INTRODUCTION TO

ENGINEERING ECONOMY
Engineering Economy
Lecture no. 1
Thursday, December 9, 2021
Why Engineering Economy is Important
to Engineers (and other professionals)
Engineers “Design”
Engineers must be concerned with the
economic aspects of designs and
projects they recommend and perform
 Analysis
 Design
 Synthesis
Why Engineering Economy is Important
to Engineers (and other professionals)
Engineers must work within the realm
of economics and justification of
engineering projects
Work with limited funds (capital)
Capital is not unlimited – rationed
Capital does not belong to the firm
 Belongs to the Owners of the firm
 Capital is not “free”…it has a “cost”
 Definition
ENGINEERING ECONOMY IS INVOLVED WITH
THE FORMULATION, ESTIMATION, AND
EVALUATION OF ECONOMIC OUTCOMES
WHEN ALTERNATIVES TO ACCOMPLISH A
DEFINED PURPOSE ARE AVAILABLE.
ENGINEERING ECONOMY IS INVOLVED WITH
THE APPLICATION OF DEFINED
MATHEMATICAL RELATIONSHIPS THAT AID
IN THE COMPARISON OF ECONOMIC
ALTERNATIVES
Why Engineering Economy is Important
to Engineers (and other professionals)
Knowledge of Engineering Economy
will have a significant impact on you,
personally.
 Make proper economic comparisons
In your profession
 Private sector
 Public sector
In your personal life
Role of Engineering Economy in
Decision Making
Remember: People make decisions –
not “tools”
Engineering Economy is a set of tools
that aid in decision making – but will
not make the decision for you
Engineering economy is based mainly
on estimates of future events – must
deal with the future and risk and
uncertainty
Role of Engineering Economy in
Decision Making
The parameters within an engineering
economy problem can and will vary
over time
Parameters that can vary will dictate a
numerical outcome – apply and
understand
Sensitivity Analysis
Role of Engineering Economy in
Decision Making
Sensitivity Analysis plays a major role
in the assessment of most, if not all,
engineering economy problems
The use of spreadsheets is now
common and students need to master
this valuable tool as an analysis aid
 Problem-Solving Approach

1. Understand the Problem

2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor
 Problem-Solving Approach
1. Understand the Problem
2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor

Major Role of
Engineering
Economy
 Problem-Solving Approach
1. Understand the Problem
2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor

One of the more

difficult tasks
 Problem-Solving Approach
1. Understand the Problem
2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor Where the major
tools of Engr.
Economy are
applied
 Problem-Solving Approach
1. Understand the Problem
2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the “best” alternative
6. Implement and monitor Tools
Present Worth, Future Worth
Annual Worth, Rate of Return
Benefit/Cost, Payback,
Capitalized Cost, Value Added
 Time Value of Money

• Time Value of Money

• Money can “make” money if Invested
• Centers around an interest rate

The change in the amount of money over a

given time period is called the time value of
money; by far, the most important concept
in engineering economy
 Performing a Study
• To have a problem, one must have
alternatives (two or more ways to solve a
problem)
• Alternative ways to solve a problem must
first be identified
• Estimate the cash flows for the
alternatives
• Analyze the cash flows for each
alternative
 Alternatives
• To analyze, one must have:
• Concept of the time value of $$
• An Interest Rate
• Some measure of economic worth
• Evaluate and weigh
• Factor in noneconomic parameters
• Select, implement, and monitor
 Needed Parameters

• First cost (investment amounts)

• Estimates of useful or project life
• Estimated future cash flows (revenues and
expenses and salvage values)
• Interest rate
• Inflation and tax effects
 Cash Flows

• Estimate flows of money coming into the

firm – revenues salvage values, etc.
(magnitude and timing) – positive cash
flows
• Estimates of investment costs, operating
costs, taxes paid – negative cash flows
 Alternatives

• Each problem will have at least one

alternative – DO NOTHING
• May not be free and may have future
costs associated
• Do not overlook this option!
 Alternatives

•Goal: Define, Evaluate, Select and Execute

The Question:
Do
Alt. 1 Which One do
Nothing
we accept?
 Mutually Exclusive

• Select One and only one from a set of

feasible alternatives
• Once an alternative is selected, the
remaining alternatives are excluded at
that point.
 More Alternatives

• Goal: Define, Evaluate, Select and Execute

Do
Alt. 1 ………... Alt. j
Nothing

Which one do we accept?

 Default Position

• If all of the proposed alternatives are not

economically desirable then…
• One usually defaults to the DO-NOTHING
alternative
 Taxes
• Taxes represent a significant negative
cash flow to the for-profit firm.
• A realistic economic analysis must assess
the impact of taxes.
• Called and AFTER-TAX cash flow
analysis
• Not considering taxes is called a BEFORE-
TAX Cash Flow analysis.
 Taxes
• A Before-Tax cash flow analysis (while not
as accurate) is often performed as a
preliminary analysis.
• A final, more complete analysis should be
performed using an After-Tax analysis
• Both are valuable analysis approaches
 Interest Rate
INTEREST - MANIFESTATION OF THE
TIME VALUE OF MONEY. THE AMOUNT
PAID TO USE MONEY.
 INVESTMENT
INTEREST = VALUE NOW - ORIGINAL AMOUNT
 LOAN
INTEREST = TOTAL OWED NOW - ORIGINAL
AMOUNT

RENTAL FEE PAID FOR THE USE OF SOMEONE

ELSES MONEY…EXPRESSED AS A %
 Inflation Effects
• A social-economic occurrence in which
there is more currency competing for
constrained goods and services
• Where a country’s currency becomes
worth less over time, thus requiring more of
the currency to purchase the same amount
of goods or services in a time period
 EQUIVALENCE
• Example
• You travel at 68 miles per hour
• Equivalent to 110 kilometers per hour
• Thus:
• 68 mph is equivalent to 110 kph
• Using two measuring scales
• Miles and Kilometers
 EQUIVALENCE
• Is “68” equal to “110”?
• No, not in terms of absolute numbers
• But they are “equivalent” in terms of the
two measuring scales
• Miles
• Kilometers
 ECONOMIC EQUIVALENCE
• Economic Equivalence
• Two sums of money at two different
points in time can be made economically
equivalent if:
• We consider an interest rate and,
• No. of time periods between the two
sums
Equality in terms of Economic Value
 Terminology and Symbols
• Specific symbols and their respective
definitions have been developed for use in
engineering economy.
• Symbols tend to be standard in most
engineering economy texts world-wide.
• Mastery of the symbols and their respective
meanings is most important in understanding the
subsequent material!
 Terminology and Symbols

• P = value or amount of money at a time

designated as the present or time 0.
• Also, P is referred to as present worth (PW),
present value (PV), net present value (NPV),
discounted cash flow (DCF), and capitalized
cost (CC); dollars
 Terminology and Symbols

• F = value or amount of money at some

future time.
• Also, F is called future worth (FW) and
future value (FV); dollars
Terminology and Symbols

• A = series of consecutive, equal,

end‑of‑period amounts of money.
•Also, A is called the annual worth (AW) and
equivalent uniform annual worth (EUAW);
dollars per year, dollars per month
• n = number of interest periods; years,
months, days
 Terminology and Symbols

• i = interest rate or rate of return per

time period; percent per year, percent per
month
• t = time, stated in periods; years,
months, days, etc
 Computer Solutions

• Use of a spreadsheet similar to

Microsoft’s Excel is fundamental to the
analysis of engineering economy
problems.
•All engineers are expected by training to
know how to manipulate data, macros,
and the various built-in functions common
to spreadsheets.
 Important TERMS
• CASH INFLOWS
• Money flowing INTO the firm from outside
• Revenues, Savings, Salvage Values, etc.

• CASH OUTFLOWS
• Disbursements
• First costs of assets, labor, salaries, taxes
paid, utilities, rents, interest, etc.
 Cash Flows
• For many practical engineering economy
problems the cash flows must be:
• Assumed known with certainty
• Estimated
• A range of possible realistic values provided
• Generated from an assumed distribution and
simulated
 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
 End-of-Period Assumption
• END-OF-PERIOD Convention

ALL CASH
ALL CASH FLOWS
FLOWS ARE
ARE ASSUMED
ASSUMED TOTO OCCUR
OCCUR ATAT
THE END
THE END OF
OF AN
AN INTEREST
INTEREST PERIOD
PERIOD EVEN
EVEN IF
IF THE
THE
MONEY FLOWS
MONEY FLOWS AT
AT TIMES
TIMES WITHIN
WITHIN THE
THE
INTEREST PERIOD.
INTEREST PERIOD.
THIS IS
THIS IS FOR
FOR SIMPLIFICATION
SIMPLIFICATION PURPOSES
PURPOSES
The Cash Flow Diagram: CFD
• Extremely valuable analysis tool
• First step in the solution process
• Graphical Representation on a time scale
• 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
 Summary
Engineering Economy Study:
 Involves modeling the cash flows
 Computing specific measures of economic worth
 Using an interest rate(s)
 Over a specified period of time
The concept of equivalence helps in
understanding how different sums of money
at different times are equal in economic
terms