Machine Problem No.

ENGINEERING ECONOMY
Objective
1. To perform engineering economic analysis using Microsoft Excel(R) functions

Theoretical Discussion
Engineering economy involves the systematic evaluation of the benefits and costs of projects involving
engineering design and analysis. Majority of engineering economy studies involve the commitment of capital
for extended periods of time, so the effect of time must be considered. Interest is the amount of money paid for
the use of capital over time.
Interest calculations involve the use of cash flow diagrams such as the one shown in Figure 1.1.

Figure 1.1. Cash Flow Diagram

The horizontal line is a time scale, with progression of time moving from left to right. The period labels
represent the intervals of time (year, quarter, month, etc.). By default, the end-of-period cash flow convention
is used. That is, cash flows happen at the end of the period. The arrows signify cash flows and are placed at the
end of the period. Normally, downward arrows represent expenses and upward arrows represent receipts. The
cash flow diagram is dependent on the point of view (borrower or lender).
The following notation is utilized in formulas for compound interest calculations:
i
N
P
F
A

effective interest rate per interest period

number of compounding periods
present sum of money
future sum of money
cash flows in a uniform series (annuity) for a specified number of periods, starting at the end of
the first period and continuing through the last period

Interest formulas relating F, P and A have been derived.

Single-Payment Compound Amount Factor
= (1 + )
Single-Payment Present Worth Factor
= (1 + )
Uniform Series Present Worth Factor
(1+) 1

= [ (1+) ]

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(1)
(2)
(3)

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Capital Recovery Factor
(1+)

= [(1+) 1]

(4)

Uniform Series Compound Amount Factor

= [

(1+) 1

(5)

= [(1+) 1 ]

(6)

Sinking Fund Factor

Interest tables listing the different factors at different effective interest rates are available. These minimize the
use of the interest factor formulas. Microsoft Excel(R) includes financial functions that can simplify the
calculation of these factors for use in economic analysis. These financial functions are based on the same
assumptions as stated above. Some of these functions are listed in Table 1.1.
Table 1.1. Microsoft Excel(R) Financial Functions
Syntax
Function
RATE(nper,pmt,pv,fv,type,guess)
returns the interest rate of an annuity
PV(rate,nper,pmt,fv,type)
returns the present worth value of an annuity; does not include any cash
flow in year 0
FV(rate,nper,pmt,pv,type)
returns the future worth value of an annuity
NPV(rate,value1,value2, ...)
returns the net present worth of some non-uniform stream of cash
flows; does not include cash flow in year 0
NPER(rate, pmt, pv, fv, type)
returns the number of payment periods for a stated present value to
equal a stated future value
PMT(rate,nper,pv,fv,type)
returns the periodic payment for an annuity
IPMT(rate,per,nper,pv,fv,type)
returns the interest portion of a specific payment for some period of
time
PPMT(rate,per,nper,pv,fv,type)
returns the principal portion of a payment for some period
IRR(range,guess)
returns the internal rate of return of the cash flows
MIRR(range,guess)
returns the external rate of return of the cash flows

Illustrative Example
AMT, Inc. is considering the purchase of a digital camera for the maintenance of design specifications by
feeding digital pictures directly into an engineering workstation where computer-aided design files can be
superimposed over the digital pictures. Differences between the two images can be noted, and corrections, as
appropriate, can then be made by design engineers. The capital investment requirement is $345,000 and the
estimated market value of the system after a six-year period is $115,000. Annual revenues attributable to the
new camera system will be $120,000, whereas additional annual expenses will be $22,000. You have been
asked by the management to make an IRR and an ERR analyses and to make a recommendation. Additionally,
determine the PW, FW and AW of the venture. The corporations MARR is 20%. Assume that the external
reinvestment rate is the same as the MARR.

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ENGINEERING ECONOMY
1. Prepare the spreadsheet, including the input data, as shown in Figure 1.2

= - D3

= D$4 - D$6

= - D4

Figure 1.2. Spreadsheet Data

2. Create another table to combine the cash flows in year 6. Allot spaces for the required values. Refer to
Figure 1.3

= D10

= D15 + D16

Figure 1.3. Spreadsheet Data

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3. Supply the allotted spaces with the appropriate functions. Type in an equal sign and click on the Insert
Function icon (Figure 1.4).

Figure 1.4. Insert Function Icon

The following dialog box appears (Figure 1.5). Search the required function.

Figure 1.5. Insert Function Dialog Box

4. Selecting the function brings out the Function Arguments Dialog Box (Figure 1.6 to Figure 1.10). This
is useful if one is not familiar with the correct syntax for the functions. A description of the field is also
given. Fill out the box by referencing the correct cell/s in the spreadsheet.

IRR

Figure 1.6. Function Arguments Dialog Box for IRR

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ERR

Figure 1.7. Function Arguments Dialog Box for ERR

PW (note that the values correspond to the cash flows starting from period 1, and should be
equally spaced in time; any cash flow that occurs in period 0 should be added to the result of the
NPV function)

Figure 1.8. Function Arguments Dialog Box for PW

FW (note that PV was referenced as a negative value ~ convention for cash flows)

Figure 1.9. Function Arguments Dialog Box for FW

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AW

Figure 1.10. Function Arguments Dialog Box for AW

5. The answers are then displayed in the appropriate boxes, as shown in the completed spreadsheet in
Figure 1.11.

Figure 1.11. Completed Spreadsheet

The equivalent worth, IRR and ERR analyses showed that the purchase of the equipment is economically
desirable.

Reference
Sullivan, William G., Wicks, Elin M. and Koelling, Patrick C. (2012). Engineering Economy, 15th edition.
England: Pearson Education Limited

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Machine Problem No. 1

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Preliminary Data
Answer the following problems using MS Excel(R). Save the workbook on the mapped network drive using the specified
filename format. Use one sheet per problem.
1. Amy Parker, a 22-year old and newly hired marine biologist, is quick to admit that she does not plan to keep close
tabs on how her retirement plan will grow in time. Amys contribution, plus that of her employer, amounts to $2,200
per year starting at age 23. Amy expects this amount to increase by 3% each year until she retires at the age of 62 (40
end-of-year payments). What is the compounded future value of Amys plan if it earns 7% per year? What is the
discounted present value of the plan?
2. After years of being debt-encumbered college student, Lara decides that she wants to pay for her dream car in cash.
Not having enough money now, she decides to specifically put money away each year in a dream car fund. The car
she wants to buy will cost $60,000 in eight years. She is going to put aside $6,000 each year to save for this. At what
interest rate must she invest her money to achieve her goal of having enough to purchase the car in 8 years?
3. Ned and Larrys Ice Cream Company produces specialty ice cream and frozen yogurt in pint-sized containers. The
latest annual performance report praised the firm for its progressive policies but noted that environmental issues like
packaging disposal were a concern. In an effort to reduce the effects of consumer disposal of product packaging, the
report stated that Ned and Larrys should consider the following proposals.
Proposal A package all ice cream and frozen yogurt in quart containers
Proposal B package all ice cream and frozen yogurt in half-gallon containers
By packaging the product in containers larger than the current pints, the plastic-coated bleached sulphate board
containers will hold more ounces of product per square inch of surface area. The net result is less discarded
packaging per ounce of product consumed. Additional advantages to using larger containers include lower packaging
costs per ounce and less handling of labor per ounce.
Changing to a larger container requires redesign of the packaging and modifications to the filling production line.
The existing material-handling equipment can handle the pints and quarts, but additional equipment will be required
to handle half-gallons. Any new equipment purchased for proposals A and B has an expected useful life of 6 years.
The table summarizes these proposals, as well as the current production of pints.

Capital investment, $
Packaging cost, $/gal
Handling labor cost, $/gal
Postconsumer landfill contribution, yd3/yr

Current (pints)
0
0.256
0.128
6,500

A (quarts)
1,200,000
0.225
0.120
5,200

B (half-gallons)
1,900,000
0.210
0.119
4,050

Because Ned and Larrys promotes partnering with suppliers, customers and the community, they wish to include a
portion of the cost to society when evaluating these alternatives. They will consider 50% of the postconsumer landfill
costs to average $20 per cubic yard nationwide.
Ned and Larrys uses an MARR of 15% per year. A study period of 6 years will be used, at which time the equipment
purchased for proposals A and B will have negligible market value. Production will remain constant at 10,625,000
gallons per year. Using PW, FW, AW, IRR and ERR analyses, determine whether Ned and Larrys should package
ice cream and yogurt in pints, quarts or half-gallons. (important: remember that when comparing alternatives using
the rate-of-return methods, the incremental analysis procedure is used.)

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