = (1.05)X
b. Original deposit = X = 1000/1.05 = $952.38
Interest = $1000 - $952.38 = $ 47.62 18
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1.4 Interest Rate and Rate of Return

Inflation means that cost and revenue cash flow estimates
increase over time. This is due to the changing value of money
that is forced upon country's currency by inflation, thus
making a unit of currency worth less relative to its value at a
previous time.

Inflation contributes to:

• A reduction in purchasing power of the currency.
• An increase in the consumer price index.
• An increase in the cost of equipment and its maintenance.
• An increase in the cost of salaried professionals and hourly
employees.
• A reduction in the real rate of return on personal saving and
certain corporate investments.
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1.4 Interest Rate and Rate of Return

Inflation represents a decrease in the value of a given currency.

$1 now will not purchase the same amount as $1 did 20 years
ago. Bank interest rates reflect two things: real rate of return
plus the expected inflation rate.

From the borrower's perspective, the rate of inflation is simply

another interest rate tacked on to the real interest rate. From
the point of the saver, or investor, inflation reduces the real
rate of return on investment.

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1.5 Terminology and Symbols

• P= value or amount of money at a time designated as the
present or time 0, preset worth(PW), Present Value “PV”, Net
present value ”NPV”, Discounted cash flow ”DCF”, and
capitalized cost “ CC”.
• F = value of money at some future time. It is future worth “
FW”, Future value” FV”.
• A = series of consecutive, equal, end of period amounts of
money. It is the annual worth” AW” and Equivalent uniform
annual worth ”EUAW”.
• n = number of interest periods; years, month, days.
• i = interest rate or rate of return per time period; percent per
year; percent per month; percent per day.
• T = time, stated in periods; years, months, days.
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1.5 Terminology and Symbols

Example:
A new college graduate has a job with Boeing Aerospace. She plans to borrow
$10,000 now to help in buying a car. She has arranged to repay the entire
principal plus 8% per year interest after 5 years. Identify the engineering
economy symbols involved and their values for the total owed after 5 years.
P = $10,000 i = 8% per year n=5 years F=?

Example 6:
Today, Julie borrowed $5000 to purchase furniture for her house. She can
repay the loan in either of the two ways described below. Determine the
engineering economy symbols and their value for each option.
a) Five equal annual installations with interest based on 5 per year.
b) One payment 3 years from now with interest based on 7 % per year.

(a) P = $5000 i=5% per year n= 5 years A=?

(b) P = $5000 i=7% per year n= 3 years F=?

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1.5 Terminology and Symbols

Example 1.7:
You plan to make a lump sum deposit of $5000 now into an investment
account that pays 6% per year, and you plan to withdraw an equal end
of year amount of $1000 for 5 years, starting next year. At the end of
the six year, you plan to close your account by withdrawing the
remaining money. Define the engineering economy symbols involved.
P= $5000 A = $1000per year for 5 years F=?
i = 6% n = 5 years for the “A” series and 6 for the “F” value.

Example 1.8:
P=?, i= 6% per year, n= 1 year,
F= P + interest= P+ $5000
F = P+P(interest rate)
Interest = 5000 = F – P = [P + P(interest rate)]-P = P(interest rate)
5000 = P(0.06)
P = 5000/0.06 = $83,333.33
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1.6 Cash Flows: Their Estimation and Diagramming

Samples of Cash Inflow Estimates:
• Revenues, operating cost reductions, Asset salvage value, Receipt of loan
principal, Income tax savings, Receipt from stock and bond sales,
Construction and facility cost savings, saving or return of corporate capital
funds.

Samples of Cash Outflow Estimates:

• First cost of assets, Engineering design costs, Operating costs, Periodic
maintenance and rebuild costs, Loan interest and principal payments, Major
expected/unexpected upgrade costs, Income taxes, Expenditure of
corporate capital funds.

• Net cash flow = receipt – disbursements = cash inflow – cash outflows.

• The end of period convention means that all cash flows are assumed to
occur at the end of an interest period. When several receipts and
disbursements occur within a given interest period, the net cash flow is
assumed to occur at the end of the interest period.
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1.6 Cash Flows: Their Estimation and Diagramming

 Extremely valuable analysis tool

 First step in the solution process
 Graphical Representation on a time scale
 Positive cash flows are normally drawn upward from the time line
 Negative cash flows are normally drawn downward from the time
line
 Does not have to be drawn “to exact scale”
 But, should be neat and properly labeled
 Required on most in class exams and part of the grade for the
problem at hand

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1.6 Cash Flows: Their Estimation and Diagramming

 A typical cash flow diagram might look like:

1. Draw a time line

0 1 2 … … … n-1 n
One time
period

2. Show the cash flows

Always assume end-of-period
cash flows!

0 1 2 … … … n-1 n

Cash flows are shown as directed arrows (+ve for up or -ve for
down) --- (+) inflow; (-) outflow

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1.6 Cash Flows: Their Estimation and Diagramming

Example 1.9
Carla Ramos, a lead engineer for Mexico and Central American
operations, plans expenditures of $1 million now and each of
the next 4 years just for the improvement of field – based
pressure release valves. Construct the cash flow diagram to
find the equivalent value of these expenditure at the end of
year 4, at i = 12%
I = 12%
F=?
-1 0
1 2 3 4
Cash Year
flow $

A = $1, 000,000

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1.6 Cash Flows: Their Estimation and Diagramming

Ex 1.10
An electrical engineering wants to deposit an amount P now such
that she can withdraw an equal annual amount of A1 = $2000
per year for the first 5 years, starting 1 year from the deposit,
and a different annual withdraw A2= $3000 per year for the
following 3 years. How would the cash flow diagram appear if
I = 8.5% per year?

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1.6 Cash Flows: Their Estimation and Diagramming

Ex 1.11

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1.6 Cash Flows: Their Estimation and Diagramming

Example
A father wants to deposit an unknown lump sum amount into an
investment opportunity 2 years from now that is large enough
to withdraw $4000 per year for state university tuition for 5
years starting 3 years from now, Construct the cash flow
diagram if i = 15.5% .
i= 15.5%
A = $4000

Cash
flow $ 0 1 5 7
2 3 4 6 Year

P=?

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1.7 Equivalence
Example 1.12
Batteries are stored throughout the year, and 5% cost increase is added each year
to convert the inventory carrying charge for the distribution. Which of the
following statements are true and which are false:
a. The amount of $ 98 now is equivalent to a cost of $ 105.6 one year from now.
Total amount accrued = 98(1.05) = $102.9 ≠ 105.6, it is false.

b. A truck battery cost of $200 one year ago is equivalent to $ 205 now.
Required old cost is 205/1.05 = $195.24 ≠ $200, it is false.

c. A $38 cost now is equivalent to $39.9 one year from now.

The cost 1 year from now = $38(1.05) = $39.9, it is true.

d. A $3000 cost now is equivalent to $2887.14 one year ago.

Cost now is 2887.14(1.05) = $3031.5 ≠ $ 3000, it is false.

e. The carrying charge accumulated in 1 year on an investment of $20, 000 worth

of batteries is $1000
The charge is 5% per year interest, or $20,000(0.05)=$1000; It is true.
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1.8 Simple and Compound Interest

• Simple interest is calculated using the principal only, ignoring
any interest accrued in preceding interest periods.
• The total simple interest over several periods:
Interest = (Principal)(number of periods)(interest rate).

Example:
An engineer borrow $1000 for 3 years at 5% per year simple
interest. How much money will the engineer repay at the
end of year 3?
The interest for each year = 1000(0.05) = $50
Total interest for 3 years = 1000(0.05)(3) = $150
The amount due after 3 years = 1000+150 = $1150

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1.8 Simple and Compound Interest

• Compound interest reflect the effect of time value of money on the interest.
• Compound Interest = (principal +all accrued interest)(interest rate).

Example
If an engineer borrows $1000 from the company credit union at 5% per
year compound interest, compute the total mount due after 3 years.
Year 1 interest = $1000(0.05) = $50
Total amount due after year “1” = 1000+50 = $1050

Year 2 interest = $1050(0.05) = $52.5

Total amount due after year “2” = 1050+52.5 = $1102.5
Or, Total amount due after year “2” = $1000(1.05)2 = $1102.5

Total amount due after year “3”= 1102.5(1.05) = $1157.63

Or, Total amount due after year “3” = $1000(1.05)3 = $1157.63

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1.8 Simple and Compound Interest , Example 1.16

End of Year Interest Owed for year Total owed at End of year Total Owed
end of year payment after payment

Plan 1: Pay all at the end

0 $5000.00
1 $400.00 $5400.00 -- 5400.00
2 432.00 $5832.00 -- 5832.00
3 466.56 $6298.56 -- 6298.56
4 503.88 $6802.44 -- 6802.44
5 544.20 $7346.64 $-7346.64
Total $-7346.64
Plan 2: Simple interest, pay interest annually, principal required at the end
0 $5000
1 $400 $5400 $-400 $5000
2 $400 $5400 $-400 $5000
3 $400 $5400 $-400 $5000
4 $400 $5400 $-400 $5000
5 $400 $5400 $-5400
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$-7000
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1.8 Simple and Compound Interest , Example 1.16

End of Year Interest Owed for year Total owed at End of year Total Owed
end of year payment after payment

Plan 3: Compound interest and portion of principal Repaid Annually

0 $5000.00
1 $400.00 $5400.00 $-1400.00 4000.00
2 320.00 $4320.00 -1320.00 3000.00
3 240.00 $3240.00 -1240.00 2000.00
4 160.00 $2160.00 -1160.00 1000.00
5 80.00 $1080.00 -1080.00
Totals $-6200.00
Plan 4: Pay Equal Annual payments of compound Interest and Principal
0 $5000
1 $400 $5400.00 $-1252.28 4147.72
2 $331.82 4479.54 $-1252.28 3227.25
3 $258.18 3485.43 $-1252.28 2233.15
4 $178.65 2411.80 $-1252.28 1159.52
5 $92.76 1252.28 $-1252.28
Totals $-6261.41
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1.8 Simple and Compound Interest , Example 1.16

$ 5000 AT TIME 0 is equivalent to each of the following:

• Plan 1: $7346.64 at the end of year 5 at 8% compound interest.
• Plan 2: $400 per year for 4 years and $5400 at the end of year
5 at 8% simple interest.
• Plan 3: Decreasing payments of interest and partial in years 1
($1400) through 5 ($1080) at 8% compound interest.
• Plan 4: $1252.28 per year for 5 years at 8% compound interest.

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1.9 Minimum Attractive Rate of Return

• To be profitable, the investor expects to receive more money
than the amount invested. A fair rate of return must be
realizable ”ROR”.

• Engineering alternatives are evaluated upon the prognosis that

a reasonable ROR can be expected. The reasonable rate is
called the Minimum Attractive Rate of Return “ MARR”, and
is higher than the rate expected from a bank or some safe
investment that involves minimal investment risk.

• The MARR is established by “financial” mangers and is used

as a criterion against which an alternative’s ROR is measured,
when the accept/ reject decision.
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1.9 Minimum Attractive Rate of Return

• Equity Financing: The corporation uses its own funds from
cash on hand, stock sales, or retained earning. Individuals can
use their own cash, savings, or investments.

• Dept Financing: The corporation borrows from outside sources

and replays the principal and interest according to some
schedule.
ROR ≥ MARR > Cost of capital

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1.10 Introduction to Spread Sheet Use

• Using the symbols P, F, A, I, and n exactly as defined in the previous

section, the excel functions are:
• To find the present value P: PV(i%, n, A, F)
• To find the future value F: FV(i%, n, A, P)
• To find the equal, periodic value A: PMT(i%, n, P, F)
• To find the number of periods n: NPER(i%, A, P, F)
• To find the compound interest rate i: RATE(n, A,P,F)
• To find the compound interest rate i: IRR(first _ cell :last _ cell)
• To find the present value P of any series: NPV(i%, second _cell : last _
cell)+first _cell
• If some parameters don’t apply, they can be omitted and zero is
assumed. If the parameter omitted, the comma must be entered .
• The function must proceed by an equal sign “=“
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1.10 Introduction to Spread Sheet Use

 Introduces the concepts associated with using a

spreadsheet program like Microsoft Excel
 To build and improve your knowledge of modeling
by using Excel you must build your own models and
experiment with the various functions
 Reference Example 1.17
 Design a spreadsheet model to evaluate this project

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1.10 Introduction to Spread Sheet Use

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