ENGR 112

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ENGR 112

• Economic Analysis II

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Engineering Economic Analysis

• Time Value of Money
• 1 today is more valuable than 1 a year later
• Engineering economy adjusts for the time value of
  money to balance current and future revenues and
  cost

0
5
10
Years
3
Recap

• Capital vs. Interest
• Types of Interest
• Simple vs. Compound
• Cash Flow Diagrams
• Calculate a Future given a Principal and vice
  versa
• P/F and F/P ? F P(1 i)N
• Frequency of Compounding
• Quarterly, monthly, daily
• n m x N ? F P(1 i/m)mN

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Annuity

• A series of uniform cash flows
• Begins at end of period one
• Continues through the end of period N
• Annuity given a Principal (A/P)
• Annuity given a Future (A/F)

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IDDI Company Case

• The I Dint Do It (IDDI) Company plans to borrow
  150,000 from the Trust Me Bank (TMB) at an
  interest rate of 9 per year, compounded
  quarterly, in order to finance the installation
  of pollution reduction equipment. The TMB will
  agree to the loan only if IDDI makes quarterly
  payments during the next 4 years. Use the A/P
  formula to determine the quarterly payment.

P 150,000
i 9 per year, compounded quarterly
m 4
N 4
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IDDI Company Case Solution
Quarterly compounding ? i/4 0.09/4 0.0225
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IDDI Company Cash Flow Diagram
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In Class Problem

• What is the total amount of interest paid over
  the 4 years of the loan period?

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Analyzing a Project

• Present Worth
• Internal Rate of Return (IRR)

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Analyzing a Project

• Present Worth
• Value at time zero (e.g., today) that is
  equivalent to the cash flow series of a proposed
  project or alternative
• Easy to understand and use
• Matches our intuitive understanding of money
• PW gt 0 ? Desired Value!!
• PW 0 ? Economic indifference
• PW lt 0 ? Should be avoided, if possible

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Present Worth

• Useful when
• Setting a price to buy or sell a project
• Evaluating an investment or project when the
  price to invest or the first cost is given
• Calculating and equivalent value for an irregular
  series of cash flows

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Present Worth

• Assumptions
• 1. Cash flows occur at the end of the period,
  except for first costs and pre-payments
• i.e., insurance, leases
• 2. Cash flows are known, certain values
• 3. The interest rate (i) is given
• 4. The problems horizon (N) is given

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Voice Recognition for Construction Inspection

• A large construction job will take 4 years to
  complete. The costs of the many required
  inspections can be reduced by purchasing a voice
  recognition system to act as the front end for
  a word processor. Then inspectors can be trained
  to record their comments and revise the written
  output of an automated form.
• The firm interest rate is 12. What is the PW
  of the cash flows for the voice recognition
  system? The first cost for purchase and training
  is 100K. Savings are estimated at 30K, 40K,
  65K, and 35K for the 4 years of construction.

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VR Project Cash Flow Diagram
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VR Project Solution
PW -100K 30K(P/F,0.12,1) 40K(P/F,0.12,2)
65K(P/F,0.12,3) 35K(P/F,0.12,4)
PW 27,182
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In Class Problem

• Find the present worth of the 4 different years
  using formulas in Excel.
• Find the present worth of the 4 different years
  using Excel financial functions.

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Analyzing a Project

• Internal Rate of Return (IRR)
• Interest rate that makes the PW equal zero
• Firms, government agencies and individuals must
  compute the cost of financial projects
• Solution
• Calculate the IRR for a project or for a
  financial source
• Then, compare the resulting IRR with an interest
  rate for the time value of money

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Golden Valley Manufacturing

• By replacing its assembly line conveyor with an
  asynchronous conveyor, Golden Valley
  Manufacturing will save 50,000 per year in
  rework, inspection, and labor costs. The
  asynchronous conveyor will cost 275,000, and its
  life is 15 years (when its salvage value equals
  0). If Golden Valley uses a 10 interest rate,
  should the asynchronous conveyor be installed?

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GVM Cash Flow Diagram
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GVM Solution

• PW 0 -275K 50K(P/A, IRR, 15)
• (P/A, IRR, 15) 275K / 50K 5.500
• From tables
• (P/A, 0.16, 15) 5.575
• (P/A, IRR, 15) 5.500
• (P/A, 0.17, 15) 5.324

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In Class Problem 4

• Use Excel to find the value of IRR of return
  using interpolation

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GVM Solution
16.30 gt 10 GOOD INVESTMENT!!
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In Class Problem 5

• Use Excel to find IRR

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Internal Rate of Return
PW
Present Worth PW
0
-PW
i
Interest rate i