Introduction

Economy
Introduction
Lecture Outline:

• Class Agreement
• About this course
• Course Evaluation
• Aims of this course
• Course Contents
• Terminology
Class Agreement
• We are in the same team
• Be responsible (Focus)
• Be respectful to others
• Enjoy with assignments and quizzes
• Help us with your objective opinion &
feedback
About this course
Engineering Economics
 Course Code: MED 204
 Course Hours:
 Lecture 2 hours
(Sunday 13.10 pm : 14.50 pm )

 practical 2 hours
(Exercise)
Course Evaluation

Methods of
assessment
Marks Percentage
Assignments 10

Attendance 10

Quizzes 10

Project 10 Assignments
Attendance
Midterms 20
Quizzes
Final Exam 40 Project
Midterms
Agenda
 Introduction to the Staff
 Introduction to the Course
 Textbooks and Course Overview
 Course Objectives/Contents
 Evaluation and Grading
 Lecture 1: Introduction to Engineering Economy.
Introduction to the Staff

 Course instructor:
Dr. Arafa S. Sobh

 E-mail address for correspondence:

[email protected]
 Textbooks
 L., Blank and A. Tarquin, “Engineering Economy”, Seventh
Edition, 2012, McGraw-Hill Inc.

 R. Panneerselvam, “Engineering Economics”, 2012, PHI

Learning Private Limited, New Delhi.
Course Contents
Tentative topics of the course include:
 Introduction to engineering economy.
 Time value of money and basic interest formulas
 Decision-making among alternatives.
 Breakeven analysis.
 Depreciation analysis.
 Income taxes
 Risk and uncertainties
 Course Overview
 This course is designed to help engineers to acquire the
basic knowledge and skills about:

- Basic concepts of engineering economics; Simple and

compound interest formulas and factors; Economic
evaluation and decision making among engineering
alternatives, Decision making of asset replacement;
Breakeven analysis; Depreciation analysis; Inflation ;Taxes,
Economic evaluation of public projects; Supply, demand,
marginal c o nc ept and o ptimizatio n. Risks and
uncertainties.
Course Objectives
Course Objectives Include:
 Understand the basic concepts of engineering economics
a n d h o w t o pe r f o r m t h e e n gi n e e r i n g pr o c e s s e s
considering the economic perspective.
 Def ine the time value of money and calculating the basic
monetary values in an engineering problem's cash flow.
 Apply the basic compound interest formulas to make
decisions of selecting different engineering alternatives.
 Enable students of converting real world engineering
problems into cash flow diagrams.
 Enable students to work in teams.
 Engineering Economy

Chapter 1
Introduction to Engineering Economy
Lecture outline
Engineering economy definition

Economics goals

Why engineering economy is important to engineers?

Engineering economy role in decision making

Problem solving approach

Performing an engineering economy study

Engineering Economy Definition

Engineering economy involves formulating, estimating, and

evaluating the expected economic outcomes of alternatives
designed to accomplish a def ined purpose. Mathematical
techniques simplify the economic evaluation of alternatives.

Engineering economy deals with the methods that enable

one to take economic decisions towards minimizing costs
and/or maximizing benefits to business organizations.
Why Engineering Economy is Important to Engineers
?

Engineers design and create (Designing involves economic

decisions)

Engineers must be able to incorporate economic analysis

into their creative efforts

Often engineers must select and implement from multiple

alternatives

Understanding and applying time value of money, economic

equivalence, and cost estimation are vital for engineers
Why Engineering Economy is Important to Engineers
?

 Without an economic background, most engineering

problems are trivial.

-For example, the problem of air pollution could easily be

solved by giving everyone an electric car. It is only when we
add the economic constraint that electric cars are too
expensive for most people that the real engineering begins.

 Engineering economy is used to answer many different

questions such as:
Which engineering projects are worthwhile?
Which engineering projects should have a higher priority?
How should the engineering project be designed?
How to make short and long-term investment decisions?
Engineering economy role in decision making

Decision making is a broad topic, for it is a major

aspect of everyday human existence.
There are lots of problems in the world:
1) Simple Problems
 Should I pay or use credit?
Shall we fix or replace a burned-out motor?
 If we use three crates of an item a week, how
many crates should we buy at a time?
Engineering economy role in decision making

2) Intermediate Problems (mainly economic)

 Which equipment should be selected for a new
assembly line?
 Which materials should be used as roofing, siding, and
structural support for a new building?
 Which printing press should be purchased? A low cost
press requiring three operators, or a more expensive one
needing only two operators?
Engineering economy role in decision making

3) Complex Problems (mixture of economic, political, and

social)
 The decision of Mercedes Benz to build an automobile
assembly plant in Tuscaloosa, Alabama.
 Setting the annual budget for a corporation.

 For the medium and economic parts of the complex

problems, use Engineering Economic Analysis.
Engineering economy role in decision making
Engineering economy role
Decisions made during the engineering design phase of
product development determine the majority of the costs of
manufacturing that product. Thus, a competent engineer
must have an understanding of the principles of economics
as well as engineering.
Engineering Economy is a set of tools that aid in decision
making – but will not make the decision for you (People
make decisions – not “tools”)
Engineering economy is based mainly on estimates of
future events – must deal with the future and risk and
uncertainty
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 Eng.
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
Tools
6. Implement and monitor Present Worth, Future Worth
Annual Worth, Rate of Return
Benefit/Cost, Payback,
Capitalized Cost, Value Added
Rational Decision Making

Recognize problem

Define goals

Assemble relevant data

Identify feasible alternatives

Select the criterion to determine the best alternative

Construct a model

Predict each alternative’s outcomes / consequences

Choose best alternative

Audit result
 Rational Decision Making

Manufacturing Profit

Design
and
planning

Investment

Marketing

One of the primary functions of engineers: making capital budgeting decisions

 Rational Decision Making

Example: Which Car to Lease?

Saturn vs. Honda
1. Recognize a decision Need a car
problem
2. Define the goals or Want mechanical
objectives security
3. Collect all the relevant Gather technical as well
information as financial data
4. Identify a set of feasible Choose between Saturn
decision alternatives and Honda
5. Select the decision Want minimum total
criterion to use cash outlay
6. Select the best alternative Select Honda
Performing an engineering economy study
 In order to apply economic analysis techniques below
terms and concepts should be understood well.

• Time value of money

• Cash flows
• Alternatives
• Interest and interest rate
• Types of interest
• Economic equivalence
Performing an engineering economy study

Time value of money

 Money can “make” money if Invested

The change in the amount of money

over a given time period is called the
time value of money; by far, the most
i m po r t a n t c o n c e pt i n e n gi n e e r i n g
economy.
Performing an engineering economy study

Time value of money

 Money has a time value because it can earn more money
over time (earning power).
–Money has a time value because its purchasing power
changes over time (inflation).
–Time value of money is measured in terms of interest rate.

If you put $100 in a bank at 9% interest for one time

period you will receive back your original $100 plus $9
 Performing an engineering economy study

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
Performing an engineering economy study

Cash flows
 A cash f low is a diagram presents the f low of cash as
arrows on a time line scaled to the magnitude of the
cash flow, where expenses are down arrows and receipts
are up arro ws. Ye ar- e nd c o nv e nti o n ~ e xpe nse s
occurring during the year are assumed to occur at the
end of the
year.
 Example:
A wide land to build f lats will cost $20,000 when purchased.
Building will cost $1000 per year. The f la ts will generate
revenues of $5000 per year for 5 years. The salvage value is
$7000.
Performing an engineering economy study

Cash flows
Performing an engineering economy study

Alternatives
To have a problem, one must have alternatives (two or
more ways to solve a problem)

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!
Performing an engineering economy study

Alternatives
 Goal: Define, Evaluate, Select and Execute

The Question:
Do Which One do we
Alt. 1
Nothing accept?
Performing an engineering economy study

Alternatives
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.
Performing an engineering economy study

Alternatives
More alternatives
• Goal: Define, Evaluate, Select and Execute

Do
Alt. 1 ………... Alt. j
Nothing

Which one do we accept?

Performing an engineering economy study

Alternatives
Default Position

•If all of the proposed alternatives are not economically

desirable then…
• One usually defaults to the DO-NOTHING alternative
Performing an engineering economy study

Interest and interest rate

Interest:
The amount paid to use money.

Interest is the cost of use money

Interest is a payment for the use of

money and such can be considered in two
ways:
Lender (return, earn)
Borrower (cost)
Performing an engineering economy study

Interest and interest rate

Interest:

 INVESTMENT

INTEREST = VALUE NOW - ORIGINAL AMOUNT

 LOAN

INTEREST = TOTAL OWED NOW - ORIGINAL AMOUNT

Performing an engineering economy study

Interest and interest rate

Interest rate:
Interest percentage per time unit

I N T E R E S T PE R T I M E U N I T
IN T E R E ST R A T E 
O R IG IN A L A M O U N T
Performing an engineering economy study

Interest and interest rate

Lending Example

•You borrow $10,000 for one full year

•Must pay back $10,700 at the end of one year
•Interest Amount (I) = $10,700 - $10,000
•Interest Amount = $700 for the year
•Interest rate (i) = $700/$10,000 = 7%/Year
Performing an engineering economy study

Interest and interest rate

Investing Perspective
•Assume you invest $20,000 for one year in a venture that
will return to you, 9% per year.
•At the end of one year, you will have:
•Original $20,000 back
•Plus……..
•The 9% return on $20,000 = $1,800

We say that you earned 9%/year on the investment. This is

your RATE of RETURN on the investment
Performing an engineering economy study

Types of interest
Simple interest:
 Interest paid (earned) on only the original amount, or
principal borrowed (lent).
 It is calculated using the principal only, ignoring any
interest accrued in preceding interest periods.
Compound Interest
Interest paid (earned) on any previous interest earned, as
well as on the principal borrowed (lent).

For compound interest, the interest accrued for each

interest period is calculated on the principal plus the total
amount of interest accumulated in all previous periods.
 Performing an engineering economy study

Economic equivalence
 means that different sums of money considered at different
times are equal in economic value

Example:
$100 now is said to be equivalent to $106 one year from now,
if the $100 is invested at the interest rate of 6% per year.
Performing an engineering economy study

Equivalence illustrated
 $20,000 now is not equal in magnitude to $21,800 one
year from now
•But, $20,000 now is economically equivalent to $21,800
one year from now if the interest rate is 9% per year.

•To have economic equivalence you must specify:

•Timing of the cash flows
•An interest rate (i% per interest period)
•Number of interest periods (n)
 des
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End