Freshman Engineering Clinic

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Freshman Engineering Clinic

• Introduction to Engineering Economics
• 12 February 2001

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Introduction to Economics

• The Goals for Teaching Engineering Economics
• Role of Engineers in Management
• Capital Investments in Industry
• Financial decision making between alternatives
• Justification of purchasing new equipment or
  process
• Eide, Jenison, Mashaw Northup (2000)

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Economics and Engineering

• Two Primary Methods for Justifying Purchases
• Rate of Return on Investment
• Annual profit / Investment
• Payback Period
• Investment / Annual Profit

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While that is all You Need

• The time value of money makes it a bit more
  complicated to calculate
• 100 today is not worth the same amount as
• 100 5 years ago
• 100 1 year ago
• 100 1 year from now
• 100 5 years from now

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Discount vs. Interest

• INTEREST
• Money from the past needs to increase by the
  interest rate based on the changing value of
  money
• DISCOUNTING
• Money in the future needs to be discounted by the
  discount rate to bring it to its present worth

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Economics Power of Interest

• Simple Interest
• I Pni
• Interest Accrued
• P the principle amount
• n the number of periods
• i - the interest rate in each period
  

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Example of Simple Interest

• How much money (interest) do you make monthly if
  someone promises you 6 annual interest on a loan
  of 1000 that they will pay the principle back at
  the end of a year?
• P 1000
• n 12 periods
• i 6 / 12 periods 0.5 per month (period)
• I (1000)(1)(0.005) 5

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Formula for Loan Interest

• What is paid back at the end of the period?
• F P I
• Where I Pni
• So..
• F P Pni
• Or F P (1ni)

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Power of Compounding Interest

• It gets a bit more interesting when we allow the
  interest accumulated to flow back into the
  calculation at the end of every period that is
  what we call compounding the interest (and the
  problem)
• For this we calculate

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Periods affect the Calculation

• What must be paid after 4 years on 8000 that is
  borrowed at 12 when compounded
• Annually ? 12,588.15
• Semi-annually ? 12,750.78
• Monthly ? 12,897.81
• Daily ? 12,927.57
• Hourly ? homework

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Investing When you Graduate

• 1,200 saved by you for each of the 10 years
  between ages 22 and 31 growing at 8
• 1,200 saved by you for 34 years from age 32 to
  65 growing at the same 8
• One is worth 257,027 vs. 205,580 see p.173

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Calculating Moneys Time Value

• Present Worth is the most powerful tool
• It is defined as
• the amount that must be invested now to produce
  a prescribed sum at a future date
• This is the inverse of finding a future sum

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Some Examples

• Interest Problem
• Problem 8, page 199
• Discount Problem
• Problem 7, page 199

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Economic Decisions

• Should I invest now?
• What is it likely to be worth if I do?
• What is it the current benefit of a payment
  someone will make to me in the future?
• If a series of payments are made over a specific
  time span, what are they worth now?

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Classwork

• Break into teams and decide which is best if we
  assume money is worth 8
• 3,000 deposited 2 years ago
• 3,250 deposited last year
• 3,500 now
• Or 4,700 4 years from today
• Assume annual compounding

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Analysis of Alternatives

• Annual Cost Method
• Initial Cost turned into an annuity over the
  period
• Maintenance and Operating costs /yr
• Salvage Value brought from the future into an
  annuity over the period
• Annual Cost ICa MO - Sa

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Homework due 19 Feb 2001

• Compute Hourly Value from slide 8
• Problem 4
• Page 199
• Freshman Engineering Clinic Workbook
• Engineering Fundamentals and Problem Solving
• Eide, Jenison, Mashaw Northup (2000)