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ENGINEERING ECONOMY
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SESSION_I
INTRODUCTION
FOUNDATIONS OF
ENGINEERING ECONOMY
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1.
Foundations: Overview
1. Questions
2. Decision Making
3. Study Approach
4. Interest Rate
5. Equivalence
6. Simple and Compound Interest
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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1.
Foundations: Overview
7. Symbols
8. Spreadsheet Functions
9. Minimum Attractive Rate of Return
10. Cash Flows
11. Doubling Time
12. Spreadsheets
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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ENGINEERING ECONOMY
SESSION I
Section 1.1
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
ENGINEERING ECONOMY
SESSION I
Section 1.2
Role of Engineering
Economy in Decision
Making
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Major Role of
Engineering
Economy
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Where the
major tools of
Engr. Economy
are applied
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Tools
Present Worth, Future
Worth
Annual Worth, Rate of
Return
Benefit/Cost, Payback,
Capitalized Cost, Value
Added
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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ENGINEERING ECONOMY
Performing and
Engineering Economy
Study
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Do
Nothing
The Question:
Alt. 1
Which One do
we accept?
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Do
Nothing
Alt. 1
...
Alt. j
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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P and F
The symbols P and F represent one-time
occurrences:
$F
Specifically:
1
n
n-1
t=n
$P
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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P and F:
It should be clear that a present
value P represents a single sum of
money at some time prior to a future
value F
This is an important basic point to
remember
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Annual Amounts
It is important to note that the
symbol A always represents a
uniform amount (i.e., the same
amount each period) that extends
through consecutive interest periods.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
40
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Annual Amounts
Cash Flow diagram for annual
amounts might look like the
following:
$
A
$
A
$
A
$
A
..
$
A
N-1
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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The MARR
A firms financial managers set a
minimum interest rate that that all
accepted projects must meet or exceed.
The rate, once established by the firm is
termed the Minimum Attractive Rate of
Return (MARR).
The MARR is expressed as a percent per
year.
Numerous models exist to aid a firms
financial managers in estimating what this
rate should be in a given time period.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Setting a MARR
Start with the WACC
Add a buffer percent (?? Varies from firm
to firm)
This yields an approximation to a
reasonable MARR
This becomes the Hurdle Rate that all
prospective projects should earn in order
to be considered for funding.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
55
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MARR - %
Safe
Investment
WACC - %
0%
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Opportunity Forgone
What if the firm has a budget of, say,
$150,000?
A cannot be funded not sufficient
funds!
B is funded and earns 14.5% return or
more
A is not funded, hence the firm loses the
OPPORTUNITY to earn 13%
This often happens!
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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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.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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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
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End-of-Period Assumption
END-OF-PERIOD Convention
ALL CASH
CASH FLOWS
FLOWS ARE
ARE ASSUMED
ASSUMED TO
TO OCCUR
OCCUR
ALL
AT THE
THE END
END OF
OF AN
AN INTEREST
INTEREST PERIOD
PERIOD EVEN
EVEN
AT
IF THE
THE MONEY
MONEY FLOWS
FLOWS AT
AT TIMES
TIMES WITHIN
WITHIN
IF
THE INTEREST
INTEREST PERIOD.
PERIOD.
THE
THIS IS
IS FOR
FOR SIMPLIFICATION
SIMPLIFICATION PURPOSES
PURPOSES
THIS
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Now is denoted as t = 0
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Sample CF Diagram
Positive CF at t = 1
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Problem Perspectives
Before solving, one must decide upon the
perspective of the problem
Most problems will present two
perspectives
Assume a borrowing situation; for
example:
Perspective 1: From the lenders view
Perspective 2: From the borrowers
view
Impact upon the sing convention
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Lending Borrowing
From the Lenders Perspective
A = +$1,100/yr
0
-$5,000
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
P = +$5,000
0
A = -$1,100/yr
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Example 1.17
A father wants to deposit an unknown
lumpsum amount into an investment
opportunity 2 years from now that is large
enough to withdraw $4,000 per year for
state university tuition for 5 years starting
3 years from now.
If the rate of return is estimated to be
15.5% per year, construct the cash flow
diagram.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
72
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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72/i
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approximate
= 72/n
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Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Spreadsheet Applications
Section 1.12 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.
You instructor will determine the extent
and depth of use of Excel for this course.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter Summary
Engineering Economy:
Application of economic factors
and criteria to evaluate
alternatives considering the time
value of money (interest and time)
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Summary of Important
Points
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter 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
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Chapter Summary
The concept of equivalence helps
in understanding how different sums
of money at different times are equal
in economic terms.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter Summary
Simple and Compound Interest
The differences between simple
interest (based on principal only) and
compound interest (based on principal
and interest upon interest) have been
described in formulas, tables, and
graphs.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Chapter Summary
Compounding of Interest
The power of compounding is very
noticeable, especially over long periods
of time.
Notion of computing interest on
interest
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter Summary
The MARR
The MARR is a reasonable rate of
return established as a hurdle rate to
determine if an alternative is
economically viable.
The MARR is always higher than a
return from a safe investment.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter Summary
Attributes of Cash Flows
Difficulties with their estimation.
Difference between estimated and
actual value.
Endofyear convention for cash-flow
location.
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter Summary
Attributes of Cash Flows
Net cash flow computation.
Different perspectives in determining
the cash-flow sign convention.
Construction of a cash-flow diagram.
Introduction to spreadsheet analysis
Blank & Tarquin: 5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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